A New Consumer Credit
Regime: Benefits, Compliance
Costs and Firm Behaviour
3 October 2013
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Contents
1
2
3
4
Executive Summary....................................................................................................................................................... 1
1.1
Introduction ........................................................................................................................................................... 1
1.2
Compliance Costs ................................................................................................................................................ 1
1.3
Wider Economic Effects...................................................................................................................................... 3
1.4
Main Changes from the March Report ............................................................................................................ 6
1.5
Benefits .................................................................................................................................................................... 8
1.6
Structure of this Report .................................................................................................................................... 10
Overview of our Approach ...................................................................................................................................... 12
2.1
Introduction ......................................................................................................................................................... 12
2.2
Relation to our March Report ......................................................................................................................... 12
2.3
Approach to the Analysis.................................................................................................................................. 14
2.4
Structure of this Report .................................................................................................................................... 14
Overview of the New Regime and our Modelling Approach ........................................................................... 15
3.1
Interim Permission Regime............................................................................................................................... 15
3.2
Authorisation and Annual Fees ....................................................................................................................... 16
3.3
Appointed Representatives .............................................................................................................................. 17
3.4
Approved Persons .............................................................................................................................................. 18
3.5
Group Licensing .................................................................................................................................................. 19
3.6
High-level Standards and Conduct Rules ...................................................................................................... 20
3.7
Supervision and Regulatory Reporting .......................................................................................................... 21
3.8
Financial Promotions .......................................................................................................................................... 23
3.9
Complaints and Redress ................................................................................................................................... 24
3.10
Prudential Standards for Debt Management Firms ..................................................................................... 24
3.11
Client Asset Requirements for Debt Management Firms ......................................................................... 26
3.12
Fees Requirements for Debt Management Firms ....................................................................................... 27
3.13
Obligations related to Peer-to-peer Platforms............................................................................................ 27
3.14
Policies Specific to High Cost Short Term Credit ...................................................................................... 28
3.15
Change of Regulator .......................................................................................................................................... 29
Compliance Costs and Firm Behaviour ................................................................................................................. 32
4.1
Introduction ......................................................................................................................................................... 32
4.2
Understanding and Measuring Compliance Cost ........................................................................................ 32
4.3
Link between the Direct Impact of Compliance Costs and the Behaviour of Existing Suppliers ... 33
4.4
Two-sided Modelling Approach to Measuring Compliance Costs ......................................................... 35
4.5
Overview of the Market and the Population of Market Participants ..................................................... 36
4.6
Summary Results ................................................................................................................................................. 38
4.7
Comparison to the March Report .................................................................................................................. 41
5
6
7
8
4.8
One-off and On-going Costs by Category ................................................................................................... 43
4.9
Banks and Building Societies............................................................................................................................. 46
4.10
Monoline Card Issuers....................................................................................................................................... 51
4.11
Online Payday Lenders ...................................................................................................................................... 53
4.12
Traditional and Bricks & Mortar Lenders ..................................................................................................... 56
4.13
Home Credit Lenders ....................................................................................................................................... 58
4.14
Other Non-bank Lenders and Consumer Hire........................................................................................... 61
4.15
Credit Unions ...................................................................................................................................................... 63
4.16
Secondary Credit Brokers (Motor)................................................................................................................ 64
4.17
Secondary Credit Brokers (Non-motor Retail) .......................................................................................... 66
4.18
Credit Brokers and Other Credit Intermediaries ...................................................................................... 70
4.19
Online Introducers: Lead Generators and Aggregators............................................................................ 72
4.20
Debt Management and Related Activities ..................................................................................................... 74
4.21
Debt Collectors and Debt Administrators .................................................................................................. 77
4.22
Credit Reference Agencies............................................................................................................................... 79
4.23
Impacts on the Distribution Chain and the Volume of Overall Lending ............................................... 80
4.24
Pricing Impacts and the Volume of Overall Lending .................................................................................. 81
Wider Impacts of Regulatory Change .................................................................................................................... 83
5.1
Form of Regulatory Change ............................................................................................................................. 83
5.2
Downside Risk due to Nature of the Regulator ......................................................................................... 85
5.3
Implications of Regulatory Regime for Innovation ...................................................................................... 86
5.4
Impacts on Firm’s Appetite to Offer Products and Serve Consumers.................................................. 88
5.5
Implications of Regime for Barriers to Entry ............................................................................................... 90
5.6
Regulatory Badging ............................................................................................................................................. 91
5.7
Extent of the Grey Market ............................................................................................................................... 94
Implications for Consumers ..................................................................................................................................... 95
6.1
Introduction ......................................................................................................................................................... 95
6.2
Access to Credit ................................................................................................................................................. 95
6.3
Choice of Credit Products ............................................................................................................................... 97
6.4
Cost of Credit ..................................................................................................................................................... 98
6.5
Impact on Payday Lending............................................................................................................................... 100
6.6
Comparison to the March Report ................................................................................................................ 100
Benefits ........................................................................................................................................................................ 101
7.1
Introduction ....................................................................................................................................................... 101
7.2
Types of Consumer Detriment ..................................................................................................................... 102
7.3
Qualitative Benefits .......................................................................................................................................... 107
7.4
Quantitative Estimation of Benefits .............................................................................................................. 115
7.5
Overview of the Benefits of the New Regime........................................................................................... 119
Payday Lending........................................................................................................................................................... 123
9
10
8.1
Introduction ....................................................................................................................................................... 123
8.2
Market Overview .............................................................................................................................................. 125
8.3
Consumer Detriment in the Payday Lending Market .............................................................................. 130
8.4
Benefits of HCSTC-specific Policies ............................................................................................................. 132
8.5
Wider Impacts of HCSTC-specific Policies ................................................................................................ 135
8.6
Summary and Conclusions ............................................................................................................................. 147
Appendix: Our Approach to Modelling Firm Behaviour ................................................................................. 150
9.1
Direct Impact of Compliance Costs for Existing Suppliers .................................................................... 150
9.2
Model for Assessing Impact............................................................................................................................ 156
Appendix: Our Approach to Modelling Firm Distributions............................................................................ 158
10.1
Introduction ....................................................................................................................................................... 158
10.2
Our Approach ................................................................................................................................................... 159
10.3
Our Results ........................................................................................................................................................ 160
10.4
Comparison to Critical Research’s Findings .............................................................................................. 160
11
Appendix: Detriment in Consumer Credit Markets ........................................................................................ 161
12
Appendix: Estimating Quantitative Benefits ........................................................................................................ 164
12.1
Estimating Unaddressed Consumer Detriment ........................................................................................ 164
Executive Summary
1 Executive Summary
1.1 Introduction
The Government intends to transfer responsibility for the regulation of consumer credit from the Office of
Fair Trading (OFT) to the Financial Conduct Authority (FCA). Conduct rules are expected to be broadly
unchanged for most firms (payday lending being a notable exception) — however, the new regime will also
contain new elements, such as supervisory reporting.1 The FCA wishes to understand the incremental
compliance cost, behavioural and market impacts of its proposals for the regulation and supervision of the
consumer credit market by the FCA, and also the expected benefits of the transfer in regime to the FCA.
Europe Economics has focused on an economic analysis of the transfer in regime of the new regime. This
work builds upon our previous report published with the FCA’s March 2013 Consultation Paper, reflecting
new evidence presented in responses to that Consultation Paper in addition to fieldwork which we have
undertaken in June–August 2013. This report also reflects revisions by the FCA to its planned regime and
an extension in scope to include an analysis of the benefits of the transfer to the FCA.
1.2 Compliance Costs
The consumer credit market is a heterogeneous one in terms of its market participants, business models,
products and customers served. The current economic downturn has seen overall volumes fall as lending
criteria have been tightened, particularly by mainstream lenders which have partially withdrawn from nonprime markets. This has put some segments under severe stress.
It is also important to note that the base population data upon which we have based our analysis has
changed since our previous study. In our March report we used Critical Research’s work on the OFT’s
active licensed population as a key parameter in our work (based on a survey conducted in summer 2012).
The FCA separately commissioned an update by Critical Research of its study, with field research
conducted in June–July 2013. This revealed a population larger than that previously estimated — and we
have updated our own models to reflect this. This has consequent implications on our analysis. It is worth
highlighting that the main increases in population size are in segments where we anticipate substantial exit.
Whilst we expect the overall number of firms in the consumer credit market to stabilise in a number of
segments the combined effect of natural wastage and exit due to regulatory burden is likely to be very
substantial, at least in terms of the number of market participants. This is because — with the notable
exception of payday (which we discuss at 1.4 below) — we expect exit to be mostly focused on firms only
marginally attached to the consumer credit market at present.
We set out below a table summarising the expected incremental compliance costs of firms across the
whole consumer credit sector. This indicates that £92–167 million in one-off compliance costs (including
interim fees) and £35–£60 million in on-going costs are anticipated as arising due to the FCA’s proposals
for the transfer in regime.
1
The FCA will, of course, review the operation of the consumer credit market and may subsequently consider new
requirements in the light of that work.
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Executive Summary
Table 1.1: Compliance Cost Impacts for the Entire Consumer Credit Market
Small
£m
Large
£m
£m
Total
£m
£m
£m
Interim
Interim fees
9.3
-
14.2
1.2
-
1.5
10.5
-
Administration
3.4
-
5.5
0.4
-
0.6
3.8
-
6.1
19.7
1.6
2.1
14.3
-
21.8
Fees and administration
12.8
-
-
15.7
Other one-off costs
Authorisation fee
26.6
8.1
19.6
25.4
Authorisation administration
5.2
-
8.8
1.0
-
1.8
6.2
-
10.6
Approved Persons
4.4
-
7.2
1.7
-
3.9
6.2
-
11.2
High-level Principles and Conduct Standards
1.6
-
2.5
0.1
-
1.0
1.7
-
3.6
Supervision and Regulatory Reporting
6.9
-
10.4
3.2
-
8.3
10.1
-
18.6
Complaints and Redress
0.1
-
0.3
0.0
-
7.1
0.1
-
7.5
Financial Promotions
3.8
-
6.5
0.6
-
1.5
4.4
-
8.0
Appointed Representative Regime
7.4
-
10.0
0.1
-
0.1
7.5
-
10.1
STHCC-specific Policies
0.1
-
0.2
1.2
-
1.7
1.4
-
1.9
Debt Management-specific Policies
0.0
-
0.0
0.4
-
1.7
0.4
-
1.7
Retail conduct review
6.2
-
10.0
8.2
-
15.5
14.5
-
25.5
53.2
82.6
24.7
62.3
77.9
144.9
65.9
102.3
26.3
64.4
92.2
166.7
All one-off costs
17.4
46.2
On-going costs
Annual fees
7.6
-
11.9
9.9
-
14.4
17.5
-
26.3
Approved Persons
0.5
-
0.8
0.2
-
0.5
0.7
-
1.3
High-level Principles and Conduct Standards
0.1
-
0.3
0.1
-
0.1
0.2
-
0.4
Supervision and Regulatory Reporting
1.9
-
3.3
0.3
-
1.1
2.3
-
4.3
Complaints and Redress
0.1
-
0.2
0.0
-
1.8
0.1
-
2.0
Financial Promotions
3.3
-
6.5
0.4
-
2.9
3.6
-
9.4
Appointed Representative Regime
9.6
-
12.9
0.1
-
0.2
9.7
-
13.1
STHCC-specific Policies
0.0
-
0.0
0.8
-
0.9
0.8
-
1.0
Debt Management-specific Policies
0.0
-
0.0
0.4
-
2.0
0.4
-
35.9
12.1
23.9
35.1
23.0
2.0
59.8
The majority of our analysis is focused upon our characterisation of segments within the overall consumer
credit arena. This is presented at Section 4 of this report. Here we highlight some of the major cost
impacts in aggregate.
The costs of authorisation are a relatively large component within one-off costs: these are to fund the
setup of the regime at the FCA. Similarly the largest single driver of on-going cost is the annual fees that
will be payable to the FCA. The figures in the above table have a mid-point, ignoring those fees payable to
the OFT that will be avoided, of about £26–35 million on an on-going basis. This is aligned to the expected
budget for the FCA’s role in consumer credit. It is worth noting the obvious point that the FCA will have
substantially more resources to call on than those available to the OFT — both money to fund a more
active approach to enforcement and also more detailed and regular information on the supervised entities.
Another significant driver of one-off costs is our estimate of conduct reviews. This is not a specific
proposal per se, but rather captures a number of different potential drivers of costs and behavioural change.
At present the FCA’s intention is to keep conduct rules broadly as is. Even if the actual changes to conduct
rules are considered minimal or potential changes to conduct implied by the application of the high-level
rules are relatively small, we believe that all firms would nevertheless wish to review their entire system to
reassure themselves that their existing business systems and processes are fit for purpose with the new
regime and that they would not be open to unexpected action from the FCA. This review process alone
could take a significant amount of resource, regardless of the changes that may need to be made, with
bigger, more complex firms expected to expend more resource on the review, which is a normal
consequence of such changes in regulator, particularly when the new one says it will be more proactive.
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Executive Summary
Such a conduct review is likely to be non-trivial. It is also critical to consider whether and how the new
regime applies to existing contracts. It is our understanding that the FCA will apply a ‘go forward’
approach and only treat new contracts entered into post-transfer and actions or inactions after 1 April
2014 about existing contracts under these rules, i.e. it will not apply the new rules retrospectively. The
latter would be a cause for concern for lenders and potentially generate a need to “re-paper” some or all
existing contracts.
The scale of our estimate here is significantly constrained by the assumption that there will be no need to
re-paper existing contracts and no major system changes because the conduct rules are remaining broadly
the same (i.e. any implied change would be arguably classified as due to current non-compliance with those
conduct rules). Though still a significant sum these are cost levels well below those cited with respect to
the recent implementation of the CCD. This aspect of the regime transfer is a very real and live issue for
market participants, driven by the fact that a more extensive exercise involving re-papering and system
change would impose significantly higher costs than we present in this study.
A further significant source of cost — at least in those segments affected — relates to the Product Sales
Data reporting requirements. These are not intended to cover the whole consumer credit market but
rather to be focused upon short-term unsecured lending.
The FCA is aiming to deliver benefits due to the introduction of new rules and an increase in compliance
due to more resources being devoted to authorisation, supervision and enforcement. Consideration of
these possible benefits is discussed below at 1.4 and in more detail at Section 6.1.
1.3 Wider Economic Effects
1.3.1 Market exit and competition effects
We expect the intermediary sector to be hard hit, with the reduction in the number of credit brokers and
credit intermediaries from these combined effects expected to be about twenty per cent over the period.
These exiting participants are expected largely to be those only marginally engaged in the consumer credit
market now, and, indeed, the number of credit intermediaries has fallen in the recent past. The level of
exit which we anticipate in this study would be driven partly by continued natural wastage but also as a
response to an increased regulatory burden due to the transfer of regime to the FCA. We expect exit in
the following market segments:
Non-bank lenders and consumer hire firms — a reduction in firm numbers from current levels of 7.5–
12.5 per cent due to natural market wastage and a reduction due to regulatory burden of 15–20 per
cent amongst smaller participants and 0–5 per cent amongst larger ones. Combined with the natural
wastage assumptions identified above this equates to a total reduction in firm numbers from current
levels of about 20 per cent.
Bricks & mortar — natural wastage driving a 5–10 per cent reduction in market participants. There
would also be a reduction due to regulatory burden 12.5–17.5 per cent in small players, and 2.5–7.5
per cent in others.
Home credit lenders — natural wastage driving a 5–10 per cent reduction in market participants and
regulatory burden driving a 10–15 per cent reduction in small market participants, and a 0–5 per cent
reduction in others.
Online payday — a 12.5–17.5 per cent reduction in market participants. This includes firms leaving due
to the OFT’s follow-up to its recent compliance review. Regulatory burden drives an additional 25–30
per cent reduction in market participants.
Secondary credit brokers — natural wastage will drive a reduction of 7.5–12.5 per cent (2.5–7.5 per
cent in motor) whilst the regulatory burden would mean that small retailers (in terms of their
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Executive Summary
participation in the consumer credit market) are expected to decline by 7.5–12.5 per cent in motor and
by 22.5–27.5 per cent otherwise. Firms which are substantially engaged are not expected to leave in
large numbers (0–5 per cent).
Credit brokers and other credit intermediaries — natural wastage will drive a reduction of 10–15 per
cent. In addition the regulatory burden small firms are expected to reduce in number by about 17.5–
22.5 per cent from current levels, with larger firms suffering a 2.5–7.5 per cent decline.
Debt management and related activities — a reduction of 5–10 per cent due to natural market wastage.
In addition we expect a reduction of 5–10 per cent due to the regulatory burden, focused on smaller
commercial debt management firms (a minority within the overall segment).
Debt collectors — a reduction of 5–10 per cent due to the regulatory burden, focused upon those
small firms only marginally attached to the consumer credit area.
These population assumptions are detailed further at Table 4.3 within Section 4. Looking across the entire
population of firms as it currently stands we summarise the position as set out below.
Figure 2.4: Summary of Exit Assumptions
Increased compliance costs can either be passed on to consumers or absorbed into profit. Any price
increase raises the possibility of demand reducing in response. Our analysis of the expected pass-through
of costs implies that the likely price increases should not cause material change in credit volume. The
larger price changes are in product areas which exhibit a high degree of price insensitivity (e.g. home
credit); in more mainstream areas the potential impacts are relatively small. The exit by participants
(particularly intermediaries) anticipated should not in the main have a significant effect on consumer choice,
i.e. the negative effects on competition should be small.
As regulatory interventions change, so the expected profitability of certain products or consumer groups
can change also: this can then drive changes in a business’s strategy and its willingness to innovate. Given
that the conduct rules are expected to remain broadly unchanged, and given also the scale of the cost
increases, we do not anticipate a significant impact here directly driven by the proposed policy mix.
Similarly whilst an increased regulatory burden should increase the barriers to entry we expect this to be
limited. As an exception, the High Cost Short Term Credit (HCSTC, including notably payday lending but
specifically excluding forms such as home credit)-specific policies are likely to have significant impacts on
profitability, lending volumes and access to credit. These are discussed separately below.
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Executive Summary
1.3.2 Impact on lending volume
These impacts should be relatively slight, with the exception of payday lending — which we discuss at 1.4
below. Of course, particularly in the lowest income quintiles, any cost change has the potential to generate
negative outcomes for particular individuals (i.e. “personal detriment”). This could — at the individual level
— be severe if the eventual outcome involved illegal lending or no credit access at all, either of which can
result in severe financial distress. Our analysis does not identify systematic negative outcomes that would
be directly attributable to the transfer to the new regime.
1.3.3 Impact on the cost of credit
Changes in the cost of credit are largely driven by the extent to which additional compliance costs are
passed through to consumers. Our analysis indicates that pricing effects may be quite limited, with a total
likely cost impact passed through to consumers of £22–£40 million.
This impact would be allocated fairly equally across the five consumer income quintiles, with the top
income quintile being asked to absorb 26 per cent of this, and the bottom quintile needing to absorb 15 per
cent. The bottom quintile may be least able to substitute other consumer credit products, and this would
be where scope for increased financial distress would appear greatest.
In debt management, given consolidation and the fact that demand is likely to be relatively inelastic (and
apparent difficulties in comparing prices which will not be fully resolved by the FCA’s fees proposal), a high
pass-through of additional costs to commercial debt management customers is, we believe, likely.
1.3.4 Impact on innovation
The more robust and well-funded supervisory and regulatory regime of the FCA could also have broader,
less tangible consequences. Market participants like the certainty of the CCA regime. Whilst some
characterise the CCA as heavily gold-plated and over-complicated, everyone is used to it and familiar with
the case law that has been built up over time. The prospect of the new regime raises fears in the industry
of both unduly precipitate actions by the regulator and uncertainty around the FCA’s interpretation of the
new regime and how it will choose to exercise its powers. One result of this would be firms becoming
more reluctant to innovate, take risks and lend, or even drive additional exit from the consumer credit
market.
The likelihood of this is hard to judge, depending largely on the psychology of the sector, and furthermore
may well not be symmetric across the different segments. We note that in the current depressed market
conditions such negative sentiments may be more commonplace than otherwise. We believe that most
firms will adopt a “wait and see” policy. Indeed how the FCA handles the transition to the new regime may
make a significant difference in not just cost terms — i.e. using ex-OFT people familiar with what has
happened before should ease transition costs — it may also have a bearing on any uncertainty around the
new regime. Again, the importance of the execution of the transfer by the FCA makes robust conclusions
about the scale and likelihood of this downside risk impossible at this juncture. Equally it could result in the
re-engineering of business models by some firms, or the re-focusing of business away from (or towards)
particular demographics.
Firms concerned with uncertainty surrounding the new rules, and with the ability of the regulator to change
its interpretation of the new rules at some future date will also likely reduce the rate of innovation in the
sector and hence product choice. It is worth noting that if the industry does curtail the supply of certain
products to particular demographics, this will not necessarily mean that there is a social cost attached. If
the products in question are actually a source of consumer detriment (the assessment of which is outside
the scope of our research) then any costs incurred may only be private ones borne by the industry. On
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Executive Summary
the other hand if the industry’s premature response is effectively an over-reaction (i.e. removing beneficial
products) then the associated loss would be social.
1.4 Main Changes from the March Report
The results presented are somewhat above those presented in our March Report. There are four main
drivers of difference, these being:
Revised base population data. It is also important to note that the base population data upon which we
have based our analysis has changed. In our March report we used Critical Research’s work on the
OFT’s active licensed population as a key parameter. The FCA separately commissioned an update by
Critical Research of its study. This latter work revealed a population larger than that previously
estimated — and we have updated our own models to reflect this. This has consequent implications
on our analysis: for example, the estimates of credit brokers and retailers have increased. The estimate
of lending intermediated through these channels has not changed. The implication is that many of the
additional intermediaries are only marginally attached to the consumer credit market — as such, exit
should be higher.
Policy changes by the FCA. These include in turn:

The basis for calculating authorisation and periodic fees.

