Create responsible lending journeys

CONC establishes that credit commitments must not “adversely impact the consumer’s financial situation” (CONC R5.2.1 (2)).  An affordable loan is one that can be repaid without undue difficulty, from a proportion of a customer’s disposable income. Credit providers must perform an affordability check to assess if the product is right for the customer. The complexity arises when establishing monthly income and expenditure.

Analysing income data

Monthly salaried workers typically have income that is consistent and predictable, but for others (e.g. self-employed, weekly paid, contract or gig workers) earnings vary. Each group needs to be assessed differently to properly deduct the consistency and reliability of their income.

Currently,  the most reliable method for gathering income data when performing an affordability check is to request a payslip or a bank statement. However, physical documentation presents a substantial operational and customer experience challenge as today customers are expecting an answer in minutes, and will materially impact application conversion.

The emergence of Open Banking offers a new and exciting opportunity to lenders.  Learn more about how it benefits lenders and customers here.

Analysing expenditure data

Lenders must also establish non-discretionary (essential) and discretionary expenditures.  It’s worth exploring if realistic reductions in discretionary spending could be made if necessary.  Expenditure can be assessed by asking a customer to complete an income and expenditure form. However, while thorough, this approach will increase friction in customer journeys, reducing conversion.

Alternatively, in lower-risk circumstances, expenditure can be roughly assessed by looking at the Office of National Statistics (ONS) data that shows the customer’s life circumstances (eg. marriage status, number of dependents, etc.).

Lenders should establish the right approach for each customer.

Suitability assessment looks at whether the credit product is appropriate for the applicants’ specific needs and circumstances.  An area of very active focus by the FCA in the UK consumer credit market has been on the use of unstructured debt in circumstances where structured debt is the appropriate solution. 

Unstructured debt (overdrafts, credit cards, short term loans, lines of credit) allow customers quick and easy access to extra funds to manage income and expenditure fluctuations.  However, this is typically interest-only credit, or at least require low monthly capital repayments.  The lack of repayment plans creates significant risk of customers falling into cycles of perpetual debt.  None of these products should be used to fund larger or longer term credit needs.

Sustainability is an assessment of the risk that a customer’s credit commitment, while affordable today, will continue to be affordable.

While you cannot predict the future, you can consider the risk of a customer being unable to sustain long term repayments.  More unpredictable earnings increase the risk, as does elevated existing long-term credit commitments.

The consequences of any changes to a customer’s circumstances should also be considered – a default on a second charge mortgage would create a much more negative outcome than falling behind on an unsecured personal loan.

Sustaining repayments through additional borrowing is unacceptable and should be considered a primary indicator of vulnerability.

Sustainability risk is mitigated by reducing the proportion of monthly disposable income required to meet monthly commitments.  Reducing the amount by extending term needs to be done carefully.  Is the extended period of customer indebtedness in their best interests?