The prudential rules to be applied to debt management firms have changed in form.

The application of prudential and client asset rules to not-for-profit debt management firms.

The treatment of sole traders with employees: sole traders are exempt from the requirement to
have a money laundering or compliance oversight Approved Person — provided that the sole trader
in question has no employees.

Rules relating to debt management fees have been proposed.

Supervisory reporting has been extended to include PSD for payday and home credit lenders.

Rules specific to HCSTC have been incorporated (as discussed below).

Certain rules relevant to lenders have been extended to cover P2P platforms.
Revised compliance cost assumptions. These relate either to responses received by the FCA and HM
Treasury to the March Consultations, or else additional evidence uncovered by us as part of our
fieldwork on the revised study.
Revised behavioural assumptions. We have noted above that the new starting population contains more
marginally attached firms than we previously believed. We still expect these to exit the market, either
due to natural market wastage or due to the regulatory burden of the new regime acting as a tipping
point. In a number of cases we have revised our modelling assumptions on exit due to the latter factor
to reflect this.
1.4.1 Payday lending
A key change from the March report has been the introduction of HCSTC-specific polices. These have a
particular affect on the payday sector. Financial promotions related to payday lending are to include risk
warnings which aim to contribute towards de-biasing consumers in relation to their ability to repay loans.
The policies relating to affordability assessments and limiting rollovers and CPAs are designed to incentivise
payday lenders to grant loans only to those consumers who can afford to repay them. The policies are also
intended to reduce detriment associated with aggressive revenue collection and inappropriate advice (i.e.
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Executive Summary
lenders encouraging customers who cannot repay a loan to roll it over multiple times instead of seeking
debt advice).
Impacts on revenue
The policies of a cap of two rollovers and a restriction in the use of CPAs are likely to have a significant
impact on the ability of lenders to recover revenue within their current business models and lending profile.
The cap of two rollovers suggests revenues of up to £200 million of revenues could be affected, around 24
per cent of total industry revenue in 2011/12.
Impacts on the industry and volume of lending
We believe that these impacts will not simply be absorbed into industry profits or passed wholly onto
consumers, and that between 25 and 30 per cent of firms will exit the market as their business models are
no longer profitable and they are unable to recover the necessary levels of revenue through increased
prices. This will largely be among those firms that target marginal consumers (i.e. customers with a very
high risk of default with whom revenue recovery mechanisms are the only way to make the loans
profitable). Other firms that also serve such marginal consumers as part of their customer base could be
expected to cease to do so as a result of more rigorous affordability assessments. There might be some
change in business models where firms continue to serve such customers and recoup the revenue from
other sources such as default fees and higher charges. We estimate an initial reduction in lending of
between £625 and £750 million.
In time lending volumes may recover as firms find ways to serve new customers who do not require the
use of multiple rollovers or CPAs to recover cash. However, the population of consumers described above
to whom lending would not be profitable without the use of rollovers or CPAs, would no longer have
access to this form of credit.
Impacts on access to credit
This will impact a significant proportion of consumers –– we estimate between 18 and 30 per cent of
current payday customers would be denied access to credit. For the majority of consumers this restriction
is indeed the policy intent, and likely to be beneficial. However, the alternative options for these
consumers may not be beneficial. We developed scenarios that include doing without, accessing debt
management service, borrowing from friends, illegal lending. Consumers who resort to borrowing from
friends and family (up to 12 per cent of affected payday customers), accessing debt management
programmes (unknown, but assumed up to one per cent of affected customers), accessing other forms of
mainstream credit (up to three per cent) and doing without (up to eight per cent of affected consumers)
are likely to experience net benefits from the policies. More marginal consumers who may do without
essential expenditures as a result of the policies may not benefit in the long-run. Consumers who turn to
other forms of high-cost credit would benefit to the extent that these forms are less costly than payday
lending. The proportion of affected customers who would turn to illegal or unregulated lending is
unknown, but thought to be low.
However, there may be some consumers for whom payday lending is not unaffordable (or detrimental)
who would nevertheless suffer restricted access. Even though these consumers would pursue alternatives
as described above, these would not reflect their preferences. The tighter the restrictions (in particular of
rollovers) the more likely consumers who can afford to borrow will be constrained from doing so.
Impacts on the cost of credit
We consider there to be a material likelihood that the limiting of roll-overs and the restrictions in CPA
usage will not only mean a reduction in lending volumes but is likely to also see default fees and related
charges rise as those participants remaining in the market seek to recoup lost revenues. We therefore
estimate that the revenues that could be recouped from consumers at around £10–12 million.
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Executive Summary
Limitations of our analysis
Our analysis draws on data from the OFT collected through a survey of payday lenders (representing 85
per cent of the market), and insights from a clearing bank on the use of CPAs. We note that individual
lenders within the OFT dataset may not be representative of the industry as a whole and as such the
analysis based on individual firms’ lending practices should be considered illustrative. We also draw on
existing research on payday consumers, as well as information from the survey conducted by Policis for the
report supporting the March consultation paper.
Our analysis of the impacts of the policies is limited by the fact that we do not have access to data to assess
how individual consumers (or types) are made better or worse off by having a payday loan. It is also not
straight-forward to judge the relationship between rollovers and financial difficulty (particularly where the
loan is of very short duration). It is therefore not possible to quantify the extent to which a restriction in
access to payday credit would reduce detriment. Nor is it possible to undertake detailed welfare analysis
of different options, i.e. quantitatively evaluate how different rollover caps would affect consumers and so
to calibrate an optimal rollover cap. However, we make use of qualitative judgements to establish broad
benefits from the policies.
Data and information limitations mean that it is not reasonably practical to quantify all the relevant benefits.
Ideally, quantification of all benefits would entail assigning a value to the scale of detriment currently
suffered by payday users, and assessing the degree to which the payday policies would reduce this
detriment. The resulting value of the benefits would then be adjusted to take into account any negative
outcomes of the policies (such as restricted access to credit leading to worse outcomes for consumers).
However, we are unable to estimate the full value of detriment related to payday lending due to an absence
of sufficiently robust and comprehensive detriment data (i.e. data are only available for the scale of
complaints, and not for unobserved detriment which is likely to be high). There is also not sufficient data
to estimate the extent to which negative alternative outcomes might reduce the benefits of the policies for
consumers.
Nevertheless, our analysis makes full use of the available information and enables us to draw conclusions on
the likely benefits of the policies on a qualitative level. In addition, the relative level of these benefits is
estimated where data allow.
1.5 Benefits
The transfer of regulation of consumer credit to the FCA is expected to give rise to benefits over and
above the OFT regime. This will be achieved through a number of channels. The primary channel should
be improved market functioning and business practices through greater compliance with past OFT guidance
and the CCA, brought about by the enhanced supervision and enforcement powers of the FCA. In
assessing the benefits, we have focused on the most relevant detriment and market failures and how the
policies could address them.
We define consumer detriment as negative consumer outcomes. Consumer detriment includes observable
harm suffered by consumers, for example as evidenced in complaints data. It also covers unobservable
detriment, where consumers are not aware of the ultimate cause of their suffering or sub-optimal
outcomes, such as losses caused by not getting the best loan deal.
The main types of consumer detriment arising from market failures (and exacerbated by firm and consumer
behaviour) are as follow:
Unaffordable borrowing/lending, debt traps or spirals — consumers can have incentives to take out
credit they cannot afford.
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Executive Summary
Poor value credit or services — consumers can suffer detriment where the price of a credit product or
service is persistently more than the marginal cost of providing it.
Detriment arising from conflicts of interest — conflicts of interest exist whereby credit product and
service providers act in a way that benefits them at the expense of the consumer. This could have
detrimental outcomes including unsuitable advice or products being given to consumers and the loss of
client money and assets.
Lack of access to credit — consumers can experience detriment when they are unable to access credit,
access sufficient credit, or access a sufficient variety of credit products, where they would be in a
position to manage the credit.
The table below illustrates the consumer credit markets where we expect the most significant detriment.
This draws on quantitative analysis of observable and the qualitative analysis of unobservable detriment.
Given the concerns already expressed over the availability and coverage of data here, there is inevitably a
significant element of judgement within this.
Table 1.2: Consumer detriment across consumer credit markets
Poor sales of products and
Unaffordable lending
services
Loss of client money and
Unsuitable advice
assets
Banks & Building Societies
Card Monolines
Payday
Mainstream & Bricks and Mortar
Home credit
Non-Bank Lenders & Consumer Hire
Credit Unions
Secondary Non Motor Retail
Secondary Motor
Traditional Credit Brokers
Aggregators & Lead Generators
Credit reference agencies
Debt Managers and Related
Debt Collectors and Related
Key: Red = high qualitative evidence or quantitative detriment; Amber = medium qualitative evidence or quantitative detriment; Yellow = low
quantitative or qualitative detriment; Clear = no strong qualitative or quantitative evidence; Grey = particular type of detriment not relevant for
that sector.
There is significant detriment related to unaffordable lending and poor sales in the payday lending sector,
and similar levels of detriment related to poor sales and unsuitable advice in the debt manager and debt
collector sectors. In the non-bank lending sector, there is significant detriment associated with poor
product sales.
The benefits of the new regime stem from the efficacy of the new policies in addressing these areas of
detriment. The table below combines our analysis of detriment and our analysis of which policies are likely
to have the greatest impact on this detriment, to arrive at an overview of the benefits of the regime in each
sector.
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Executive Summary
Table 1.3: Benefits of the new regime by sector
Unaffordable
lending
Banks & Building Societies
Low
Poor sales of
products and
services
Medium
Limited
Loss of client
money and
assets
Limited
Unsuitable
advice
Card Monolines
Low
Low
Low
Limited
Payday
High
High
Medium
Limited
Mainstream & Bricks and Mortar
Low
Medium-high
Low
Limited
Home credit
Low
Medium-high
Low
Limited
Non-Bank Lenders & Consumer Hire
Medium
Medium-high
Medium
Limited
Credit Unions
Low
Medium
Low
Limited
Secondary Non Motor Retail
Low
Low
Low
Limited
Secondary Motor
Low
Low
Low
Limited
Traditional Credit Brokers
Low
Low
Low
Limited
Aggregators & Lead Generators
na
Low
Low
Limited
Credit reference agencies
na
Low
Low
Limited
Debt Managers and Related
na
High
Medium
Medium-high
Debt Collectors and Related
na
Medium-high
Medium-high
Limited
The beneficial impact in payday lending and debt management for certain types of detriment is expected to
be high, a combination of effective policies and evidence of significant detriment. However these benefits
may be offset in part by the wider impacts of the policies on access to credit.
As a sub-set of the overall benefits, we estimate the monetary value of benefits arising from the reduction
in observable detriment, using complaints data from the OFT and Financial Ombudsman Service (FOS). We
estimate the total observable detriment in the consumer credit markets between £194 million and £353
million. The benefit of the policies in reducing this observable detriment is estimated to be between £32
million and £118 million, with a central estimate of £69 million.
The central estimate of the on-going costs described above is about £47 million, i.e. a £21 million less than
the on-going benefits. However one-off costs also need to be considered. The central estimate of one-off
costs is about £129 million: so ignoring inflation, the one-off direct compliance costs would need to be
capable of being amortised over more than six years for the reduction in observable detriment to be more
than the increase in compliance costs. We highlight that this comparisons does not recognise unobserved
detriment, which could be significant, or the impact on access to credit arising due to the reduction in scale
in the payday lending sector described above.
The quantification of all benefits of the policies is not reasonable practical due to limitations in the available
data. In particular, detriment arising from unobserved detriment is not possible to quantify as this is not
reflected in, for example, complaints data (the causes of this kind of detriment are difficult for consumers
to identify and complain about).
1.6 Structure of this Report
We describe our overall approach in Section 2. We then present an overview of the proposed new regime
in Section 3. We then move on to part of the economic analysis that considers both the incremental
compliance costs implied by the new regime and the expected consequences on firm market entry and exit
behaviour — this is in Section 4.
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Executive Summary
Wider regulatory impacts — such as upon the rate of innovation as well as the scope for downside risk in
the regime transfer — are described at Section 5. Section 6 maps across these impacts to outline the
potential implied effects on consumers. Section 7 focuses upon the anticipated benefits of the new regime.
Section 8 presents a consolidated analysis of the payday lending policies.
Sections 9-12 are appendices. Section 9 describes in greater detail the approach taken to modelling firm
behaviour. Section 10 sets out our approach to modelling the size distribution of firms in the consumer
credit market. Section 11 provides additional detail on consumer detriment across all sectors. Section 12
contains details about how we estimate the quantitative benefits presented in Section 7.
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Overview of our Approach
2 Overview of our Approach
2.1 Introduction
The Government intends to transfer responsibility for the regulation of consumer credit from the Office of
Fair Trading (OFT) to the Financial Conduct Authority (FCA), which will be responsible inter alia for the
regulation of conduct in retail financial markets, and along with the Prudential Regulation Authority have
superseded the Financial Services Authority (FSA). It is intended that the legislative underpinning of the
credit market regulation regime will then switch from a Consumer Credit Act-based (CCA) regime to a
Financial Services and Markets Act (FSMA) regime, provided that it can be demonstrated that an FSMAbased regime for consumer credit will deliver regulatory proportionality and good value.
The FCA is interested in understanding the impacts of its proposals on the consumer credit market. Our
work has considered the potential benefits, as well as the costs, and behavioural and market consequences
of the transfer in regime.
2.2 Relation to our March Report
Europe Economics (hereafter, “we”) published a report on 6 March 2013 on the expected compliance
costs and firm behaviour associated with the policy mix presented by the (then) FSA.2 This work was
prepared in parallel with the March Consultation Paper and we refer to it hereafter as our “March Report”.
This new study serves two purposes: firstly, our analysis has now been extended to include the benefits
accruing due to the transfer in regime from the OFT to the FCA.
Secondly, it updates the March Report to reflect new information and a revised policy mix presented by the
FCA. In this respect it is designed such that it can be read in isolation from the March Report: indeed,
some parts of the analysis have been carried across more or less unchanged. New information has been
derived from various sources, including those published subsequent to the March Report:
Responses to both the FCA’s first consultation paper and HMG’s consultation.
OFT (March 2013), "Payday Lending: Compliance Review Final Report".
Personal Finance Research Centre, University of Bristol (March 2013), "The impact on business and
consumers of a cap on the total cost of credit" for BIS.
The National Audit Office’s report on “Regulating Consumer Credit” (December 2012) and the
associated Technical Paper.
Europe Economics worked in collaboration with Policis to understand the implications of the new regime
for the cost of compliance to firms and for firm behaviour in developing our work for the March Report.
In this earlier work we focused on the economic analysis: the impacts on the incremental costs of
compliance, the impact of these cost changes on firm behaviour and on wider economic impacts, including
high-level analysis of the impacts on consumers’ credit access, choice and pricing.
Policis concentrated on contextual analysis around market and firms’ attitudes to the new regulatory
regime and how these may play out in terms of potential response by firms and outcomes for consumers.
Policis reported separately on this in April 2013.3 Policis’ work — in particular a quantitative survey of
market participants — supported the development of the March report, and has again been used as a
2
3
http://www.europe-economics.com/publications/europe_economics_final_report_6-3-13.pdf
www.policis.com/publications/regulation/new-credit-regime.pdf
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Overview of our Approach
resource for the updating of this work now. The analysis was also informed by a large body of qualitative
research with trade associations and firms across the market, also conducted by Policis — again in
connection with the work on CP13/7.
The diagram below offers an overview of the various strands of the analysis.
Table 2.1: Overview of Approach in the March Report
A crucial input into the March study was a quantitative survey of firms participating in the consumer credit
market. This was co-designed by Europe Economics and Policis, but Policis was responsible for the
execution of the survey (i.e. setting the sample, engaging with firms, and gathering and cleaning the data).
The questionnaire for this work covered various aspects of the firms’ finances and profitability, business
models and strategy. It also included questions relating to compliance activity and costs, and attitudes
towards regulatory reform and the transfer to the new regulatory regime. Over 100 firms participated in
the quantitative study, from across the consumer credit market. Firms were also invited to complete
sector-specific questionnaires designed by Policis to cover aspects of business models and firm behaviour
tailored to their own area of the market. We refer to this as the “Policis survey (conducted prior to
CP13/7)” within this report.
The models developed by Europe Economics for the economic analysis (described at 4.3 and 4.4 below)
required particular data inputs in order to produce meaningful outputs: this meant that 89 of the surveyed
firms were included in this analysis. These models focus upon the compliance cost drivers and profit
impacts of specific policy proposals associated with the transfer in regime. We have used the same data
generated through the Policis survey (conducted prior to CP13/7) in updating these models as part of this
study, with the results presented at Section 4 of this report. Similarly our analysis of the wider impacts and
consumer impacts (at Sections 5 and 6) draws upon the outputs of these models, relevant academic
literature and specific questions from the Policis survey (conducted prior to CP13/7).
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Overview of our Approach
The survey was complemented by over 60 qualitative interviews also undertaken by Policis prior to the
completion of the previous study. This work included interviews with trade associations and firms across
the consumer credit market. Our work drew — and continues to draw — upon those aspects of the
qualitative research dealing with specific policy proposals.
In addition, Europe Economics conducted five structured interviews with various trade associations as part
of our work leading up to the publication of the March report. Europe Economics has conducted an
extended set of interviews with trade associations as part of the work updating and extending our analysis.
2.3 Approach to the Analysis
The economic analysis set out in this study aims: to assess the incremental compliance costs; to understand
the behavioural response of firms given regulatory change; and to assess the benefits associated with the
transfer of the regime.
We consider the expected behavioural changes by firms currently operating in the market, as driven by our
estimation of the firm’s expected compliance cost and its relation to the firm’s profitability. The
mechanisms underpinning such behavioural changes are discussed briefly below and in more detail in the
methodological appendix at Section 9.
We also consider wider effects of the shift in the nature of the regulatory regime and the implications of
these on the market and the variety and quality of the products available. This is described in Section 5.
We also review the implications for consumers (access to credit; the choice of products available to
different consumer groups; and the cost of accessing credit for different consumer groups) in Section 6.
The benefits are discussed qualitatively and quantitatively in Section 7.
2.4 Structure of this Report
We present an overview of the proposed new regime in Section 3. We then move on to part of the
economic analysis that considers both the incremental compliance costs implied by the new regime and the
expected consequences on firm market entry and exit behaviour — this is in Section 4.
Wider regulatory impacts — such as upon the rate of innovation as well as the scope for downside risk in
the regime transfer — are described at Section 5. Section 6 maps across these impacts to outline the
potential implied effects on consumers. We describe the benefits of the new regime at Section 7. Section 8
presents a consolidated analysis of the payday lending policies.
Sections 9-12 are appendices. Section 9 describes in greater detail the approach taken to modelling firm
behaviour. Section 10 sets out our approach to modelling the size distribution of firms in the consumer
credit market. Section 11 provides additional detail on consumer detriment across all sectors. Section 12
contains details about how we estimate the quantitative benefits presented in Section 7.
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Overview of the New Regime and our Modelling Approach
3 Overview of the New Regime and our
Modelling Approach
This report has been developed in a live policy-making environment. It reflects the FCA’s revised policy
mix having received feedback on its March Consultation Paper. We set out here a summary of the
proposals as we have assessed them in this report.
The FCA’s proposals differentiate between higher and lower risk activities. Lower risk activities include
consumer hire and those credit intermediaries where this activity is secondary to the firms’ main
commercial activities, i.e. selling goods and non-financial services. For example a motor dealer would be
expected to fall into this category.
Underneath each policy description we outline the modelling approach adopted by us. Where applicable
we differentiate between the top-down and bottom-up approaches below (these are described more fully
in the following chapter).
3.1 Interim Permission Regime
Firms in possession of an OFT licence that wish to continue to trade will be required to notify the FCA
(with a few exceptions, e.g. not for profit debt advice bodies covered by a group licence will be
“grandfathered” into limited permission) and — other than not-for-profit debt advisers and credit unions
— pay an interim permission fee (where the firm is already FCA-regulated this would be an interim
variation of permission).
3.1.1 Modelling approach
All firms (including those that would opt for appointed representative status) — other than not-for-profit
debt advisers and credit unions — remaining within the market are assumed to pay the interim registration
fee (being £350, or a reduced rate of £150 for sole traders).
In contrast to the other administrative tasks that we describe below, there is no evidence available on the
likely time duration to deal with the interim permission form, because no one had yet used it at the time of
the fieldwork undertaken. We took as our reference point the least onerous task of those where we had
information, i.e. about 0.5 days.4 The level of information involved in the interim application is expected by
the FCA to be qualitatively different (and below even this level), however we note that most business
interactions (including form-filling) with government or regulatory bodies tend to consume more time than
anticipated and, more importantly, we consider that any extra time here contributes to the pool of time
available to firms to consider the new regime and its implications.
We have split the time taken 20:80 between senior management staff and compliance/ finance or IT staff
(except in the case of sole traders). This balance is similar to what we have used in previous studies: e.g. in
our work on the introduction of FSA-authorisation to general insurance and mortgage intermediaries we
assumed that for large firms 10 per cent of the time was from management-level staff, with the balance
4
This related to the average administrative time associated with the Approved Persons regime although, as noted at
3.4.1 below, in our modelling of that policy we in fact adopted a slightly higher estimate.
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Overview of the New Regime and our Modelling Approach
from compliance or other staff, whereas for very smallest firms as much as 70 per cent of the time was
allocated to management.5
3.2 Authorisation and Annual Fees
Secondary credit brokers (such as those at point-of-sale), lower risk lenders and consumer hire firms
would be subject to a more limited assessment procedure, based upon modified threshold conditions and
would have a “limited permission”.
Other firms would require authorisation (or a variation of permission if already FCA-authorised in another
business area) or to become appointed representatives where that is an option (see below). Firms wishing
to be fully authorised would be required to put together an authorisation pack demonstrating compliance
with the necessary Threshold Conditions. This pack might include details of legal status, office location,
business plans, group structure and its financial and managerial resources.
3.2.1 Modelling approach
Fees payable to the FCA are likely to be an important element within the additional costs due to the new
regime. We have made a number of assumptions about the possible nature of these, which we describe
below.
Firms that can access the limited permission scheme, such as secondary credit brokers, would pay a £500
fee. This is regardless of size. This was applied in both the bottom-up and top-down models. In the latter
case secondary intermediaries have been modelled as discrete segments. About one third of the non-bank
lender and consumer hire category were taken to be car, tool or other forms of consumer hire firms and
similarly able to adopt the limited permission, based upon our interpretation of population data from
Critical Research.6
For firms taking the full authorisation route we adopted four levels of authorisation fee depending on an
analysis of business complexity identified by the FCA:
Straight-forward (e.g. mainstream credit brokers): £1,000;
Moderately complex (e.g. debt collectors): £5,000;
Complex (e.g. high cost, short term lenders — such as payday and home credit, and debt managers):
£10,000; and
Very complex (i.e. Credit Reference Agencies): £15,000.
Credit unions and community benefit societies can access a concessionary rate of £200. Where a variation
of permission was applicable — because the firm self-identified as being already FCA-authorised — these
fee levels were halved (unless the firm qualified as “straight-forward”, or not-for-profit, in which case the
VOP fee is to be waived).
Our analysis of the data generated by the Policis survey (conducted prior to CP13/7) indicated 1–2 days as
being the typical time spent on preparing the OFT’s licence application. The reference point for the
5
6
Europe Economics (2002), “The Costs and Benefits of Mortgage and General Insurance Authorisation”: this study
was prepared for the FSA.
Critical Research was commissioned by the (then) FSA to provide information on the population of OFT-licence
holders to feed into CP13/7. We have had access to the data sets underpinning Critical Research’s reports titled
"Consumer credit licence-holders: Population sizing & segmentation research. Key Findings" and "Consumer credit
licence-holders: Population sizing & segmentation research. Technical Report", published with the FSA’s
Consultation Paper. In addition, Critical Research has updated aspects of this research (and extended others) —
at the FCA’s request. This new research was conducted in June–July 2013, with the data available to us after that.
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Overview of the New Regime and our Modelling Approach
administrative aspects of authorisation was also taken from responses to this survey, albeit in this case
using data only from those firms with actual experience of being supervised by the FCA, being an average of
3–4 days in total. The incremental administrative cost assumed in both models for preparing the
authorisation pack was therefore taken as two days. The administration around a variation of permission
has been taken as half this level, which was again in line with the data gathered by Policis.7 In the “bottomup” version we also considered whether a business plan, or additional supporting materials, might be
required by the FCA which would complicate the authorisation process. This additional cost was incurred
where a firm had consumer credit turnover above £10 million per annum, but had identified its business
planning as incomplete (e.g. lacking detailed cash flows) or limited (which was in fact — perhaps
unsurprisingly — rare in the Policis survey (conducted prior to CP13/7) sample).
As we have noted at 3.2 above, firms would be obliged to pay annual periodic fee. Again we made a
number of assumptions in order to assess the impact of this. For firms with a limited permission we
assumed an annual payment to the FCA of £500, with an additional variable element calculated as 0.04 per
cent of consumer credit revenues, if the latter exceeded £250,000. We estimated the variable element in
order to align the overall on-going fees with the FCA’s estimated budgetary needs and this should be seen
as illustrative. The periodic fees are only to be consulted upon in 2014.
For fully authorised firms, the annual fee was taken to be £500 if the firm had annual consumer credit
revenues below £0.1 million. Otherwise, the annual fee was taken to be £1000, with, again, an additional
variable element equal to 0.04 per cent of consumer credit revenues, if the latter exceeded £250,000. The
calculation of the variable element should, again, be considered illustrative.
All free-to-client debt advisers and those credit unions (and community benefit societies) with less than
£250,000 in consumer credit income would not be required to pay the periodic fees.
The administrative side of paying the annual fee was taken to be equivalent to annual average time spent
relating to renewing the OFT licence.
3.3 Appointed Representatives
An appointed representative has a contractual relationship with an authorised person (a principal) under
which the principal accepts contractual responsibility for the conduct of regulated activities by the
appointed representative. Multi-principal arrangements will also be available. This would be an alternative
for such firms to authorisation by the FCA. The option to be an appointed representative will not be
available to lenders, unless they only provide loans free of interest and without any other charges, or to
credit reference agencies. Lenders can act as principals.
It is noted that in the home credit arena and in mail order — where self-employed agents are an important
part of the business model for most firms — these are not required to hold an OFT licence at present and
would not be required to become appointed representatives or to be authorised directly by the FCA.
(Instead the proposed approach is to permit continuation of the current arrangements regarding selfemployed agents in these areas).
3.3.1 Modelling approach
The Appointed Representative (AR) regime has the potential to lower costs by substituting a principal, with
whom the AR has a pre-existing business relationship, for the FCA. A key restriction here is that the
qualitative feedback and quantitative survey data indicated very clearly that the firms who might act as
7
There is no doubt that some firms will take significantly longer on this, particularly larger, more complex firms.
Then again, smaller, less complex firms — of which there are significantly more — are likely to spend rather less.
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Overview of the New Regime and our Modelling Approach
principals had little enthusiasm for this and we have therefore kept participation in the AR regime to a
relatively low level.
We have assumed that a principal would seek full compensation for its activities in training and bolstering
the control environment from ARs (e.g. by adjusting other pricing arrangements between the parties). We
have assumed that an AR would as a minimum receive two days’ additional training and be subject to
external costs of £825 (e.g. to cover additional IT support). In the “credit broker” segment, where many
firms are already ARs in other business areas these estimates were reduced to reflect prior knowledge of
FSMA-style requirements. These one-off costs of being an AR are below those from authorisation.
In terms of on-going costs, monitoring and continuing support would be necessary: we have estimated the
cost of these at £1500 per annum (£1125 for firms with pre-existing exposure to the FCA appointed
representative regime). This is below the cost of being directly authorised, but slightly above the likely cost
of a limited permission. A trade-off between the upfront saving and such an on-going additional cost may
still mean that the AR regime is economically advantageous for firms with the option of a limited
permission. On the other hand, we do not see the AR regime as purely a numbers-based decision by firms:
some firms are likely to prefer dealing only with their already established commercial partners rather with
than the FCA. Nevertheless this may change the relative appeal of the AR regime in those areas where
limited permission is the comparator (see the discussion of secondary credit brokers at 4.16 and 4.17
below).
3.4 Approved Persons
The FCA’s supervisory approach includes the identification of particular controlled functions whereby the
designated person requires pre-approval from the FCA. Approved persons will be vetted by way of a ‘fit
and proper’ test, which will consider among other things:
Honesty, integrity and reputation
Competence and capability
Financial soundness
Where the conduct of the approved person is deemed below standard then the FCA can and does take
action. The approach adopted within consumer credit differentiates between different activities in terms of
who will require approval and the nature of the approval process. The main distinctions are summarised
below.
Significant influence (i.e. governing) functions. This would apply to nearly all segments except to firms
with a limited permission.
Secondary credit brokers (such as those at point-of-sale), consumer hire firms and lower risk lenders
(e.g. golf clubs offering deferred payment of annual membership fees) would require the pre-approval of
an individual responsible for apportionment and oversight.
Most lenders would be required to gain approval for a Money Laundering Reporting Officer. This
applies to lenders which are subject to the Money Laundering Regulations and do not have a limited
permission.
Commercial debt management and credit repair firms would be required to have an individual approved
as a compliance oversight officer (under SYSC). Large debt management firms (including large not-forprofit operators) would also need an approved person responsible for the client asset oversight
function.
Sole traders (without employees) are largely exempt from the approved person regime.
Whilst the OFT considers fitness and integrity, this is not considered directly equivalent to the proposals
for Approved Persons: as such we have treated this as a new requirement.
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Overview of the New Regime and our Modelling Approach
It is highlighted that the application of the approved persons by the FCA is potentially subject to change
and/or delay in implementation. This is due to the on-going policy development by the FCA regarding the
recommendation by the Parliamentary Commission on Banking Standards (PCBS) that a new Senior
Persons regime should replace the approved person regime.
3.4.1 Modelling approach
The responses to the quantitative survey identified the number of senior management in each firm and also
how many of these — if any — were already approved persons by the FCA.8 The net of these has been
taken as the number of senior managers requiring approval under the new regime. To these were added
an individual to take responsibility for the oversight of anti-money laundering activity or of compliance
where that has been built-in as a requirement of the new regime.
This approach has been over-ridden in the case of secondary credit brokers where a single person only will
be required to take responsibility for apportionment and oversight.
In consideration of the time taken to obtain the approval we have used the research data as our reference
point, specifically the estimates from firms that are already FCA authorised (i.e. we have not relied upon
estimates from those without experience of the processes involved). These estimates averaged about 0.5
days per approval. This is slightly above past estimates — on the other hand many of the firms making such
applications will not have prior experience of the Approved Persons regime. To make just allowance for
this we took 0.75 days as being an appropriate guide to the administrative processes involved. The time
has been allocated 80 per cent to compliance (or finance staff where no compliance staff were in situ), with
the balance allocated to senior management.
In the “top-down” approach we drew upon the new work conducted by Critical Research, as well as the
results from the Policis survey (conducted prior to CP13/7). Those small (below £250,000 consumer
credit revenues) and larger lenders (i.e. above this level) without prior experience of the FCA (e.g. those in
home credit), and excluding sole traders, were assumed to have two and five persons respectively each
requiring pre-approval. The approach in other segments was fundamentally similar except that small and
large firms were assumed to have one and two persons respectively each requiring approval.
Sole traders without employees are excluded from this requirement. Drawing on the Critical Research
work conducted prior to CP13/7 we estimated that about 69 per cent of sole traders had no employees:
this was taken to be broadly representative and an appropriate adjustment made.
3.5 Group Licensing
Consumer credit activity can only be conducted under an appropriate licence. Whilst most market
participants will have an individual licence, group licensing is a concession whereby certain firms or
individuals avoid the need to apply for such an individual licence, a group licence providing an effective
umbrella for their activities.
There are two broad groups that have been granted group licences on public interest grounds by the OFT:
Members of altruistic advice organisations, such as Citizens Advice Bureaux. These play an important
role in the provision of not-for-profit debt advice.
Members of designated professional bodies with established disciplinary arrangements.
8
A substantial minority of firms actively using an OFT licence are also registered with the FSA with respect to
another part of their business, such as variously mortgage lending, insurance intermediation, etc. These firms are
modelled as having a slight advantage in adapting to the new regime over those firms without such experience of
the FSA.
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Overview of the New Regime and our Modelling Approach
The altruistic advice organisations provide debt advice in the course of business and so should be subject to
the FCA’s regime as of 1st April 2014. The intention is that the threshold conditions would be modified.
In terms of the designated professional bodies, many may be able to operate under the Exempt Professional
Firms (EPF) regime set out within FSMA where their regulated activities are incidental to their professional
services and the relevant designated professional body has appropriate rules (which require approval by the
FCA) in place governing their regulated activities. Certain professional activities, e.g. insolvency
practitioners, whose activities are limited solely to certain specified matters will be exempt from the EPF.
Firms whose regulated activities are not incidental to their professional services will have to obtain FCA
authorisation. Professional firms, e.g. accountants, captured within the population estimate have been
included within the credit broker category.
3.6 High-level Standards and Conduct Rules
The FCA makes rules that set standards of behaviour for regulated firms.
The Principles for Businesses (PRIN) define certain high-level principles which set out the overarching
standards of behaviour for regulated firms, such as a requirement to treat customers fairly.
The General Principles (GEN) incorporates general administrative rules such as how the FCA logo may
be used by firms and how firms describe their regulated status.
The Systems and Controls Sourcebook (SYSC) sets out rules and guidance on how a firm should
manage its affairs.
The Money Laundering Regulations 2009 already apply to many firms in the sector. However, there are
some distinctions between the CCA regime, even with the OFT’s guidance,9 and the requirements under
SYSC which will be introduced by the FCA.
It is important to note that the FCA’s intention is that the substance of the conduct standards contained
within the CCA will continue in effect, either by remaining in the CCA or as FCA rules or guidance.
Notwithstanding this, the FCA will, of course, review the operation of the consumer credit market and
may consider new requirements in the light of that work. For the purposes of the cost-benefit analysis
here we have assumed that conduct rules remain largely the same.
It is also worth noting that — as identified by Policis’ qualitative research conducted in connection with
CP13/7 — in a number of areas voluntary conduct standards have recently been improved by different
parts of the consumer credit industry (e.g. debt management).
3.6.1 Modelling approach
The FCA’s intention is to map across conduct standards broadly unchanged. We focus here on the “nuts
and bolts” changes that we believe are implied (but consider the likelihood and scale of firms reviewing
their retail conduct below, at 5.2).
On PRIN, we considered the requirements for record-keeping and for adequate risk management to be a
potential driver of process change and hence cost. In our bottom-up model those firms indicating that they
were not fully confident in risk management were considered as requiring additional training. The time
duration and likely cost of this was with reference to desk-top research into relevant training vendors.
In terms of record-keeping we distinguished between adequate record-keeping for the OFT regime and
what we deemed the qualitative shift in requirement necessary for the FCA. Firms currently have an
obligation to have satisfactory records (not just to satisfy the OFT’s needs) so those firms that were not
9
http://www.oft.gov.uk/shared_oft/business_leaflets/general/oft954.pdf, downloaded 13th February 2013.
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Overview of the New Regime and our Modelling Approach
confident in their own record-keeping were deemed examples of non-compliance (i.e. by having inadequate
financial records) so that the cost of these becoming adequate should not be reflected in the compliance
cost numbers.
However our view is that when firms look ahead to life with the FCA they will readily identify a supervisor
that is more pro-active, requires regular reporting and also seeks ad hoc reporting: the effect being that
some firms will need to upgrade their systems in order to cope. For example, in the bottom-up model, a
firm reliant on manually prepared accounts or on external accounts preparation was assumed to acquire a
simple financial management system.
On SYSC, the treatment of financial crime oversight was taken as a likely key cost driver. This has the
following elements. First we have data from the survey on whether there is an MLRO or not already in
place (we have assumed that firms without an MLRO will need to incur additional training costs). Where
there is not one, and the firm is not a sole trader without employees, this can be treated as either a paygrade difference, e.g. the gap between the cost of a compliance person and, say, a manager (with that uplift
reflected as an extra on-going cost) or as a requirement to have training on financial crime (as a one-off
cost) to transition someone into that role. We have taken the latter approach. This is not low cost: such
training is likely to consume at least two days and may involve external costs of at least £1,000.
Second, where the relevant MLRO is required to be an Approved Person then an extra person has been
added to the Approved Persons costing calculations. We have not assumed that those firms currently
without a system for reporting suspicious transactions in place would need to acquire one: implicitly this
assumes that such firms are broadly coping with the money-laundering regulations now.
In the top-down model we assumed that:
Half of sole traders would require additional investment in financial management or compliance
software at a cost per firm of £205. This cost is based on quotes from vendors of entry–level financial
management software. This affected about 12 per cent of the firms in the top-down model, against
about 10 per cent in the bottom-up variants.
Twenty-five per cent of small firms, and five per cent of other firms, were assumed to need additional
training or other remedial action in terms of financial crime (if there was no prior contact with the
FCA) at a one-off cost of £1400. This cost is based upon estimates from vendors of relevant training.
About 22 per cent of the firms in the Policis survey (conducted prior to CP13/7) sample required such
training.
Ten per cent of small and five per cent of large firms were assumed to require remedial risk
management training (this was about 15 per cent in the Policis survey (conducted prior to CP13/7)
sample).
3.7 Supervision and Regulatory Reporting
Firms will be required to report a number of data elements per annum to the supervisor (reporting would
be semi-annual if consumer credit-derived annual revenues exceed £5 million). Reporting would involve
multiple data points per firm (identified in Table 1, Chapter 4 of the FCA’s October Consultation Paper),
but with a concession that secondary credit brokers, consumer hire firms and lower risk lenders will be
required to report fewer data elements (five). The data sets include items such as: turnover, transaction
numbers, complaints, and so on. No such reporting requirement exists within the OFT regime.
In addition Product Sales Data (PSD) reporting is to be established for payday lenders and home credit
providers). This would include a mix of data (identified in Table 2, Chapter 4 of the FCA’s October
Consultation Paper), summarised below:
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Overview of the New Regime and our Modelling Approach
Table 3.1: PSD Requirement
Firm data
The FCA reference number of the
lender and broker (if different)
Customer data
Date of birth and postcode of the
borrower
Borrower and household income
Borrower statuses: marital,
residential, employment, car
ownership
Loan data
The type of loan; payday or home
collected credit
Loan details: amount, term, interest
rate (i.e. APR), fee
Rollover information
The reason the loan was taken (if
known)
Another reporting rule would require the Auditors of debt management firms to send a client assets report
to the FCA (essentially reporting on compliance with the client money rules).
Credit firms will also need to verify standing data each year and notify the FCA of any changes in standing
data. The FCA is also intending to introduce a requirement that firms must notify the FCA of changes in
control over them, as and when they become aware that the change is happening. This is not dissimilar to
an obligation on CCA licensees to notify the OFT of changes in control of them.10
3.7.1 Modelling approach
The new regime involves firms reporting data to the FCA, at least once per annum, to support supervisory
analysis. Part of the data set is expected to be readily available for the vast majority of firms (turnover,
customer numbers). However where more data are required then this may be more onerous, although
the contents of the data sets remain undefined.
We have modelled the following costs to reflect such reporting:
Training to adapt the firm’s Financial Management system, e.g. to develop new reporting modules to
capture the required data.
GABRIEL (the FCA’s reporting engine) training if the firm is not already FCA-authorised. This has been
taken as a half-day and is drawn from the results of the Policis survey (conducted prior to CP13/7).
Time-related costs in which actually to file the necessary report, based upon one day. This was
reduced to half a day for lower risk firms, which will have a lower key reporting obligation. This is
drawn from the results of the quantitative research.
PSD reporting has been treated separately. We conducted research with vendors of compliance and
reporting software currently serving different aspects of the consumer credit market likely to be affected
(e.g. home credit). Based on this dialogue the cost aspects of PSD reporting have been modelled as
follows:
For firms with annual turnover below £5 million there would be a one-off cost of £1500 for a new
automated loan book software licence (with 25 per cent of that recurring on an annual basis) and a
one-off cost computed at 50 pence per customer to transfer or update customer records.
For firms with annual turnover above this level but below £50 million there would be a one-off cost of
£10,000 in systems changes (with 25 per cent of that recurring on an annual basis) and a one-off cost
computed at 50 pence per customer to transfer or update customer records.
10
Although, in most cases, (except credit firms with limited permission), the threshold for being a controller is lower
under FSMA than under the CCA.
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Overview of the New Regime and our Modelling Approach
For firms with annual turnover above £50 million there would be a one-off cost of £75,000 in systems
changes (with 25 per cent of that recurring on an annual basis) and a one-off cost computed at 50
pence per customer to transfer or update customer records.
These assumptions have been applied to payday firms (both bricks & mortar and online) and home credit in
both the bottom up and top down models.
We have assumed that all firms would incur these costs. Many market participants are — of course —
highly automated (indeed this is a key aspect of the business model of most if not all online payday
providers). In this case our assumption can be conceptualised as the costs associated with adjusting
existing systems to make appropriate for PSD reporting.
3.8 Financial Promotions
The CCA currently contains prescriptive provisions on credit advertising. These will be repealed and
replaced with a financial promotions regime contained within FCA rules and guidance (based partly on
those aspects of OFT guidance related to financial promotions and the 2004 and 2010 Consumer Credit
Advertising Regulations).
This alignment of the supervision of consumer credit advertising with the supervision of existing financial
promotions regime means that:
There will be high-level rules to be clear, fair and not misleading.
Guidance will state that firms should ensure financial promotions are accurate and do not emphasise any
potential benefits of a credit product without also giving a fair and prominent indication of any relevant
risks; are sufficient for and likely to be understood by the average member of the group at which they
are aimed; do not disguise, diminish or obscure important information, statements or warnings; and are
clearly identifiable as such. The guidance will also state that any comparison needs to be meaningful and
presented in a fair and balanced way.
The FCA will:
For higher risk activities, proactively monitor advertisements made to assess whether they comply with
the relevant consumer credit rules, and take action where in breach.
Undertake thematic work that focusses on a product, risk, media type or section of the rules.
Review complaints received through its hotline.
The FCA is proposing additional rules that a firm (a) must not approve a financial promotion to be made in
the course of a personal visit, telephone conversation or other interactive dialogue (e.g. pre-approving a
script) nor (b) communicate a financial promotion that is not in writing, to a customer outside the firm's
premises, unless the person communicating it only does so at an appropriate time of the day and identifies
that person and the firm represented at the outset and makes clear the purpose of the communication.
This may require enhanced legal or compliance department involvement in such promotions (e.g. signing off
content). The FCA will also have the power to challenge unfair terms in consumer contracts.
Specific requirements related to payday lending are discussed at 3.14 below.
3.8.1 Modelling approach
The Policis research indicated what processes firms typically adopted with their promotions — e.g.
obtaining prior sign-off from a compliance officer or lawyer. For those firms whose current processes
were lacking to some degree we assumed a one-off training cost and an incremental time cost attached to
each new advert, the latter being applied to each of the declared number of new promotions used. Where
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Overview of the New Regime and our Modelling Approach
it was indicated by a firm that web-based advertising was used we assumed that this was updated weekly by
larger firms and monthly by smaller ones. The average time taken to approve an advert was taken as one
hour: this was a judgement.
In the top-down model data on the number of promotions and firm-level approaches were not available to
us. We assumed that those small and large firms without prior contact with the FCA would seek one and
two days training respectively to familiarise themselves with the new requirements, and with an on-going
time commitment of one day for small firms and five days — on average — for larger ones. At one hour
per approval, this can be interpreted as 7–8 adverts per annum for a small firm and 40 for a larger one.
We have assumed that the additional rule related to cold-calling described above will not have any material
consequences on firm behaviour. The cost of training and preparation related to this is subsumed into the
training and related incremental costs already described.
3.9 Complaints and Redress
For credit firms that do not have FSMA authorisation for other activities at the moment, the complaints
record rule, the complaints reporting rules and the complaints data publication rules do not currently
apply. The FCA’s proposed rules switch these provisions on for credit firms. The reporting requirement
would be twice per year. Full details are provided within the FCA’s Consultation Paper.
There is also a proposal to extend the Financial Ombudsman Service’s (FOS) compulsory jurisdiction to
include complainants from micro-enterprises (the latter are currently excluded as they fall outside of the
CCA’s definition of an individual).
3.9.1 Modelling approach
We have assessed a policy option whereby a firm with more than 1000 complaints per annum would be
required to record, report and publish. In our bottom-up model, where a firm’s actual complaints
exceeded 1000 per annum and, for example, the firm lacked a system capable of publishing (but could
record and report) these it was assumed in the first instance publication would be a manually-driven
process, with a time cost allocated to each complaint. If this exceeded the cost of an IT system to handle
this automatically, then investment in the latter was assumed to be necessary, with one-off and on-going
support costs based upon the past experience of market participants with such systems already (an upgrade
to publishing was assumed to cost £15,000 where a reporting system was already in place). Those firms
with a system already in place able to publish complaints were assumed to suffer no additional costs.
In the top-down model we assumed that 0.5 per cent of firms would be affected and that each of these
would incur one-off costs of over £1,000 and on-going costs a little below that (these estimates are based
on the FCA’s own experience, as set out in CP 09/21).
3.10 Prudential Standards for Debt Management Firms
The current proposal is that prudential requirements would apply only to debt management firms (including
not-for-profit firms that, in the past twelve months, had client assets in excess of £1 million, or projected
client assets to exceed that threshold in the next twelve months). The policy proposal would be that firms
would be required to hold capital equal to 0.25 per cent of the total value of debt repayments outstanding.
This would be subject to a minimum of £5,000 (i.e. a firm with total relevant debts under management
below £2 million would still need capital of at least £5,000). Capital for this purpose might comprise any or
all of the following:
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Overview of the New Regime and our Modelling Approach
Share capital (or capital other than share capital (for example, the capital of a sole trader, partnership or
limited liability partnership).
Retained profit reserves, including interim profits net of tax.
Sub-ordinated debt.
The value of any intangible assets (after March 2017), any investments in own shares (after March 2017),
investments in subsidiaries, interim net losses and excess of drawings over profits for a sole trader
or a partnership would need to be deducted from this calculation.
Provided that the above sum continues to meet the calculated prudential requirement this capital could be,
of course, be put to use in the business. There are no prudential requirements within the current regime,
although of course individual firms may choose to hold balances now for essentially prudential purposes.
This requirement would apply to all commercial debt management firms, and those not-for-profit firms that
have retained client monies in excess of £1 million at any point in the previous twelve months.
3.10.1 Modelling approach
We have based our calculations on an illustrative proposal whereby the capital requirement would be equal
to 0.25 per cent of the total value of debt repayments outstanding, subject to a minimum of £5,000. This
was compared to the currently available capital and so we identified any shortfall firm by firm. The caveat
on this analysis is that we did not have data on the value of intangible assets for these firms.
In our bottom-up model we were able to match the requirement to the individual balance sheets of the
firms responding to the survey, with three from 12 needing to raise additional funds based on this work,
with one needing to raise a substantial sum (about £1m). The costs of raising capital were calculated with
reference to the sums being raised and the disclosure within the survey as to shareholder composition (e.g.
whether the firm was quoted, an unlisted PLC, etc.)
Analysis of the data available to us indicates that outstanding debt repayments average around 30 times the
value of annual turnover. On this basis, in the top-down model we estimate that materially all firms would
be above the minimum value, i.e. £5,000. We have assumed that about 25 per cent of this would need to
be raised as additional capital. We have not made any adjustment for any on-going need to raise additional
capital each year, e.g. because the debt management is growing. We were also provided with financial
reporting data on a larger sample of debt management firms by the FCA. We compare the outcomes of
these different approaches at 4.20 below.
We have taken four per cent as the likely one-off cost of raising any additional capital, which would cover
legal fees and any fees charged by external share-holders as well as any internal administrative costs of
actually raising the capital.11 It can be argued that — given the extent of the advance notice in the
prudential regime, and the likely small scale of the additional capital required in most cases — that many
firms will seek to adjust capital levels through profit retention and so avoid these external costs of raising
capital. To this extent our estimates can be viewed as conservative (although increasing profit retention
can be argued to increase a firm’s cost of capital).
We draw a distinction between the one-off cash costs associated with raising additional capital and the ongoing opportunity cost of holding that additional capital on the firm’s balance sheet. With respect to the
latter we estimated the cost of capital — specifically the cost of equity capital — for quoted debt
11
For instance Hennessey (2007) estimated a marginal cost of fund-raising of 5-11 per cent for quoted firms and
Kaserer (2008) estimated 9-12 per cent for UK-based firms. Since firms raising extra capital from retained profits
will not incur any cash costs four per cent can be seen as a blended rate (i.e. if 40 per cent of the funds raised are
assumed to be from external shareholders at a cost of 10 per cent, and the rest is from retained profits, then the
result is an average cost of four per cent).
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Overview of the New Regime and our Modelling Approach
management firms within a CAPM framework. The sample available for this work was extremely small —
indeed there are currently just two quoted debt management firms (two more de-listed in the recent past).
The results indicated a cost of 4.5–6 per cent. These are post-tax figures, with the equivalent pre-tax
return being about 5.9–7.9 per cent.12 We have assumed that this extra capital would be invested, e.g. in
government bonds, and, after deducting the returns on this, our estimated on-going cost of holding any
additional capital raised to meet the initial shortfall is 4.4–6.1 per cent. We used the mid-point of this
range, about 5.25 per cent.
We note that this money can still be used in the business such that additional profits may be available on
such capital. On the other hand, bearing in mind that these firms have not seen fit to inject such capital
already, we must assume that such opportunities are limited or else the firms prefer alternative ways of
accessing them.
3.11 Client Asset Requirements for Debt Management Firms
OFT guidance requires all debt management firms to have segregated accounts for client monies held. The
proposals for the new regime would impose additional requirements: for example, all firms would need to
have a CASS resolution pack and the processes in place to allocate client monies to individual clients in
their accounting records within one day of receipt; all firms holding client money would need an audit at
the year-end (providing results to the FCA within four months). As identified under “Approved Persons”
above, a senior responsible individual will need to be identified.
More stringent record-keeping requirements would also be applicable to the debt management sector:
Regular internal reconciliations (these will need to be less elaborate in the case of small firms).
Selection of bank requirements including notification and acknowledgement of trust.
Independent annual audit.
Due diligence of banks holding client monies and documented consideration of whether to hold such
monies with more than one bank.
Recording any mandates held.
Making records available in the event of firm failure.
The same client asset requirements would be applied to the largest not-for-profit debt management firms
that have retained client monies in excess of £1 million at any point in the previous twelve months, or
project to hold more than that threshold in the coming twelve months.
3.11.1 Modelling approach
Again, this policy relates only to the debt management segment.
The Policis survey indicated what each firm currently did (e.g. whether it used annual external audits). This
was used to model whatever remedial strategies would be required to become compliant with the new
regime. The costs of these, such as a new IT system, were based upon evidence from those firms with
such a system already in place. Where processes changed additional training was also assumed to be
necessary. On the other hand where a firm was already — by its own estimation at least — compliant with
the requirements of the new regime no incremental costs were calculated.
In the top-down model we assumed that around ten large firms would require one-off and on-going
expenditure both in excess of £30,000 in order to comply. These estimates are drawn from the FCA’s
CP12/20, which considered client money rules and their impact on insurance intermediaries.
12
Whilst the sample is very small, this is in fact close to, albeit below, long-run stock market return data.
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Overview of the New Regime and our Modelling Approach
3.12 Fees Requirements for Debt Management Firms
The FCA would make rules requiring that:
All fees-related information should be provided to clients at the initial point of enquiry.
A customer must be informed in the first written or oral communication that free debt counselling,
debt adjusting and the provision of credit information services are available to customers and that the
consumer can find out more by contacting the Money Advice Service. A link to the Money Advice
Service web-site should be included on the firm’s web-site.
The fees should not have the effect that the customer pays all, or substantially all, of those fees in
priority to making repayments to lenders in accordance with the debt management plan and do not
undermine the customer’s ability to make significant repayments of a consistent amount to the
customer’s lenders throughout the duration of the debt management plan, starting with the first month
of the plan, but do not prevent a firm operating a full and final settlement model, in which the firm
holds money on behalf of the customer and does not distribute that money promptly, pending
negotiating a settlement with the customer’s lenders.
3.12.1 Modelling approach
The evidence available to us indicates that about 17 per cent of the annual revenue of debt management
firms is currently derived from upfront fees. The Debt Management Protocol (which debt managers which
are members of the trade associations intend to introduce from 1st October 2013) would spread upfront
fees over six months and include early distributions to lenders (market practice means that — normally —
creditors do not receive any payment for at least the first one–two months). We have assumed that
adherence to the Protocol would make a firm compliant with the FCA’s rules on upfront fees, with minimal
additional change. As such, those debt management firms implementing the Protocol on should not need
to make further change or to incur additional expense to comply with this policy. However there are
other debt management firms which are not members of the trade associations. Our understanding is that
these do not make payments to creditors from any upfront fees received.
There are several complexities to be overcome in making a transition to early creditor payments from
upfront fees. First, IT system changes are needed and debt management firms would also need to contact
with creditors earlier to make a payment to them in the first month. The processes around the
communication of fees-related information would also require review and, potentially, amendment. We
have assumed 5–25 days labour time for small and large firms respectively, applied to 10 per cent of the
debt management firms remaining in the market.
3.13 Obligations related to Peer-to-peer Platforms
There are a number of requirements that would ordinarily be applied to conventional consumer credit
providers which are typically ‘switched off’ in respect of agreements entered into via P2P platforms. This is
because the agreements are classified as being ‘non-commercial’ in that the lenders tend to be individual
consumers and are not considered to be ‘carrying on a consumer credit business’. Additional obligations
are to be required of peer-to-peer platforms in order to promote a level playing field and to enhance
consumer protection. In summary, these are:
Provide pre-agreement explanations to borrowers explaining the key features of the loan. This will not
apply if the loan exceeds £25,000 and is for business, or exceeds £60,260 if the loan is not for business.
Assess the creditworthiness of borrowers. This will not apply exceeds if the loan exceeds £25,000 and
is for business, or exceeds £60,260 if the loan is not for business.
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Overview of the New Regime and our Modelling Approach
Give borrowers the right to withdraw within 14 days, no reasons given. This will not apply if the loan
exceeds £25,000.
Comply with some financial promotions rules.
Comply with rules governing the provision of notice of sums in arrears or in default. This will not apply
exceeds if the loan exceeds £25,000 and is for business.
If facilitating loans secured against a borrower’s home be required to provide a risk warning (by
electronic means) to borrowers before granting the loan: “Your home may be repossessed if you do not
keep up repayments on a mortgage or any other debt secured on it”.
3.13.1 Modelling approach
Our research indicates that the larger peer-to-platforms are broadly compliant with the additional
requirements identified above. We have therefore assumed that the re-modelling of business practices will
be relatively contained: a focused review of practices and — in a minority of cases — IT spending (e.g. to
automate the production and delivery of notices where sums are in arrears or in default).
3.14 Policies Specific to High Cost Short Term Credit
The FCA has designed a policy package specific to high-cost short term credit (HCSTC), which includes
payday lending but excludes forms such as home credit. These include the following measures:
Financial promotions related to HCSTC are to include health warnings which it, it is hoped, will
contribute towards de-biasing consumers. Similarly, affected lenders are to provide information about
the availability of debt advice at the point of roll-over.
The roll-over of HCSTC loans will be capped at two.
The use of Continuous Payment Authorities (CPAs) will be restricted for HCSTC lenders: no more
than two unsuccessful attempts will be able to be made. Part-payment (e.g. requesting some fraction of
the amount due) will no longer be possible.
Affordability standards are to be strengthened by transposing elements of the relevant OFT guidance
that fit with the CCD’s determination of creditworthiness into FCA rules. These rules would specify
what objective lenders need to achieve, without being wholly prescriptive as to how to achieve that
objective.13
Obviously an important aspect of any such policy package is an appropriate and well-considered definition
of the affected lending in order to minimise both the scope for regulatory arbitrage by the firms targeted
(e.g. too tight a definition allowing product changes to avoid such additional measures).
3.14.1 Modelling approach
The FCA has designed a policy package specific to HCSTC. This has a particular impact upon payday
lenders. We have modelled the compliance costs arising from these measures as follows:
Advertising rules: the direct cost for payday lenders of health warnings will probably not be significant.
These might include reviewing advertising protocols and one-off adjustments to advertisement
13
For example, the OFT’s Irresponsible Lending Guideline (2011) identifies a number of ways in which a creditor
"might, depending on the circumstances, include some or all of" in determining the affordability of a borrower:
record of previous dealings with the borrower; evidence of income; evidence of expenditure; a credit score; a
credit report from a credit reference agency; and information obtained from the borrower (e.g. on an application
form). It is the lender’s choice — and also responsibility — to determine what is proportionate in the
circumstances of a particular borrower.
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Overview of the New Regime and our Modelling Approach
templates. The Policis survey (conducted prior to CP13/7) (in relation to the March Report) shows
that those payday lenders in the sample use on average around two different advertising media (mainly
website-based promotions, email campaigns, TV and press advertising). If every lender were to review
its advertising protocols and make adjustments to two mediums, we estimate that this could take
between four and six days of a compliance officer’s time (assuming between two and three days per
medium). The costs of changing advertisements could be aligned with other necessary changes (phased
in) so as to reduce the incremental costs. The inclusion of health warnings or notifications of the
availability of debt advice at roll-over might slow down the customer acquisition process, dampening
growth. Given the role of third-party capital this could matter.
Affordability standards: To the extent that they are not already adequately carried out, affordability
assessments would increase the cost to lenders of acquiring customers, and potentially slow down the
loan approval process. Direct costs would include the additional time that lenders would have to
invest in conducting the assessments, particularly if this cannot be automated. As the new policy is
principles-based, i.e. not specifying exactly what needs to be done, the policy may reinforce the trend of
heterogeneity in affordability assessment methods, rather than leading to complete harmonisation. This
policy builds on existing OFT guidance on affordable lending, and stakeholders representing PDLs
indicate that the industry is already moving towards better practices in relation to affordability
assessments. Therefore a likely direct incremental one-off cost would relate to firms reviewing their
affordability assessment protocols. We estimate that it would take between five and ten days (2–3 days
for small firms) to do this (NB this does not include any re-definition of the customer base to be
served). We further estimate that between five and 10 per cent of PDL customers would be affected
(i.e. are currently not subject to full affordability checks and would experience a change). We assume
that the conduct of such checks would take approximately fifteen minutes of a sales representative’s
time and the purchase of a creditworthiness assessment report from a suitable vendor.
The cap on the roll-over of loans: The direct compliance cost implied by this policy would, we believe,
be trivial for those firms staying in the market beyond re-working IT systems to flag the roll-over limit
and the monitoring of adherence to that. (We assume that firms would have sufficient time to change
lending practices before the policy is implemented). However we believe that this policy — in
conjunction with the restriction on CPA usage and the tightening of affordability standards will mean
that at least some, and perhaps most, payday lenders remaining in the market would attempt a process
of re-defining their core and their marginal customer. We describe our expected costs of this here.
Similar to the review of affordability protocols we anticipate a direct incremental one-off cost of
between twenty and thirty days reviewing customer data in order to come to this conclusion (two to
five days for small firms).
The restriction in use of CPAs: There would be a cost associated with re-configuration of CPA
protocols — this would be one-off but would probably not be substantial given the severity of the
restriction. We are aware that smaller, bricks & mortar PDLs do not use CPAs and we assume that
60–70 per cent of PDLs use CPAs (and would continue to do so). Re-optimising the CPA protocols
would perhaps not be worth the effort since the question would simply be over when the second
request is made. We assume that it would take 5–10 days of an IT worker.
Over and above these compliance costs would be revenues lost, e.g. from the cap on roll-overs. These are
likely to be substantial: we describe our expectations in this regard in detail in Sections 8.
3.15 Change of Regulator
This is not a specific policy proposal per se, but rather captures a number of different potential drivers of
costs and behavioural change. Even if the actual changes to conduct rules are considered minimal or
potential changes to conduct implied by the application of the high-level rules are relatively small, the
evidence from the qualitative research suggests that firms would see the transfer to the new regime as
requiring all responsible and prudent firms nevertheless to review their entire system to reassure
themselves that their existing business systems and processes are fit for purpose with the new regime and
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Overview of the New Regime and our Modelling Approach
that they would not be open to unexpected action from the FCA. Equally, greater resource will be put into
enforcement, which will become stricter. The review process alone could take a significant amount of
resource, regardless of any changes that may then need to be made. Bigger, more complex firms would be
expected to expend more resource on the review, which is a normal consequence of changes in regulator
or in regulation, particularly when the new one says it will be more proactive.
Such a conduct review is likely to be non-trivial. It is also important to consider whether and how the new
regime applies to existing contracts. We understand that Government intends to retain the current rules
for pre-contract information and for the form and content of credit agreements in the CCA secondary
legislation with amendments that are necessary to reflect the change in regulator. In addition it is our
understanding from the FCA that it will apply a ‘going forward’ approach to other rules about agreements
and communications with clients and only treat new contracts entered into post-transfer and actions or
inactions after 1 April 2014 about existing contracts under these rules, i.e. it will not apply the new rules
retrospectively, which would be a cause for concern for lenders and potentially generate a need to “repaper” some or all existing contracts (this may be further complicated by the ‘rolling’ nature of many credit
agreements, e.g. relating to credit cards). The FCA takes the view that the application of rules to existing
contracts referred to above should not involve the re-papering of those contracts, although firms will need
to adjust references to their regulators in documentation, etc. issued from 1st April 2014. Our work
reflects this view.
In considering the new regime there might also have been a requirement to notify existing customers of the
change of the regulator and/or regime (e.g. that the FCA has replaced the OFT and that the CCA has been
— partly — superseded: any correspondence with customers after 1st April will, of course, need to refer to
the new regulator). An extension of this point is the legal status of existing credit contracts which are
underpinned by the CCA — certain stakeholders have expressed the concern that if this is changed such
that the Act is no longer the underpinning legal framework then some similar notification to customers
could also be necessary. Again it is our understanding from the FCA that this will not be necessary.
This is a very real and live issue for market participants, driven by the fact that a more extensive exercise
involving re-papering and system change would impose significantly higher costs. If substantial costs were
imposed by a requirement to re-paper existing agreements, this may result in a significant level of exit.
Equally it could result in the re-engineering of business models by some firms, or the re-focusing of business
away from (or towards) particular demographics. We revisit this scenario in the following sections (in
particular at 5.2).
The change in regime also means that additional regulatory and supervisory tools will be available. An
important potential source of benefit relates to an increased deterrent effect exercised on firms to prevent
them from committing wrongdoing, and the ability to take swift strong action against those that do. The
FCA’s enforcement powers are much greater than those of the OFT, enabling it inter alia to:
withdraw authorisations and approvals;
stop an individual from carrying out specific regulated activities;
suspend a firm for up to 12 months from carrying out specific regulated activities;
publicly censure firms and approved individuals;
impose substantial financial penalties;
seek injunctions;
seek restitution orders; and
prosecute firms and individuals who undertake regulated activities without authorisation.
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Overview of the New Regime and our Modelling Approach
3.15.1 Modelling approach
We have focused upon some of the issues around the transfer in regime from the OFT to the FCA. The
calculation of the cost of the conduct review had two parts: a de minimis period in days and a variable
component linked to the estimated number of customers. Once combined these provided estimates that
reflect the restricted nature of the review (i.e. no need to re-paper existing contracts and no major system
changes because the conduct rules are remaining broadly the same — as described at 3.15 above — such
that implied change may be arguably classified as due to current non-compliance with those conduct rules).
Provided that the FCA will be concerned only with the application of the new regime to post-transfer
contracts, then it can be argued that there is no obligation on firms to do anything about the pre-transfer
paperwork (assuming that client contact in the normal course of business is enough to deal with rolling
contracts). If participants believed there to be any ambiguity here or some residual exposure to FCA
action then they might re-paper at least some pre-existing contracts: this could be expensive. This
contingency might result in a level of cost attributable to this area several times that represented here. For
example, the banks’ stated experience with the CCA can be used for comparative purposes. Taking the
numbers provided to us (£5-£10m per large bank) at face value and noting that the largest banks have 5
million to maybe 12 million contracts (some customers will have multiple contracts) implies a cost per
customer of 40 pence up to £2. This level of cost incorporated re-papering and also system and process
change, however: given the intention of not changing conduct requirements, then this level of costs should
not be fully replicated for re-papering alone.
Clear — and early — guidance from the FCA on the details of the policy framework would help keep such
costs down, e.g. identifying where the CCA will still apply, etc. Limited permission firms will only have a
fraction of the FCA rule book to assess and think about, but in most cases these will have little or no prior
exposure to it: therefore the more pointers that the FCA can provide to what firms need to look at (or
indeed, avoid looking at) the better in order to reduce any regulatory culture-shock. Equally, more
guidance in user-friendly language will be valuable.
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Compliance Costs and Firm Behaviour
4 Compliance Costs and Firm
Behaviour
4.1 Introduction
In this section we consider the impact of the policies described previously upon each of the segments
identified within the consumer credit sector.
For each segment we quantify the incremental compliance cost impacts by proposal and in aggregate, and
also show separately how these divide between one-off and on-going costs. We describe the underlying
assumptions of our analysis, and identify the key cost drivers. We also describe the interaction between
these estimates and the assumptions made about firm behaviour, particularly market entry and exit.
4.2 Understanding and Measuring Compliance Cost
Compliance costs are “the costs to firms and individuals of those activities required by regulators that
would not have been undertaken in the absence of regulation.”14 Compliance costs do not therefore refer
to those costs incurred by firms in activities which contribute to meeting the requirements set out by the
FCA but which would have also been undertaken in the absence of regulation. This can also work the
other way: for example, being FCA-regulated can give firms a “badge” they may be able to use to reassure
customers of the quality of their internal procedures. In the absence of regulation firms might have to
engage in additional expenditure on quality systems or brand positioning advertising to sustain the same
portfolio of products, or to hold additional capital to assure customers of their good standing.
It is important to recognise that relevant changes are not simply incurred by compliance staff or what might
be considered directly as compliance activity. Rather the costs of compliance also include those costs
arising from the distortion of business practices not directly involved in compliance. A blunt example
would be if practices were changed to comply with the letter of the regulation but not its spirit. More
subtly, it may be that in order to comply with certain regulation then more highly skilled non-compliance
employees are required, increasing staff costs. In this sense, standard compliance costs can underestimate
the costs of compliance.
The scale of incremental compliance costs of financial regulation is largely associated with firms having to
address the challenges of ensuring any of the following:
Any change or increase of regulations — forms, accounts to report, business plans to submit, training
required — that firms have now had to comply with.
Any changes in the quality of the compliance expected or recorded by local regulators (the higher the
expected compliance quality, the higher the cost).
Any change in the required level of prudential capital.
Any change in the effectiveness of the monitoring of compliance (and, in particular, the recognition of
this by firms), to the extent that this is reflected in a firm’s approach to compliance.
14
“Cost-Benefit Analysis in Financial Regulation, How to do it and how it adds value”, Isaac Alfon and Peter
Andrews, FSA, (1999).
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Compliance Costs and Firm Behaviour
All of these factors are likely to be relevant to the switch of regime from the OFT to the FCA, at least to a
degree. However quantification of all of these is not possible in a robust fashion. In such cases we address
these issues qualitatively.
4.3 Link between the Direct Impact of Compliance Costs and the Behaviour
of Existing Suppliers
Our behavioural analysis considered the expected impact of regulatory proposals on:
The nature of the market and the competitive dynamic within it;
The degree of market participation of certain types of firms (i.e. potential market exit or entry);
The business model and strategy of firms operating in the consumer credit market;
The mix of products in the market, their structure and pricing;
The supply of credit, overall and for different product types and customer segments; and
The potential for unintended or damaging effects.
The behavioural analysis, therefore, covered not only the impacts of the regulatory change for firms but
also the knock-on implications of any changes in firm behaviour for consumers. We have taken profitability
to be the baseline criterion that drives business decisions. When faced with multiple possibilities, we have
assumed that firms will choose the option that would lead to the highest profits.
Firms’ decisions typically affect outcomes in multiple time periods. In that case, firms must consider the
present value of the profits of all future periods, discounted by the appropriate factor (i.e. their cost of
capital). In addition, firms have often multiple revenue streams. When firms engage in various activities,
the total revenue is the sum of revenues from each separate product or service.
To construct our model for expected firm behaviour, and so conduct this analysis, we have made some
simplifying assumptions:
If profits, after deducting the compliance costs and an appropriate return to shareholders, remain
above a minimum level the firm would not exit the market (even if could earn greater returns on
investment elsewhere).
If profit becomes falls below this minimum in the long-term and the business cannot be made profitable,
the firm will always exit the market.
Our starting point has been the reported costs, revenue and profit taken from the quantitative survey
(typically relating to 2011). We have made two important adjustments to non-regulatory operating costs in
assessing a firm’s profit:
First, we have assumed that the owners of firms require a certain economic return from the business:
we have calculated this as a percentage of net asset value (many firms in the Policis survey (conducted
prior to CP13/7) sample are unquoted or else the quoted vehicle is not a consumer credit specialist: so
market value data are not fully available).15,16 This means that the decision point is not simply when
15
16
Firms were asked to identify a sale value of their business — however this was not well-answered (and may, of
course, have been biased upwards significantly in some cases).
We have adopted 7.5 per cent as the required pre-tax return for these calculations (about 5.7 per cent post-tax),
which has been applied to the firms’ net asset position as a broad proxy for the book value of equity. By way of
comparison, long-term stock market post-tax return data are in the range 5.5–7 per cent (across all sectors) — of
course, this is a return achieved on the market value of equity, rather than its book value. Examining the available
sample of quoted firms including both banks and consumer credit specialists (including firms not participating in the
Policis survey conducted in the context of the March consultation), we have calculated the post-tax return
achieved on the book value of equity to be 4.4 per cent in 2011 (calculated using cumulative data extracted from
- 33 -
Compliance Costs and Firm Behaviour
profits less incremental compliance costs fall below zero — our decision point would come well before
this due to including this opportunity cost within our calculations.
Second, in smaller owner-managed firms, it is often the case that the owners will seek to remunerate
themselves through a mixture of salary and dividend and this can be often driven by tax considerations.
It follows that the reported profit may not reflect underlying profitability well. We have adjusted the
reported profits of small firms (with turnover equal to or below £250,000 per annum) so that
remuneration paid to the apparent owner in excess of the average for the segment is added back to
profits.
We focus here on the impacts of the completed shift to the FSMA regime. However, there will be a
transitional period, between April 2014 when the OFT closes and April 2016 when the FCA will be ready
to introduce its full consumer credit regime.17 Firms will be likely to incur different costs during the
transition period and after it. We have assumed, in effect, that firms will look ahead to the total one-off
costs to be incurred and the likely level of on-going costs in making their assessment of whether to stay in
the market or not. This is a strong assumption: some firms could decide to stay in the market for at least
part of the interim period (2014-16) and then exit. Indeed we have assumed that one-third of those firms
intending to exit would not do so before the interim permission payment falls due (e.g. because of a waitand-see strategy, or the time taken to find a buyer or otherwise run down a loan book, etc.). On the other
hand, our approach predicts that it is the most marginal firms that would exit, so the tipping point for such
firms may be quite low.
When a new regime is introduced, firms will typically bear incremental costs. These additional costs can be
classified into one-off and on-going costs. It is also important to understand how these costs map into
fixed and variable costs. While one-off costs are fixed, on-going costs can be either fixed or variable,
depending on whether their value varies with output. For example, renewing permission every period
would be an on-going fixed cost. On the other hand, training new employees in regulatory compliance
could be considered an on-going variable cost, as the number of new employees would depend on the
volume of sales. Such variable costs have greater scope to be absorbed into “business as usual” costs.
There are a number of possibilities that will determine how a firm will respond to these incremental
compliance costs and we developed a model to determine how a firm may react based upon stylised
assumptions around the factors underpinning business decisions. In particular the model considered the
likelihood of:
No change in the business’s operations;
A change in the business strategy — including the potential for a firm to increase prices and/or reduce
supply, to specific customers or across the board, and to change the range of products/services it
offers;
17
published accounts). The median is 3.2 per cent. Using the same group, the median cost of equity is 4.0 per cent
(again this is post-tax). In fact, within reasonable parameters from the value that we have chosen, the results of
our behavioural model are not overly sensitive to this figure: if a rate of six per cent was used, no difference in
behavioural change would be predicted. At nine per cent, then of the firms in the Policis survey sample an
additional debt management firm, a home credit lender and one non-bank lender would be predicted to exit the
market (from a total of 89 firms in the sample that provided sufficient data to be included within the economic
analysis), with the costs due to the regime transfer one factor alongside the implication that these firms would not
be achieving a sustainable return against such a benchmark anyway.
The proposals for this include the following features:
Firms with OFT licences will be given interim permissions to continue their consumer credit activities until
they obtain FCA authorisation, limited permission (or a variation of permission if they are already FCA
authorised) or else become appointed representatives of authorised firms;
Any prudential and reporting requirements will then come into effect; and
During the transitional period firms will be required to comply with the new conduct standards but
supervision is likely to be less intense than it will be when the full regime comes into effect from 2016
onwards.
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Compliance Costs and Firm Behaviour
Expansion of the business;
Consolidation (i.e. merger); and
Market exit.
In Section 9 we set out the decision tree governing this model and expand upon further considerations
relating to these scenarios — as well as our thoughts relating to revenue, costs, customer acquisition and
uncertainty — that are relevant to the detailed specification of our work but not crucial to understanding
the main thrust of it.
Other factors can play a role in determining firm behaviour, such as uncertainty, concern over regulatory
risk and the impact of market psychology, which are not capable of being robustly captured. We describe
these at 5.2 (in a section on “downside risk”).
4.4 Two-sided Modelling Approach to Measuring Compliance Costs
We have assessed compliance costs under two approaches which we label “bottom-up and “top-down.”
4.4.1 “Bottom-up”
In our bottom-up approach we have used inputs from the Policis survey (conducted prior to CP13/7). This
gathered contextual financial and business information on the firms and data on how these firms
approached compliance with existing regulation and an overview of certain business practices relevant to
the policy mix but not currently subject to regulatory intervention.
In terms of compliance costs there are two major components: the volume of the change and the unit cost.
The volume effect is likely to be heterogeneous because the impact on particular business might be very
business-specific. The unit costs for most relevant inputs for our study (e.g. staff, IT system, marketing or
informational publications, training, etc.) may vary less (on the one hand, (approximately) competitive
supply of these inputs in the market should drive towards homogeneity. However, the specification of
particular inputs — such as people — may be driven by firm-specific requirements). We incorporate into
our methodology approaches designed to check the value of unit costs separately to the survey of firms.
Survey answers can sometimes be partial and self-interested. This applies to both cost estimates and the
assessments of likely behavioural change, and this can be exacerbated where the assessment is ex ante.
Someone who claims that the cost of regulatory changes will force them from the market may believe that
at the time the claim is made, but when push comes to shove shows a capacity for absorbing those costs
and does not exit the market after all. To combat the latter effect we have modelled the impacts of the
policies on firms given what they do now. This has been based as far as possible upon the experience of
firms already subject to equivalent policies. This was enabled by the presence of firms already subject to the
FSMA regime amongst those surveyed.
The estimates of incremental compliance costs generated for each firm were then treated as the firm’s
expectation of the relevant cost impacts and fed into our behavioural model along with the firms’ responses
relating to business strategy in order to generate the relevant behavioural response. The incremental cost
estimates of those firms remaining in the market were then aggregated using population data appropriately
revised for those firms exiting the market.
4.4.2 “Top-down”
In the “top-down” approach we modelled the impact directly upon on the relevant business population in
aggregate. This approach does not reflect the heterogeneity within a segment, e.g. whether a firm already
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Compliance Costs and Firm Behaviour
mirrors a proposed regulation. The aim of this approach is to sense check and complement the bottom-up
estimates.
Where firm-level data were very weak then the top-down approach has been used in isolation. This
applied in full for the following segments: credit unions, online introducers (i.e. aggregators and lead
generators) and credit reference agencies. In addition, the quantitative work conducted by the Policis
survey (conducted prior to CP13/7) did not cover firms with turnover below £250,000 amongst either
non-bank lenders or debt management firms.
For each of these segments, or sub-segments, we also had to consider the behavioural consequences in the
absence of outputs from our behavioural model. We approached this in a largely comparable way, i.e.
structured around the key elements of the behavioural framework developed in the bottom-up approach,
namely:
Would the firm incur additional compliance costs as a result of the change?
Would the firm pass these costs onto consumers without impact on demand?
If the firm cannot pass on costs, would it become unprofitable to continue to operate?
What likely strategy changes could there be?
Evidence for the choices made was drawn from various qualitative interviews, mainly conducted by Policis
in late 2012 and January 2013, but also complemented by our own work.
To reflect an element of the uncertainty in such a top-down approach we applied a range of +/- 10 per cent
to the results generated.
The modelling approach adopted for each policy proposal has been described in Section 3.
4.5 Overview of the Market and the Population of Market Participants
The consumer credit market is a heterogeneous one in terms of its market participants, business models,
products and customers served. The current economic downturn has seen overall volumes fall as lending
criteria have been tightened, particularly by mainstream lenders which have partially withdrawn from nonprime markets. This has put some segments under severe stress.
Table 4.1: Overall Volume of Household Consumer Credit Outstanding (not seasonally adjusted)
Source: Bank of England
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Compliance Costs and Firm Behaviour
The Bank of England and HM Treasury launched the Funding for Lending Scheme (FLS) to encourage
lending to households and companies. FLS was put in place at a time when the Bank of England believed
the likeliest scenario was for UK bank lending to decline. The scheme offers funding for an extended
period and it encourages banks and building societies to supply more credit by making more and cheaper
funding available if more is lent. Whilst funding costs for UK banks have fallen the Bank of England
indicated in its December 2012 Quarterly Bulletin that the impact of the FLS on lending volumes would not
be clear until 2013 (and lending by banks in fact has declined slightly since).
An increased rate of economic recovery would likely be positive for volumes. Profitability would also be
likely to increase, with increased volumes offsetting any increase in the intensity of price competition, at
least in the short term. Any increase in interest rates would probably lag recovery, perhaps significantly.
We expect the upshot of these factors to be that overall volume of the market to stabilise, at worst, and
perhaps experience very modest real growth between now and the transition to the new regime begins in
April 2014 (with the new regime not in its “steady state” until 2016).18 Against the latter, more optimistic
case, would be potential constraints such as a shift in risk aversion amongst banks, and — partly in
consequence — constrained access to wholesale funding for other lenders. The longevity of these effects
remains unclear.
Based upon this assumption about the overall scale of the market we have made estimates of the share of
lending by the individual lender segments identified in this study and similarly estimated the aggregate
revenues in each of these segments, and also of those in non-lender categories. The relative importance of
these is illustrated below.
Table 4.2: Share of Main Segments in Consumer Credit Market Revenues
Source: Europe Economics
Within the overall framework of stable volumes some segments will remain problematic due to declining
lender appetite either to fund participants or to source consumer finance through them. In addition, as we
have already noted parts of the market remain stressed, and it is likely that exit from the market will lag
any stabilisation of market. This is focused on credit intermediaries and — to a lesser extent — upon
smaller lenders (e.g. in home credit).
18
We have not considered trends applicable further out, such as continued decline in retailer finance due to
increased cannibalisation of bricks and mortar retailers by online equivalents which may arguably cause further
consolidation in this segment.
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Compliance Costs and Firm Behaviour
We believe that substantial natural wastage prior to April 2014 is likely and this has been incorporated into
our thinking. Work by Critical Research conducted in June and July 2013 and indicated about 52,000
currently active consumer credit licence holders, in addition to others who have used their licence in the
recent past or else intend to do so in the near future. Taking the latter (about 3,000 firms) into account
gives us our estimated range for the current population: about 54,000–57,000 firms. (The FCA has
identified to us a further “pot” of about 600 market participants not included within Critical’s sampling
range). Our assumptions imply about 4–6,000 of the current market participants leaving the market due to
“natural wastage” before April 2014 (i.e. 7–11 per cent of the firms).
4.6 Summary Results
4.6.1 Overview of the behavioural impacts of the transfer
In 2014 we assume that market participants make an assessment of whether or not to stay in the consumer
credit market once they know the policy mix. In our model, firms form an expectation of what difference
to their business the new regime will make and if this makes staying unattractive/ uneconomic they will take
the decision to leave, and will be expected to put that decision into effect so as to avoid any incremental
costs due to the new regime.
This means those firms that leave due to the regulatory burden avoid any aspects of the transitional regime
— other than the interim permission, and the associated administrative burden. With respect to the latter
we have assumed that one-third of those firms intending to exit would not do so before the interim
permission falls due.
There are — of course — possible counter-arguments to this approach, e.g. firms may need longer to run
down or otherwise exit their business, but this is the rationale that we have adopted, as explained at 4.3
above.
Where we have identified net exit due to either of these factors as “negligible” this does not necessarily
mean that we expect the market participants to remain constant: rather we anticipate that new entry will
match exit.
Table 4.3: Summary of Population of Firms within the Consumer Credit Market 19
Population at
time of 2013
Critical Research
fieldwork
Net exit due to
natural wastage
Net exit due to
new regime
(small; large)
Post-transfer
population
(total)
123 - 130
negligible
negligible
123 - 130
78 - 82
negligible
negligible
78 - 82
548 - 577
5% - 10%
12.5% - 17.5% small;
2.5% – 7.5% other
432 - 507
79 - 83
12.5% - 17.5%
25% - 30%
47 - 52
488 - 513
5% - 10%
10% - 15% small; 0%
- 5% other
385 - 451
Lenders and consumer hire firms
Banks & building societies
Monoline card Issuers
Traditional and brick & mortar lenders
Online payday lenders
Home credit lenders
Other non-bank lenders and consumer
hire
19
4,419 - 4,646
7.5% - 12.5%
15% - 20% small;
0% - 5% other
We discuss briefly how we have modelled the baseline population in the appendix at Section 10.
- 38 -
3,190 - 3,760
Compliance Costs and Firm Behaviour
Credit Unions
Population at
time of 2013
Critical Research
fieldwork
Net exit due to
natural wastage
Net exit due to
new regime
(small; large)
Post-transfer
population
(total)
390 - 410
negligible
negligible
390 - 410
6,125 - 6,441
4,645 - 5,392
Intermediaries
7.5% - 12.5%
17.5% - 22.5%
small; 2.5% - 7.5%
other
14,780 - 17,485
2.5% - 7.5%
7.5% - 12.5% small;
0% - 5% other
8,287 - 9,707
12,288 - 12,917
10% - 15%
22.5% - 27.5%
small; 0% - 5%
other
7,572 - 9,010
625 - 657
negligible
negligible
Credit brokers and other credit
intermediaries
21,795 - 22,912
Secondary credit brokers (motor)
10,238 - 10,764
Secondary credit brokers (non-motor)
Aggregators and lead generators
44,946 - 47,250
625 - 657
31,264 - 36,859
Other firms
Debt management and related
activities
1,537 - 1,616
5-10%
10% - 15% small;
0% -5% other
1,211 - 1,420
Debt collectors and administrators
1,456 - 1,531
negligible
5% - 10% small;
negligible other
1,456 - 1,531
8-9
negligible
negligible
Credit reference agencies
8-9
3,001 - 3,156
2,675 - 2,960
54,072 - 56,847
38,584 - 45,211
In a number of segments the combined effect of natural wastage and exit due to regulatory burden is very
substantial. Focusing here on the mid-points of the ranges in the above table, the combined reduction in
the number of credit brokers is expected to be over 25 per cent over the period, with non-motor
secondary credit brokers down by 35 per cent. However these exiting participants are expected largely to
be those only marginally engaged in the consumer credit market now.
We discuss the exit assumptions in the context of the relevant segments below. Overall it is worth
observing that:
A number of the segments include different types of firm: “debt management and related” includes
commercial debt managers (the focus of specific attention of certain FCA policies), as well as insolvency
practitioners and not-for-profit debt advisers (with the latter able to access concessionary treatment,
e.g. on fees). Exit focused on a sub-segment will show up less clearly at the segment level (in this cases,
we discuss the differences in the text below).
In most segments the level of incremental compliance costs expected are low in the context of the
consumer credit-related revenues generated. Given that the policy mix proposed by the FCA largely
seeks to replicate the conduct requirements of the CCA perhaps this should not be surprising. It is
conduct changes that can give affected firms a choice between reform (and hence incurring costs) or
market exit. We discuss at the end of this chapter a scenario where firms anticipate future changes in
the conduct requirements and describe what the potential consequences might be.
Those more marginal participants will be affected most (and there are more marginal participants than
we had considered in the March Report). This is particularly evident in the credit broker/intermediary
- 39 -
Compliance Costs and Firm Behaviour
and secondary credit broker (i.e. motor and other retailer) segments where the involvement of a
number of firms is currently low-scale (e.g. intermediating low volumes of low value loans). This means
that a large number of exiting firms will not have significant consequences for the consumer credit
market as a whole. (There may still be local effects).
Critical Research asked respondents in June–July 2013 directly about their intentions of staying in the
market, and the strength of those intentions (i.e. certainly/ probably/ etc.). Such intentions may not be
fulfilled (and Critical’s work indicated knowledge of the FCA and of the new regime was frequently
weak) — and may vary significantly with changes in the broader economy. We attributed 100 per cent
likelihood to “certainly”, 75 per cent to “probably would”, 25 per cent to “probably would not”, and 50
per cent likelihood otherwise (i.e. to “don’t know”). Overall applying this simplistic approach would
indicate a transferred population of about 41–42,000 firms, which is within the range identified by our
work. Once one turns to individual segments it should be noted that the degree of exit does not
always match — however, the application of this approach does highlight high levels (above 20 per
cent) of expected exit in segments such as: non-bank lenders, credit brokers, and secondary
intermediaries.
4.6.2 Total one-off and on-going compliance costs by proposed policy
We remind the reader that consumer credit related turnover of up to and including £250,000 per annum is
the FCA’s working definition of a small firm.
Table 4.2: Compliance Cost Impacts for the Entire Consumer Credit Market
Small
£m
Large
£m
£m
Total
£m
£m
£m
Interim
Interim fees
9.3
-
14.2
1.2
-
1.5
10.5
-
Administration
3.4
-
5.5
0.4
-
0.6
3.8
-
6.1
19.7
1.6
2.1
14.3
-
21.8
Fees and administration
12.8
-
-
15.7
Other one-off costs
Authorisation fee
26.6
8.1
19.6
25.4
Authorisation administration
5.2
-
8.8
1.0
-
1.8
6.2
-
10.6
Approved Persons
4.4
-
7.2
1.7
-
3.9
6.2
-
11.2
High-level Principles and Conduct Standards
1.6
-
2.5
0.1
-
1.0
1.7
-
3.6
Supervision and Regulatory Reporting
6.9
-
10.4
3.2
-
8.3
10.1
-
18.6
Complaints and Redress
0.1
-
0.3
0.0
-
7.1
0.1
-
7.5
Financial Promotions
3.8
-
6.5
0.6
-
1.5
4.4
-
8.0
Appointed Representative Regime
7.4
-
10.0
0.1
-
0.1
7.5
-
10.1
STHCC-specific Policies
0.1
-
0.2
1.2
-
1.7
1.4
-
1.9
Debt Management-specific Policies
0.0
-
0.0
0.4
-
1.7
0.4
-
1.7
Retail conduct review
6.2
-
10.0
8.2
-
15.5
14.5
-
25.5
53.2
82.6
24.7
62.3
77.9
144.9
65.9
102.3
26.3
64.4
92.2
166.7
All one-off costs
17.4
46.2
On-going costs
Annual fees
7.6
-
11.9
9.9
-
14.4
17.5
-
26.3
Approved Persons
0.5
-
0.8
0.2
-
0.5
0.7
-
1.3
High-level Principles and Conduct Standards
0.1
-
0.3
0.1
-
0.1
0.2
-
0.4
Supervision and Regulatory Reporting
1.9
-
3.3
0.3
-
1.1
2.3
-
4.3
Complaints and Redress
0.1
-
0.2
0.0
-
1.8
0.1
-
2.0
Financial Promotions
3.3
-
6.5
0.4
-
2.9
3.6
-
9.4
Appointed Representative Regime
9.6
-
12.9
0.1
-
0.2
9.7
-
13.1
STHCC-specific Policies
0.0
-
0.0
0.8
-
0.9
0.8
-
1.0
Debt Management-specific Policies
0.0
-
0.0
0.4
-
2.0
0.4
-
35.9
12.1
23.9
35.1
23.0
- 40 -
2.0
59.8
Compliance Costs and Firm Behaviour
The majority of our analysis is focused upon our characterisation of segments within the overall consumer
credit arena. However we make some introductory remarks on the overall impact and the range of values
generated before turning to these.
Interim fees are closely aligned across the various models: divergence is largely due to the smaller
proportion of sole traders within the Policis survey (conducted prior to CP13/7) sample (six of them, about
7 per cent of the total, against 25 per cent in the top-down model).
The costs of authorisation are a relatively large component within one-off costs. Again the differences
across the models are not substantial here, with some segments within the Policis survey, which was
structured primarily to take in those lenders representing the majority of credit supply, alongside examples
of small and medium size firms and different business models. It does not therefore always match closely
our assumptions about the underlying population of licence holders, which includes a large number of small
firms and firms for whom consumer credit is a marginal activity. In particular larger non-bank lenders are
registering notably higher authorisation costs in the bottom-up models than in the top-down version: the
majority of the firms captured in the Policis survey (conducted prior to CP13/7) sample (seven from 12)
are in the top authorisation fee bracket — higher than we would expect. Equally just two are lower risk
lenders, whereas about one third of the underlying population is estimated to be so-classified. Given the
relatively small sample sizes when one looks at individual segments this is unsurprising.
Supervisory reporting is a large driver of one-off cost — in large part this is driven by the intended
implementation of Product Sales Data reporting within home credit and payday. The next largest driver of
one-off costs is our estimate of the retail conduct reviews. We refer back to our discussion of the
calculation of this at 3.15 above, and note that we consider this a reasonable but nevertheless best case
outcome in this area.
The largest single driver of on-going cost is the annual fees that will payable to the FCA. The figures in the
above table have a mid-point, ignoring those fees payable to the OFT that will be avoided, of about £26–35
million. This is closely aligned to the expected budget for the FCA’s role in consumer credit. It is worth
making the obvious point that the FCA will have substantially more resources to call on than those available
to the OFT — both money to fund a more active approach to enforcement and also more detailed and
regular information on the supervised entities.
We have considered three meta-categories within the relevant population: lenders, intermediaries and
others. Each of these is composed of market segments (such as “banks and building societies”) where we
have focused our analysis.
4.7 Comparison to the March Report
The results presented are somewhat above those presented in our March Report. There are four main
drivers of difference, these being:
Revised base population data. It is also important to note that the base population data upon which we
have based our analysis has changed. In our March report we used Critical Research’s work on the
OFT’s active licensed population as a key parameter. The FCA separately commissioned an update by
Critical Research of its study. This latter work revealed a population larger than that previously
estimated — and we have updated our own models to reflect this. This has consequent implications
on our analysis: for example, the estimates of credit brokers and retailers have increased. The estimate
of lending intermediated through these channels has not changed. The implication is that many of the
additional intermediaries are only marginally attached to the consumer credit market — as such, exit
should be higher. There are several aspects to this:

As identified previously (at 4.5 and Appendix 10) the aggregation of the compliance costs to the
consumer credit industry as a whole are linked in part to the new estimates of the active population
- 41 -
Compliance Costs and Firm Behaviour
made by Critical Research. In our March Report the relevant dataset related to fieldwork
conducted in the second quarter of 2012. An updated population estimate was available to us in
preparing this study — this was based on fieldwork conducted by Critical Research in June–July
2013. Due to the smaller sample driving this updated population estimate and to reflect some of
the uncertainty inherent in any such exercise a population range was introduced as part of the
current analysis. The result is a slightly larger population — particularly in segments (e.g. credit
brokers) where we anticipate significant exit, in part due to depressed market conditions. It is
implied that the proportion of marginally attached firms is larger than previously anticipated.

In consequence of these revised estimates — and also to reflect the simple egress of time — our
assumptions about the scale of “natural” market exit prior to the transfer of regime have also been
adjusted.

In addition we have assumed that one-third of those firms intending to exit would not do so before
the interim permission payment falls due (e.g. because of a wait-and-see strategy, or the time taken
to find a buyer or otherwise run down a loan book, etc.) In the March Report, all such firms exited
before March 2014.

Equally our estimates of the volume and value of lending and other related activities drew upon
statistics published by the Bank of England. The Bank publishes these data on a monthly basis and
there was an automatic updating by us of the associated revenue and volume estimates in
consequence.
Policy changes by the FCA. These include in turn:

We have revised the fees assumptions in line with the FCA’s current thinking. The latter includes
increased concessions for certain categories, e.g. credit unions. The revised authorisation fee
assumptions no longer take into account the size of a firm. This means that — for small lenders
categorise as “complex” by there is a significant increase in the expected authorisation fee. One
possible result is an increased rate of exit — however on-going costs (especially fees) are lower so a
trade-off is in effect, at least for the smallest lenders (provided these are not close to planned
retirement)

The prudential rules to be applied to debt management firms. The base calculation for these has
changed from being a percentage of a firm’s revenue to a (lower) percentage of a firm’s total value
of debt repayment contracts outstanding at a given time.

The application of prudential and client asset rules to not-for-profit debt management firms. At the
time of our March Report not-for-profit debt management firms were exempt from the additional
policies specific to the fee-paying debt management sector. This report reflects the impact of
applying these policies (updated as above) to those not-for-profit debt management charities with
over £1 million in client assets

The treatment of sole traders with employees: sole traders are exempt from the requirement to
have a money laundering or compliance oversight Approved Person — provided that the sole trader
in question has no employees. We estimate that about 30 per cent of sole traders have employees
are would therefore not qualify for this exemption. In the March Report the exemption was treated
as applicable to all sole traders — the adjustment has increased the compliance cost of the
Approved Person regime.

Rules relating to debt management fees have been proposed.

Supervisory reporting has been extended to include PSD for payday and home credit lenders.

Rules specific to HCSTC (e.g. affecting payday lenders) have been incorporated.

Certain rules relevant to lenders have been extended to cover P2P platforms.
- 42 -
Compliance Costs and Firm Behaviour
Revised compliance cost assumptions. These relate either to responses received by the FCA and HM
Treasury to the March Consultations, or else additional evidence uncovered by us as part of our
fieldwork on the revised study. The latter stem from desk-based research on new sources (e.g. those
identified at 2.2 above) or the extended programme of interviews that we conducted as part of this
assignment. Our revised assumptions are:

The on-going cost of the Appointed Representative regime. This was increased to £1500 (£1125
for firms with prior exposure to the Appointed Representative regime) to reflect market
experience cited by respondents to the March Consultation.

Approved Persons. We have increased the time taken on the administrative aspects around the
Approved Person regime from 0.5 to 0.75 days. This reflects scepticism amongst respondents to
the March Consultation that a half day would be sufficient for those not previously familiar with the
Approved Persons regime. A further point on Approved Persons is that the exemptions applicable
to sole traders only apply to those sole traders without any employees. It is estimated that about
70 per cent of sole traders fall into the latter category.
Revised behavioural assumptions. We have noted above that the new starting population contains more
marginally attached firms than we previously believed. We still expect these to exit the market, either
due to natural market wastage or due to the regulatory burden of the new regime acting as a tipping
point. In a number of cases we have revised our modelling assumptions on exit due to the latter factor
to reflect this.
4.8 One-off and On-going Costs by Category
4.8.1 Total one-off and on-going compliance costs by proposed policy for lenders and
consumer hire firms
In line with the March Report we have identified the following broad categories of lender:
Banks and building societies;
Monoline card issuers;
Online payday lenders;
Traditional and bricks & mortar lenders, such as high street payday firms and pawnbrokers:
Home credit providers;
Other non-bank lenders, e.g. those operating in the point-of-sale arena, and consumer hire firms; and
Credit unions.
- 43 -
Compliance Costs and Firm Behaviour
Table 4.4: Compliance Cost Impacts on Lenders and Consumer Hire Firms
Small
Large
£m
£m
Total
£m
£m
£m
£m
Interim
Interim fees
0.8
-
1.2
0.6
-
0.8
1.4
-
2.0
Administration
0.3
-
0.5
0.2
-
0.3
0.6
-
0.8
Fees and administration
1.2
-
1.7
0.8
-
1.1
2.0
-
2.8
Authorisation fee
7.5
-
11.4
4.5
-
11.8
12.0
-
23.2
Authorisation administration
1.1
-
1.7
0.7
-
1.1
1.8
-
2.8
Approved Persons
0.8
-
1.4
1.2
-
2.6
2.1
-
3.9
High-level Principles and Conduct Standards
0.6
-
1.0
0.1
-
1.0
0.7
-
2.0
Supervision and Regulatory Reporting
1.5
-
2.3
3.0
-
7.6
4.5
-
9.9
Complaints and Redress
0.0
-
0.0
0.0
-
5.3
0.0
-
5.3
Financial Promotions
0.5
-
0.9
0.3
-
0.7
0.8
-
1.5
Appointed Representative Regime
-
-
-
-
-
-
-
-
-
STHCC-specific Policies
0.1
-
0.2
1.2
-
1.7
1.4
-
1.9
Retail conduct review
1.5
-
2.2
7.0
-
13.7
8.5
-
15.9
13.8
21.1
18.0
45.4
31.8
66.5
15.0
22.8
18.8
46.5
33.8
69.3
Other one-off costs
All one-off costs
On-going costs
Annual fees
1.2
-
1.7
8.0
-
10.4
9.1
-
12.1
Approved Persons
0.1
-
0.1
0.1
-
0.4
0.2
-
0.5
High-level Principles and Conduct Standards
0.0
-
0.0
0.1
-
0.1
0.1
-
0.1
Supervision and Regulatory Reporting
0.4
-
0.6
0.2
-
0.9
0.6
-
1.5
Complaints and Redress
0.0
-
0.0
0.0
-
1.3
0.0
-
1.3
Financial Promotions
0.4
-
0.8
0.2
-
1.4
0.7
-
2.2
Appointed Representative Regime
-
-
-
-
-
-
-
-
-
STHCC-specific Policies
0.0
-
0.0
0.8
-
0.9
0.8
-
3.3
9.4
15.4
11.5
2.1
1.0
18.8
4.8.2 Total one-off and on-going compliance costs by proposed policy for
intermediaries
Again, in line with the March Report, we have identified the following broad categories:
Secondary credit intermediaries — analysing those operating in motor separately from non-motor; and
Credit brokers and other credit intermediaries;
Online introducers, such as aggregators and lead generators.
- 44 -
Compliance Costs and Firm Behaviour
Table 4.5: Compliance Cost Impacts on Intermediaries
Small
£m
Large
£m
Total
£m
£m
£m
£m
Interim
Interim fees
8.3
-
12.6
0.3
-
0.4
8.6
-
Administration
3.0
-
4.8
0.1
-
0.1
3.1
-
17.3
0.4
0.5
11.6
Fees and administration
11.2
-
-
13.0
4.9
-
17.9
Other one-off costs
Authorisation fee
5.2
-
8.1
0.0
-
0.4
5.2
-
Authorisation administration
4.0
-
6.7
0.1
-
0.3
4.0
-
Approved Persons
3.3
-
5.4
0.1
-
0.2
3.4
-
5.7
High-level Principles and Conduct Standards
1.0
-
1.5
0.0
-
0.0
1.0
-
1.5
Supervision and Regulatory Reporting
5.0
-
7.4
0.1
-
0.2
5.1
-
7.6
Complaints and Redress
0.1
-
0.3
0.0
-
0.0
0.1
-
0.3
Financial Promotions
3.1
-
5.3
0.2
-
0.4
3.2
-
5.7
Appointed Representative Regime
6.7
-
9.1
0.1
-
0.1
6.8
-
9.2
Retail conduct review
4.3
-
7.1
0.4
-
0.5
4.7
-
32.6
51.0
0.9
2.2
33.4
53.2
43.8
68.3
1.3
2.8
45.1
71.1
All one-off costs
-
8.6
7.0
7.7
On-going costs
Annual fees
6.3
-
9.8
0.9
-
2.3
7.2
-
12.2
Approved Persons
0.4
-
0.6
0.0
-
0.0
0.4
-
0.6
High-level Principles and Conduct Standards
0.1
-
0.2
-
-
-
0.1
-
0.2
Supervision and Regulatory Reporting
1.4
-
2.5
0.0
-
0.1
1.5
-
2.6
Complaints and Redress
0.1
-
0.2
0.0
-
0.0
0.1
-
0.2
Financial Promotions
2.7
-
5.3
0.1
-
0.7
2.8
-
6.0
Appointed Representative Regime
8.8
-
11.9
0.1
-
0.2
8.9
-
12.1
30.6
1.2
3.3
20.9
19.7
33.9
4.8.3 Total one-off and on-going compliance costs by proposed policy for other
participants
We have identified the following broad categories:
Debt management, debt advice firms and participants in related areas;
Firms operating as debt collectors and debt administration firms; and
Credit reference agencies.
- 45 -
Compliance Costs and Firm Behaviour
Table 4.6: Compliance Cost Impacts on Other Participants
Small
£m
Large
£m
Total
£m
£m
£m
£m
Interim
Interim fees
0.2
-
0.4
0.3
-
0.4
0.5
-
Administration
0.1
-
0.3
0.1
-
0.1
0.2
-
Fees and administration
0.4
0.7
0.4
0.5
0.7
-
-
0.8
0.4
-
1.1
Other one-off costs
Authorisation fee
4.7
-
7.1
3.6
-
7.4
8.3
-
Authorisation administration
0.1
-
0.3
0.2
-
0.4
0.4
-
Approved Persons
0.3
-
0.4
0.5
-
1.1
0.7
-
1.6
High-level Principles and Conduct Standards
0.0
-
0.1
-
-
0.0
0.0
-
0.1
Supervision and Regulatory Reporting
0.4
-
0.6
0.2
-
0.4
0.6
-
1.1
Complaints and Redress
0.0
-
0.0
0.0
-
1.9
0.0
-
1.9
Financial Promotions
0.2
-
0.3
0.2
-
0.5
0.4
-
0.8
Appointed Representative Regime
0.7
-
0.8
-
-
-
0.7
-
0.8
Debt Management-specific Policies
0.0
0.0
0.4
1.7
0.4
Retail conduct review
0.4
0.7
0.9
1.2
1.3
6.8
10.5
5.9
14.6
12.7
25.1
7.2
11.1
6.2
15.1
13.4
26.3
All one-off costs
-
-
14.5
0.7
1.7
-
1.9
On-going costs
Annual fees
0.1
-
0.4
1.0
-
1.7
1.1
-
2.0
Approved Persons
0.0
-
0.0
0.0
-
0.1
0.1
-
0.2
High-level Principles and Conduct Standards
0.0
-
0.0
-
-
-
0.0
-
0.0
Supervision and Regulatory Reporting
0.1
-
0.2
0.1
-
0.1
0.1
-
0.3
Complaints and Redress
0.0
-
0.0
0.0
-
0.5
0.0
-
0.5
Financial Promotions
0.1
-
0.3
0.0
-
0.8
0.2
-
1.2
Appointed Representative Regime
0.8
-
1.0
-
-
-
0.8
-
1.0
Debt Management-specific Policies
0.0
0.0
0.4
2.0
0.4
2.0
1.2
1.9
1.5
5.2
2.6
7.1
We now turn to the individual segments.
4.9 Banks and Building Societies
Banks are the major players in a range of consumer credit products — credit cards, personal
lending/overdraft; lending at point-of-sale (POS) — which would be affected by the transfer of regime.
This implies the potential for substantial costs — at least in absolute terms. On the other hand existing
exposure to the FSMA regime and the potential for economies of scale at the larger banks may well make
the unit cost effect to each product lower than for specialised firms.
Our estimation of the compliance cost impacts is set out below (NB our analysis of the distribution of firms
in this segment indicated that none were likely to have consumer credit revenues below £0.25 million per
annum).
- 46 -
Compliance Costs and Firm Behaviour
Table 4.7: Compliance Cost Impacts on Banks (including Building Societies)
Large
£m
£m
Interim
Interim fees
negligible
0.1
Administration
negligible
negligible
Fees and administration
0.1
-
0.1
Other one-off costs
Authorisation fee
0.2
0.6
Authorisation administration
negligible
-
0.1
Approved Persons
negligible
-
0.1
High-level Principles and Conduct Standards
negligible
-
negligible
Supervision and Regulatory Reporting
negligible
-
negligible
Complaints and Redress
negligible
-
0.7
Financial Promotions
negligible
-
negligible
Appointed Representative Regime
negligible
-
negligible
3.8
-
9.0
Retail conduct review
Total one-off costs
As % of consumer credit turnover
4.0
10.5
4.1
10.6
0.0%
0.1%
On-going costs
Annual fees
4.7
-
Approved Persons
negligible
-
0.1
High-level Principles and Conduct Standards
negligible
-
negligible
Supervision and Regulatory Reporting
negligible
-
negligible
Complaints and Redress
negligible
-
0.2
Financial Promotions
negligible
-
negligible
Appointed Representative Regime
negligible
-
negligible
As % of consumer credit turnover
6.0
4.7
6.3
0.0%
0.0%
The most significant element in one-off costs relates to the retail conduct review, ranging between £4
million and £9 million across the sector. The lower figure is taken from the bottom-up model; given only a
small number of firms in the sample were willing to provide data, we lean towards the top-down figure (£9
million) as being more representative in this case. The high volume of customers (many with multiple
products) is the major driver here. We note that the response from industry is that these costs could be
even higher, noting that the cost of document and systems changes due to the Consumer Credit Directive
(CCD) was £5-£10 million per major bank: but, as we have described at 3.15, the nature of the regime
transfer is qualitatively different, with the crucial differences driven by the mapping across of existing
conduct rules and the clear signal that the FCA will operate on a “go-forwards” basis only.
Some incremental conduct review costs could be reduced due to the lengthy transition time, such that the
banks could incorporate any necessary changes related to revolving credit, where banks’ communication
with customers is relatively frequent, into business as usual costs associated with regular client contact.
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Compliance Costs and Firm Behaviour
The conduct review estimate include the costs incurred by banks in re-considering their systems to address
high level principles and conduct standards to ensure that these meet the requirements of the new regime,
regardless of whether they would need to make any changes. Given that conduct rules are not changing, it
is implied that any ensuing process change (over and above anything necessary to become compliant with
existing conduct rules) should be limited.
Fees and the associated administrative costs represent the most significant on-going costs, £5–6 million
across the sector. The total top-down one-off and on-going compliance costs represent no more than 0.1
and 0.05 per cent of the segment’s consumer credit turnover respectively. The direct consequences of the
new regime on compliance cost therefore look relatively low and we would expect the implied behavioural
consequences of these costs to be limited. Qualitative indications from the banks were that they would be
in a position to shoulder costs relatively easily. However, more material indirect consequences are also
possible, as we discuss at 5.2.
4.9.1 Behavioural impacts
Only three (very large) banks, responded fully and openly to the quantitative Policis survey (conducted
prior to CP13/7), with some participants providing only limited data sets on the grounds of commercial
sensitivity. The predicted behavioural impacts are therefore drawn from both the model results and a topdown analysis based on qualitative interviews.
Table 4.8: Expected Behaviour of Banks in the Policis Survey
Expected behaviour
No change
Change Strategy
Exit
Behavioural drivers
No change
Exit
No cost impact
Not unprofitable
Only coverable short term losses
Wider firm benefits offset losses
Can pass through to customers
Already exiting
Unprofitable for a number of reasons
Other reason for exit
Small firms
Large firms
0
0
0
3
0
0
Small firms
Large firms
0
0
0
0
0
0
0
0
0
3
0
0
0
0
0
0
As might be expected, the additional compliance costs for the banks represent a very small increase in
operating costs. No exit is predicted for the banks in the sample, and indeed across the board, we are not
expecting any net exit from this market as a result of the change in regime. This segment has seen a small
degree of new entry in the past few years, but we do not anticipate the regime transfer to promote further
entry in its own right.
Our understanding is that most large banks’ focus on customer, rather than product, profitability. This has
driven a focus on cross-sales. It is likely that such banks would wish to spread the additional compliance
costs across the whole of their product offerings, absorbing them where they choose. For example feecharging accounts have become an increasingly important source of revenue. These may provide some
means of cost-recovery, even if outside consumer credit.
Regulatory pressure in recent years has resulted in the significant decline in credit card revenues from
over-limit and penalty fees — this implies less scope to increase revenues from these products (which
- 48 -
Compliance Costs and Firm Behaviour
make up a significant proportion of banks’ consumer credit lending). If we take it that the demand for
credit is stable and not increasing, this suggests that the extent to which costs could be passed onto credit
consumers is minimal, at least in this part of the banks’ business. The qualitative feedback indicates that
larger banks may largely absorb compliance costs.
The economic situation places pressure on revenues and costs in general, and makes it more difficult to
achieve margins on lending in particular. This could be exacerbated by new compliance costs.
It would seem that many banks have little interest in taking advantage of exit — if any — by specialist
lenders from niche and sub-prime markets. This stance reflects risk appetite and current market
conditions. There is an expectation of less availability in point-of-sale credit (affecting motor and other
areas, and possibly prompting some sector rationalisation). The driver here would be the impacts on the
distribution chain rather than on the banks per se. If a retailer does not wish to be licensed by the FCA it
may wish to make use of the appointed representative regime such that the lending institution (likely to be
a bank as responsible for majority of POS lending) takes responsibility. However, banks are in general not
keen on fulfilling this role due to the risk of liability, potentially leaving retailers with no real options for
fulfilling the regulation if obtaining a limited permission is not a feasible option for the retailer — this may
mean that the consumer credit element might fall away (although the FCA’s proposed policy mix which
incorporates a limited permission for secondary credit brokers may restrict this somewhat). This is likely
to be a larger issue for motor point-of-sale given the role consumer credit has here — and that it may be
less substitutable by other forms of credit (e.g. transaction sizes are typically too large for credit cards or
other forms of unsecured credit available in the market). We discuss these points further at 4.16 and 4.17
below.
Banks may also be affected indirectly through negative impacts of the regime on aggregators, which are
responsible for introducing banks to some new consumer credit customers. Based on the qualitative
interviews with aggregators and our analysis at 4.19 a material negative impact looks unlikely.
4.9.2 Building societies
There is a statutory requirement on the FCA to report separately upon building societies. Therefore we
present below the contribution of building societies to the above analysis. Only one building society
participated in the quantitative survey so data scarcity means that the following analysis is driven by the
top-down approach (although we note that there are thought to be only six building societies currently
active in the consumer credit market).
Notwithstanding this building societies in aggregate have consumer credit outstanding of around £5 billion
(Bank of England). Other than these players most building societies do not offer current accounts (just
deposit accounts). Products for the active players include personal loans and overdrafts, with apparently
only some offering credit cards. Product distribution is mostly direct although some involvement through
aggregators and other online introducers is becoming more important.
- 49 -
Compliance Costs and Firm Behaviour
Table 4.9: Compliance Cost Impacts on Building Societies
Large
£m
£m
Interim
Interim fees
negligible
negligible
Administration
negligible
negligible
Fees and administration
negligible
negligible
Authorisation fee
negligible
negligible
Authorisation administration
negligible
negligible
Approved Persons
negligible
negligible
High-level Principles and Conduct Standards
negligible
negligible
Supervision and Regulatory Reporting
negligible
negligible
Complaints and Redress
negligible
negligible
Financial Promotions
negligible
negligible
Appointed Representative Regime
negligible
negligible
0.4
0.5
0.4
0.5
0.4
0.5
0.3
0.1
Approved Persons
negligible
negligible
High-level Principles and Conduct Standards
negligible
negligible
Supervision and Regulatory Reporting
negligible
negligible
Complaints and Redress
negligible
negligible
Financial Promotions
negligible
negligible
Appointed Representative Regime
negligible
negligible
0.3
0.1
0.0%
0.0%
One-off costs
Retail conduct review
Total one-off costs
On-going costs
Annual fees
% of CC turnover
The administrative aspects of the transfer to the new regime (relating say to obtaining variation of
permissions and approved person approvals) should not present significant problems or costs. Building
societies by and large keep an eye on what is required under FSMA, by the FCA and apply such standards
across the board — because the mortgage business is so dominant having multiple internal codes is unlikely
to make commercial sense. As with any regulatory change in the financial services sector, proper prior
notice on the details of the policies should help reduce the levels of expenditure required. This is because
IT development is crucial (particularly for larger firms) and proper software development needs a high level
of clarity.
We expect the high-level principles (PRIN, GEN and SYSC) to result in some transitional changes and
consequent incremental costs — but these are likely to be small.
The main cost drivers are fees, and the costs of conducting a review of retail conduct. However in the
latter case significant ensuing changes in conduct processes seem unlikely.
- 50 -
Compliance Costs and Firm Behaviour
Behavioural impacts
This level of incremental cost may well not be passed through to consumers by the building societies to the
extent that the main purpose of the current account offer is the cross-selling opportunity. Initiatives aimed
at facilitating account switching may increase price sensitivity on this product.
Exit by existing players is highly unlikely. Those societies not providing consumer credit now are interested
in developing current accounts, possibly on a white label basis. Such a development is unlikely to be rapid
and indeed a slowdown in additional building societies entering the consumer credit sector is likely whilst
they wait for dust to settle on the new regime.
4.10 Monoline Card Issuers
Credit cards are another key source of credit across all groups of consumer. Over 80 per cent of credit
card lending is ultimately sourced from the banks –– this section focuses on specialist credit card issuers
(i.e. excluding the card operations of the banks). This market has changed significantly in recent years.
Credit card profitability has been reduced by changing consumer behaviour (greater use of debit cards
leading to reduced interchange fees; credit cards increasingly used as a payment facility by better-off
consumers leading to reduced penalty fee income; and increasing intolerance of card fees by prime
consumers who switch easily). Regulatory intervention has reduced the income from fees, payment
allocations and insurance. Lending to lower income and higher risk borrowers has also declined (these
were responsible for significant proportion of the penalty fee income).
The sub-prime card sector is re-emerging and becoming more competitive, with new entrants offering
dedicated sub-prime propositions, although these are not currently of the scale to compensate for
shrinking availability of credit in the mass-market. Innovation in the sub-prime market includes offerings of
a range of cards to different risk segments, and dedicated sub-prime specialists serving lower income and
higher risk consumers. Business models in this sector are different to mainstream card issuers in a number
of ways: e.g. penalty fees are a more important revenue source while interchange fees, which are important
to mainstream card issuers, represent a small share of revenues. It may be that there is greater scope to
pass costs on in this sector than in the mainstream card sector.
Card issuers are largely familiar with the FSMA regime in other contexts and are confident they can adapt
to the changed requirements. However, there is concern around the level of costs for less large card
providers. Our estimation of the compliance cost impacts is set out below:
- 51 -
Compliance Costs and Firm Behaviour
Table 4.10: Compliance Cost Impacts on Monoline Card Issuers
Large
£m
£m
Interim
Interim fees
negligible
negligible
Administration
negligible
negligible
Fees and administration
negligible
-
negligible
Other one-off costs
Authorisation fee
0.2
0.5
Authorisation administration
negligible
-
0.1
Approved Persons
negligible
-
0.4
High-level Principles and Conduct Standards
negligible
-
0.1
Supervision and Regulatory Reporting
negligible
-
negligible
Complaints and Redress
negligible
-
0.4
Financial Promotions
negligible
-
negligible
Appointed Representative Regime
negligible
-
negligible
0.6
-
0.8
Retail conduct review
Total one-off costs
As % of consumer credit turnover
0.8
2.3
0.8
2.3
0.0%
0.1%
On-going costs
Annual fees
0.8
-
1.1
Approved Persons
negligible
-
negligible
High-level Principles and Conduct Standards
negligible
-
negligible
Supervision and Regulatory Reporting
negligible
-
negligible
Complaints and Redress
negligible
-
0.1
Financial Promotions
negligible
-
negligible
Appointed Representative Regime
negligible
-
negligible
As % of consumer credit turnover
0.8
1.2
0.0%
0.1%
The authorisation process (fees and administration) and the conduct review costs are again the largest oneoff costs. Annual fees are the largest element of on-going costs.
4.10.1 Behavioural impacts
Three specialist credit card issuers (i.e. not including banks that also issue credit cards) participated in the
quantitative survey, albeit more issuers provided a qualitative view. The predicted behavioural impacts are
therefore drawn from both the model results and a top-down analysis based on qualitative interviews
(including one conducted by Europe Economics).
- 52 -
Compliance Costs and Firm Behaviour
Table 4.11: Expected Behaviour of Monoline Card Issuers in the Policis Survey
Expected behaviour
Small firms
No change
Change Strategy
Exit
0
0
0
Behavioural drivers
No change
Exit
Small firms
No cost impact
Not unprofitable
Only coverable short term losses
Wider firm benefits offset losses
Can pass through to customers
Already exiting
Unprofitable for a number of reasons
Other reason for exit
0
0
0
0
0
0
0
0
Large firms
3
0
0
Large firms
0
2
0
1
0
0
0
0
The three firms responding to the survey were all very substantial firms. The compliance costs represent a
small increase in operating costs for these firms. One of the lenders is a particular case, with negative
profits after adjusting for the required rate of economic profit that we have assumed. We contend that it
is unlikely that this firm would exit the market as a result of the regime in isolation, but given its negative
profits exit for other reasons cannot be ruled out. This firm’s detailed response indicates that wider firm
benefits would offset any increased compliance costs, i.e. it expects to stay.
Given the current market it is unlikely that mainstream firms will be able to pass on costs to consumers
without impacting demand, particularly given the stated reluctance by better off consumers to pay fees and
the rise in alternative payment facilities (debit cards). A change in strategy towards more sub-prime lending
may be a possibility if this business model is better able to pass on costs to consumers through penalty fees.
Given the relatively low level of cost it is unlikely that the compliance costs directly attributable to the new
regime would drive significant behavioural change. Some customer segments may be worse off than others
where margins are particularly low — nevertheless we do not foresee any net exit as a result of the regime
change.
4.11 Online Payday Lenders
The online payday market has experienced rapid growth in the past few years, largely due to shrinking
availability of credit in the mass mid-market; significant investment in marketing activity; and the explosion
of internet-based credit infrastructure. Many firms in the market, particularly small and medium sized ones,
are in the start-up phase (i.e. losing money until they build scale). The online payday business model
generally has a higher risk profile with a higher incidence of loan roll-overs than bricks & mortar payday
lenders. Customers tend to be more upmarket with greater use of other types or credit.
The table below presents our estimates of the compliance costs to online payday lenders.
- 53 -
Compliance Costs and Firm Behaviour
Table 4.12: Compliance Cost Impacts on Online Payday Lenders (Excludes Net Lost Revenues due to
High Cost Short Term Credit-specific Policies)
Large
£m
£m
Interim
Interim fees
negligible -
negligible
Administration
negligible -
negligible
Fees and administration
negligible
-
negligible
0.4
-
0.6
Authorisation administration
negligible
-
negligible
Approved Persons
negligible
-
0.1
High-level Principles and Conduct Standards
negligible
-
negligible
0.6
-
3.7
Complaints and Redress
negligible
-
negligible
Financial Promotions
negligible
-
negligible
Appointed Representative Regime
negligible
-
negligible
STHCC-specific Policies
0.5
-
0.8
Retail conduct review
0.1
-
0.3
Other one-off costs
Authorisation fee
Supervision and Regulatory Reporting
Total one-off costs
As % of consumer credit turnover
1.6
5.5
1.6
5.5
0.4%
1.3%
On-going costs
Annual fees
0.2
-
0.2
Approved Persons
negligible
-
negligible
High-level Principles and Conduct Standards
negligible
-
negligible
0.1
-
0.3
Complaints and Redress
negligible
-
negligible
Financial Promotions
negligible
-
0.1
Appointed Representative Regime
negligible
-
negligible
0.5
-
0.6
Supervision and Regulatory Reporting
STHCC-specific Policies
As % of consumer credit turnover
0.8
1.2
0.2%
0.3%
The key cost one-off driver relates to the systems and other preparatory costs associated with supporting
the reporting of PSD to the FCA.
The HCSTC-specific policies generate notable direct compliance costs — however the main effect is in the
form of market exit and foregone revenues: it is important to note that these effects are excluded from the
above table and are discussed in Chapter 8.
The other most significant one-off costs are the authorisation process and the conduct review costs. The
latter is relatively small compared to other lender categories, driven largely by the relatively low number of
customer contracts. And — given the online nature of the firms — this might still over-state the cost
impact.
- 54 -
Compliance Costs and Firm Behaviour
Compliance costs represent a small proportion of consumer credit turnover for online payday lenders.
4.11.1 Behavioural impacts
The Policis survey contains a mix of firms, with several firms with annual revenues below £1 million.
Table 4.13: Expected Behaviour of Online Payday Lenders in the Sample
Expected behaviour
Firms
No change
Change Strategy
Exit
3
3
2
Behavioural drivers
No change
Exit
Firms
No cost impact
Not unprofitable
Only coverable short term losses
Wider firm benefits offset losses
Can pass through to customers
Already exiting
Unprofitable for a number of reasons
Other reason for exit
0
3
0
0
3
0
0
2
The compliance costs of the new regime do not drive the profits of any firm below zero, and thus our
model predicts that no firms will exit as the sole result of complying with the new regime. These results
exclude the HCSTC-specific policies that have been developed by the FCA subsequent to CP13/7 (and
which are discussed below and, at greater length, in Chapter 8). The two firms that are predicted to exit
anyway have losses (even before making our adjustment for an appropriate economic return). We believe
that these firms are in the start-up phase of their existence, i.e. expected to lose money until they build
scale. Such firms may not exit the market even though they have negative profits. Indeed, one of these
firms indicated that its costs would have to increase by up to 30 per cent for it to leave the market.
However, as we discuss below, the potential impact of the HCSTC-specific policies is very significant, even
in this context.
4.11.2 Impact of the HCSTC-specific policies
The HCSTC-specific policies, in particular the cap of two rollovers and the restrictions on CPA use, are
likely to have a significant impact on industry revenue, as these mechanisms represent important elements
of firms’ ability to collect revenue from customers who do not repay loans first time around. These
policies could affect up to £200 million of revenues, and sufficiently impact firm profits to as to lead to
market exit of between 25 and 30 per cent of payday lenders. Chapter 8 presents our detailed analysis of
the impacts of the HCSTC-specific policies.
- 55 -
Compliance Costs and Firm Behaviour
4.12 Traditional and Bricks & Mortar Lenders
This segment includes traditional lenders, e.g. pawn-brokers, and bricks and mortar payday lending (and
hybrids combining both these — and potentially other — business models). The profitability of pawnbroking increased in recent years driven by the rise in the gold price, and there was an associated rapid
growth in the number of pawn brokers: however, a subsequent decline in the price of gold has resulted in
weaker financial performance for these firms.
Smaller traditional payday lenders are facing funding challengers as banks withdraw or limit funding and even
in some cases, reportedly also merchant facilities against a backdrop of fears about reputational and
regulatory risk.
Our estimates of the compliance costs of the new regime are presented below.
Table 4.14: Compliance Cost Impacts on Traditional and Bricks & Mortar Lenders
Small
£m
Large
£m
£m
£m
Interim
Interim fees
Administration
Fees and administration
0.1
-
0.1
negligible -
0.0
0.1
-
0.1
negligible -
negligible
0.1
-
0.1
0.1
-
0.1
Authorisation fee
1.1
-
1.9
1.1
-
2.7
Authorisation administration
0.1
-
0.1
0.1
-
0.1
Approved Persons
negligible
-
0.1
0.1
-
0.2
High-level Principles and Conduct Standards
negligible
-
0.1
negligible
-
0.1
0.2
-
0.3
0.2
-
1.1
Complaints and Redress
negligible
-
negligible
negligible
-
negligible
Financial Promotions
negligible
-
0.1
0.1
-
0.1
Appointed Representative Regime
Other one-off costs
Supervision and Regulatory Reporting
negligible
-
negligible
negligible
-
negligible
STHCC-specific Policies
0.1
-
0.2
0.7
-
0.9
Retail conduct review
0.1
-
-
0.5
Total one-off costs
As % of consumer credit turnover
0.2
0.2
1.6
3.0
2.5
5.7
1.7
3.1
2.6
5.8
4.2%
6.5%
0.4%
0.8%
On-going costs
Annual fees
0.1
-
0.2
0.4
-
0.5
Approved Persons
negligible
-
negligible
negligible
-
negligible
High-level Principles and Conduct Standards
negligible
-
negligible
negligible
-
negligible
Supervision and Regulatory Reporting
negligible
-
0.1
negligible
-
0.2
Complaints and Redress
negligible
-
negligible
negligible
-
negligible
Financial Promotions
negligible
-
0.1
negligible
-
0.4
Appointed Representative Regime
negligible
-
negligible
negligible
-
negligible
STHCC-specific Policies
negligible
-
-
0.4
As % of consumer credit turnover
negligible
0.3
0.1
0.4
0.7
1.5
0.4%
0.8%
0.1%
0.2%
- 56 -
Compliance Costs and Firm Behaviour
The most significant one-off costs for these lenders are related to authorisation fees and the associated
administration; annual fees also represent the most significant on-going costs. As with online payday, the
PSD reporting requirements contribute notably to one-off costs.
The HCSTC-specific policies generate notable direct compliance costs — however the main effect is in the
form of market exit and foregone revenues: it is important to note that these effects are excluded from the
above table.
The conduct review costs are relatively less important so compared to the banks: this reflects the point
that an average customer will have fewer products relative to banks. Costs associated with financial
promotions involve training to familiarise with new requirements, and affect those firms currently only
OFT-licensed.
One-off and on-going incremental compliance costs represent approximately 4–7 and 0.4–0.8 per cent of
consumer credit turnover respectively for small lenders. The impact on larger lenders is significantly less.
4.12.1 Behavioural impacts
Eights bricks and mortar and traditional lenders responded to the quantitative survey. The types of lending
covered include pawn brokers and in-store pay-day. The majority of firms in the Policis survey are
medium-sized with consumer credit turnover of between £1million and £2million (i.e. “large” for the
purposes of the categorisation we have followed below).
Table 4.15: Expected Behaviour of Bricks & Mortar and Traditional Lenders in the Sample
Expected behaviour
Small firms
No change
Change Strategy
Exit
1
1
0
Behavioural drivers
No change
Exit
Small firms
No cost impact
Not unprofitable
Only coverable short term losses
Wider firm benefits offset losses
Can pass through to customers
Already exiting
Unprofitable for a number of reasons
Other reason for exit
0
1
0
0
1
0
0
0
Large firms
5
1
0
Large firms
0
5
0
0
1
0
0
0
Our behavioural model predicts that no firms would exit the market as a direct result of the compliance
costs of the regime change, excluding the HCSTC-specific policies that have been developed by the FCA
subsequent to CP13/7 (and which are discussed below and, at greater length, in Chapter 8). The additional
costs represent less than one per cent increase in operating costs for the firms. The prediction of the
model matches the responses to a direct question in the survey about the level of cost increase that would
be needed for the firms to leave the market — firms indicated they would withstand between five and 25
per cent cost increases before leaving the market, far greater than the actual cost increase represented by
the new regime.
Additional costs (one-off plus on-going) for one firm in the sample represented nearly 29 per cent of
consumer credit profits. This firm is engaged in number of other lending activities including POS lending,
equipment rental and consumer hire. This firm and another are predicted by our model to change pricing
strategy so that they can pass costs onto consumers. The qualitative work suggests that bricks and mortar
- 57 -
Compliance Costs and Firm Behaviour
customers are less likely to use other forms of credit and may have lower demand-price elasticity — so this
pass-through should not impact materially upon demand.
The move to the new regime is not predicted to be unprofitable for any of the specialist pawn-brokers in
the sample. The number and profitability of pawn-brokers grew in recent years driven by the rise in the
gold price (although the gold price has reversed subsequently leading to more challenging conditions), and
up-market business models have increasingly emerged alongside other new lending models focused on
much lower income customers. According to the qualitative interviews, a key driver of profitability is
customer retention, which may limit the ability of pawn-brokers to pass costs onto customers; this is
supported by the responses of these firms to these questions in the quantitative survey. It may be that
smaller players are more heavily impacted by the change in regime if the compliance costs represent a
greater proportion of their profits and they are unable to pass these onto consumers.
On the other hand we understand that a number of small market participants operate hybrid business
models, including — at least in some cases — substantial non-consumer credit activities.
4.12.2 Impact of the HCSTC-specific policies
No firm within the sample used in the quantitative research was exclusively a bricks & mortar-based payday
lender, although several did this in addition to other activities (e.g. pawn). We do not repeat our
description at 4.11.2 here, but consider it likely that similar effects would be experienced by these more
traditional lenders (however, these are only a minority of firms in this grouping).
Based on this evidence we assume that there will be exit of 12.5–17.5 per cent of small players across the
whole segment (the effect on payday lenders would be substantially above this level, as discussed in
Chapter 8). This would mainly of the most marginally attached firms, but also exit amongst shop-based
payday lenders. The latter effect would also drive 2.5–7.5 per cent exit amongst larger firms. We also
model some exit (5–10 per cent) as a result of natural wastage pre-transfer.
4.13 Home Credit Lenders
The home credit market is dominated by a firm with at least 60 per cent of the market, with many longestablished small firms and family businesses. There has been a steady trend towards consolidation.
In general, about a quarter of the home credit customer base has no alternative credit options –– with only
around half using other mainstream credit products.
The table below presents our estimates of compliance costs of the new regime.
- 58 -
Compliance Costs and Firm Behaviour
Table 4.16: Compliance Cost Impacts on Home Credit Lenders
Small
£m
Large
£m
£m
£m
Interim
Interim fees
Administration
Fees and administration
0.1
-
negligible 0.1
-
0.1
negligible -
negligible
negligible -
0.2
negligible
negligible
negligible
-
0.1
Other one-off costs
Authorisation fee
2.6
-
3.8
Authorisation administration
0.1
-
0.2
Approved Persons
High-level Principles and Conduct Standards
Supervision and Regulatory Reporting
Complaints and Redress
Financial Promotions
Appointed Representative Regime
Retail conduct review
Total one-off costs
As % of consumer credit turnover
-
1.0
negligible -
0.8
0.1
negligible
-
0.1
0.1
-
0.1
0.1
-
0.2
negligible
-
negligible
0.6
-
0.8
1.8
-
2.2
negligible
-
negligible
negligible
-
negligible
0.1
-
0.1
negligible
-
negligible
negligible
-
negligible
negligible
-
negligible
0.1
-
0.2
0.2
-
0.4
3.6
5.4
2.9
3.8
3.7
5.6
2.9
3.8
14.6%
21.2%
0.4%
0.5%
On-going costs
Annual fees
0.1
-
0.2
0.2
-
0.4
Approved Persons
negligible
-
negligible
negligible
-
negligible
High-level Principles and Conduct Standards
negligible
-
negligible
negligible
-
negligible
0.1
-
0.2
negligible
-
0.2
Complaints and Redress
negligible
-
negligible
negligible
-
negligible
Financial Promotions
negligible
-
0.1
negligible
-
0.1
Appointed Representative Regime
negligible
-
-
negligible
Supervision and Regulatory Reporting
As % of consumer credit turnover
negligible
negligible
0.2
0.5
0.2
0.7
0.9%
1.8%
0.0%
0.1%
Authorisation fees are a significant one-off cost driver: this is a function of the £10,000 fee and a high
proportion of micro-lenders (with revenues significantly below £250,000 per annum). The other main oneoff cost relates to the set-up of PSD reporting. This is a novel requirement and is likely to be particularly
challenging in a sector where we understand about one in three market participants remains manual ledgerbased.
Administrative costs and fees associated with authorisation and the conduct review cost, are the other
significant elements of compliance costs for both small and large home credit lenders. Authorisations are
higher cost for the small lenders driven by the large number of firms in the section of the market. Small
firms would also be expected to incur proportionately greater costs related to supervision and reporting
and standards training, given the current lack of familiarity with these requirements.
The results of the top-down and bottom-up models are largely aligned, with the bottom-up model results
being somewhat lower. The impact on small home credit firms is relatively large: the impact on larger firms
is much less significant.
- 59 -
Compliance Costs and Firm Behaviour
4.13.1 Behavioural impacts
Seven home credit lenders, ranging from large firms to a sole trader, participated fully in the quantitative
survey.
Table 4.17: Expected Behaviour of Home Credit Lenders in the Sample
Expected behaviour
No change
Change Strategy
Exit
Behavioural drivers
No change
Exit
No cost impact
Not unprofitable
Only coverable short term losses
Wider firm benefits offset losses
Can pass through to customers
Already exiting
Unprofitable for a number of reasons
Other reason for exit
Small firms
Large firms
3
0
0
4
0
0
Small firms
Large firms
0
2
1
0
0
0
0
0
0
4
0
0
0
0
0
0
Our behavioural model predicts that none of the firms in the sample will exit the market due to the direct
costs of the new regime. Although all firms would experience a cost impact, this would not be unprofitable
for any of them — core profitability amongst the survey respondents is quite high. For all bar one of the
firms the additional compliance costs represented a relatively small increase in operating costs (less than
three per cent). For one small firm, on-going compliance costs alone represented around a 16 per cent
increase in operating costs; even this firm would still remain profitable.
Home credit was the only or main product offered by all the firms in the sample and this may also account
for the increase in related costs the firms are willing to sustain. Indeed five firms answered a direct
question on the cost increase that they could sustain before they considered leaving the market. All
responses matched the predicted behaviour from the model; firms said they could sustain in increase in
operating costs of between 5 and 20 per cent, significantly above the actual increase in operating costs
resulting from compliance with the new regime.
We have assumed some natural wastage due to reduced availability of wholesale finance (although market
innovations have ameliorated the effect of this) and increased competitive threat from other sectors. Some
qualitative evidence suggests that some additional exit may occur due to the new regime, particularly
amongst the smaller lenders (especially older small traders) that operate manual paper-based book-keeping
with no computer of internet access. These may perceive the new regime too onerous a change to stay
within the market as an independent,20 even if the actual compliance costs do not outweigh their profits.
On the other hand, the detailed evidence from the survey shows that even small firms would remain
profitable, and that the compliance costs would represent a small increase in their operating costs.
However there may be some selection bias at work here, specifically with those smaller, less automated
firms being under-represented. On balance therefore we model net exit due to the regime transfer of 1015 per cent amongst small lenders and 0–5 per cent of firms with annual revenues above £0.25m. In
addition, we model some exit (5-10 per cent) as a result of natural wastage pre-transfer.
20
One exit route would be selling the loan book to a larger lender, but staying on as a self-employed agent of that
lender.
- 60 -
Compliance Costs and Firm Behaviour
4.14 Other Non-bank Lenders and Consumer Hire
This category includes point-of-sale lenders; secured and unsecured loan providers, as well as firms
providing consumer hire services such as: car and tool hire. One of the largest components of the nonbank lending market (by value) is point-of-sale lenders. This consists of lenders with ‘captive’ retail arms;
those with specific relationships with retailers; and those that lend via intermediaries with whom they have
no formal relationship. Non-bank lenders are becoming increasingly key to retail sales, and particularly
important for independents and low income customers. However, POS lenders have been heavily
impacted by PPI claims and are understood to be more cautious as a result. The Policis survey (conducted
prior to CP13/7) focused on these large lenders, both captive and otherwise.
The table below presents our estimates of the compliance costs on non-bank lenders and consumer hire
firms.
Table 4.18: Compliance Cost Impacts on Other Non-bank Lenders and Consumer Hire Firms
Small
£m
Large
£m
£m
£m
Interim
Interim fees
0.7
-
1.0
0.4
-
0.5
Administration
0.3
-
0.4
0.2
-
0.2
Fees and administration
1.0
1.4
0.6
5.7
1.8
-
-
-
0.8
Other one-off costs
Authorisation fee
3.8
-
Authorisation administration
0.9
-
1.3
0.5
Approved Persons
0.7
-
1.1
1.0
-
1.7
High-level Principles and Conduct Standards
0.4
-
0.7
0.1
-
0.8
Supervision and Regulatory Reporting
0.7
-
1.1
0.3
-
0.5
negligible
0.4
negligible
1.1
-
negligible
0.6
negligible
1.6
negligible
0.2
negligible
1.9
-
4.2
0.5
negligible
2.5
8.0
12.1
5.8
17.3
9.0
13.5
6.4
18.1
2.6%
3.5%
0.2%
0.7%
Complaints and Redress
Financial Promotions
Appointed Representative Regime
Retail conduct review
Total one-off costs
As % of consumer credit turnover
6.4
0.7
On-going costs
Annual fees
1.0
-
1.4
1.6
-
2.1
Approved Persons
0.1
-
0.1
0.1
-
0.2
negligible
-
negligible
0.1
-
0.1
0.2
-
0.3
0.1
-
0.2
negligible
-
negligible
negligible
-
1.0
0.4
-
0.6
0.2
-
0.8
negligible
-
-
negligible
High-level Principles and Conduct Standards
Supervision and Regulatory Reporting
Complaints and Redress
Financial Promotions
Appointed Representative Regime
As % of consumer credit turnover
negligible
negligible
1.7
2.4
2.1
4.4
0.5%
0.6%
0.1%
0.2%
We note that the authorising costs are relatively significant for this sector, both relative to other cost
elements and compared to other sectors, driven by the large number of firms within it.
- 61 -
Compliance Costs and Firm Behaviour
The estimates for small firms in this segment are drawn entirely from our top-down model, as explained
previously. The estimated impact on small firms (driven by our top-down approach) is not trivial: one-off
and on-going costs represent approximately three and one per cent of consumer credit turnover
respectively.
4.14.1 Behavioural impacts
Twelve firms from this segment participated fully in the quantitative survey. The most common consumer
credit activity is point-of-sale lending, but other activities such as secured credit lending, consumer hire and
hire purchase are also covered.
Table 4.19: Predicted Behaviour of Other Non-bank Lenders and Consumer Hire Firms in the Sample
Expected behaviour
No change
Change Strategy
Exit
Behavioural drivers
No change
Exit
No cost impact
Not unprofitable
Only coverable short term losses
Wider firm benefits offset losses
Can pass through to customers
Already exiting
Unprofitable for a number of reasons
Other reason for exit
Small firms
Large firms
0
0
0
8
2
2
Small firms
Large firms
0
0
0
0
0
0
0
0
0
6
0
2
2
0
0
2
The compliance costs related to the new regime represent a small increase in operating costs for all the
firms in the bottom-up sample. Six firms have negative consumer credit profits after we adjust for an
economic return (we consider this supportive of our assumption about substantial natural wastage in this
segment). Of these, two are predicted to be able to pass any cost increase onto customers; two would be
able to offset the costs through wider firm benefits; and two are predicted to exit.
One of the firms that is predicted to exit has low profit and turnover, relative to its asset base. It is
possible that the firm would not exit the market, but if it did it is unlikely that the new regime would be a
significant driver. This firm also stated that it could withstand a cost increase of up to five per cent before
leaving the market; the actual increase represented by the additional compliance costs is well below one
per cent.
Specialist non-bank lenders are becoming increasingly important in the POS market. Lenders with no
captive retailers that lend predominantly to the customers of smaller retailers may be negatively impacted if
these smaller retailers exit the market (i.e. cease to intermediate consumer credit) due to the new regime.
Based on the level of compliance costs set out above we estimate that approximately 15–20 per cent of
small non-bank lenders and consumer hire firms and 0–5 per cent of large firms in this category may exit
the market as a result of the new regime. This is driven, in part, by exit by secondary credit brokers (i.e.
retailers), as discussed below. This is in addition to exit due to natural wastage pre-transfer (see Table 4.1).
- 62 -
Compliance Costs and Firm Behaviour
4.15 Credit Unions
There are about 400 credit unions within the UK. In total the segment has about one million customers,
with about £600 million loans outstanding. Annual income is estimated to be at least £70 million.
The sector has seen significant consolidation in the past, but whereas the number of credit unions has fallen
lending levels are rising and new products are being introduced: the trade association, ABCUL, developed a
current account product which has been adopted by about 25 credit unions. Debt consolidation services
and pre-paid cards are also increasingly seen as the unions seek to enhance their customer offering.
Table 4.20: Compliance Cost Impacts on Credit Unions
Small
£m
Large
£m
£m
£m
Interim
Interim fees
negligible -
negligible
negligible -
negligible
Administration
negligible -
negligible
negligible -
negligible
Fees and administration
negligible
negligible
negligible
negligible
negligible -
-
-
negligible
Other one-off costs
Authorisation fee
negligible -
Authorisation administration
0.1
0.1
negligible -
Approved Persons
0.1
-
0.1
negligible
-
negligible
negligible
-
negligible
negligible
-
negligible
0.1
-
0.1
negligible
-
negligible
Complaints and Redress
negligible
-
negligible
negligible
-
negligible
Financial Promotions
negligible
-
negligible
negligible
-
negligible
Appointed Representative Regime
negligible
-
negligible
negligible
-
negligible
0.2
-
-
0.1
High-level Principles and Conduct Standards
Supervision and Regulatory Reporting
Retail conduct review
Total one-off costs
As % of consumer credit turnover
-
negligible
negligible
0.2
0.1
0.5
0.5
0.1
0.1
0.5
0.5
0.1
0.1
1.7%
2.1%
0.3%
0.4%
On-going costs
Annual fees
negligible
-
negligible
negligible
-
0.1
Approved Persons
negligible
-
negligible
negligible
-
negligible
High-level Principles and Conduct Standards
negligible
-
negligible
negligible
-
negligible
Supervision and Regulatory Reporting
negligible
-
negligible
negligible
-
negligible
Complaints and Redress
negligible
-
negligible
negligible
-
negligible
Financial Promotions
Appointed Representative Regime
negligible
negligible
negligible
-
negligible
negligible
negligible
negligible
negligible
negligible
-
negligible
negligible
0.1
As % of consumer credit turnover
-0.1%
-0.1%
0.1%
0.2%
Credit unions are exempt from the need to pay an interim permission fee and also the periodic fee (the
latter concession is only applicable if the credit union or community benefit society has consumer credit
income below £250,000). In conjunction with the other estimates this implies that small credit unions may
save versus their current obligations to the OFT.
- 63 -
Compliance Costs and Firm Behaviour
All credit unions are authorised by the FCA at present and are party to the approved person regime. It is
considered unlikely that additional approved persons would be required due to the new regime.
Credit unions apply PRIN (for regulated activities and certain ancillary ones) and principles similar to those
embodied in SYSC, although these are not identical: e.g. there is no requirement to have a full-time
compliance officer and few credit unions are thought to have one. All credit unions are encouraged to
work within the spirit of the consumer credit regime now but exemptions exist (these are dependent on
the union’s product mix). This implies some additional cost, at the least to review extant conduct and
associated processes, will be necessary.
4.15.1 Behavioural impacts
Overall incremental compliance costs should be fairly contained with this segment. The ability to pass
through any such cost increase to consumers is potentially limited: interest rate caps (which are currently
tight, but under review) may narrow or even eliminate leeway here. Credit unions that pay dividends could
cut these — or else look at merger options. Indeed, there was a spike in consolidation when the FCA
took over regulation of the sector in 2002 (although the secular trend was towards consolidation at this
time also).
Given the relative scale of the costs presented above any such pressure is expected to be slight and would
not affect the capacity of the overall credit union sector to operate within current or growing demand
levels.
4.16 Secondary Credit Brokers (Motor)
Motor dealers often act as secondary credit brokers — with significant volumes of the motor business
supported by credit provided at point-of-sale. There is a key distinction between large motor retailers with
in-house point-of-sale credit providers, and — typically — smaller dealerships that obtain credit via
relationships with lenders (e.g. banks).
Qualitative feedback indicates that banks and lenders would have little appetite for the appointed
representative regime, as with the non-motor intermediaries which are discussed below. This is expected
to be experienced differentially, with non-dealership participants potentially much less likely to have this
route as a viable option than dealerships. We have therefore modelled the compliance costs assuming that
the majority of motor intermediaries (and almost all large intermediaries) would either acquire a limited
permission, or else exit the market for consumer credit.
We have assumed that about ten per cent of small intermediaries would follow the appointed
representative route — this would likely be towards the upper end of the small definition — and about five
per cent of non-small ones. In the Policis survey (conducted prior to CP13/7), around half of the secondary
motor brokers indicated they would prefer to be an appointed representative. We have scaled back this
proportion due to the reason cited above (i.e. the reluctance of banks and lenders for the appointed
representative regime), and also due to the fact that respondents’ preferences were based upon a
restricted knowledge of the new regime, in particular the likely cost advantages associated with the limited
permission route. If in practice there is little economic advantage of becoming an appointed representative
compared with limited permission, then one would expect the expressed preferences for the AR regime to
reduce. We have assumed that the majority of larger dealerships (i.e. those with consumer credit income
above £250,000 per annum) will become directly authorised.
Our estimates of compliance costs are presented in the table below.
- 64 -
Compliance Costs and Firm Behaviour
Table 4.21: Compliance Cost Impacts on Secondary Credit Brokers (Motor)
Small
£m
Large
£m
£m
£m
Interim
Interim fees
2.1
-
Administration
0.7
-
Fees and administration
2.8
3.4
1.2
-
4.5
0.1
-
0.2
negligible 0.2
0.1
-
0.2
Other one-off costs
Authorisation fee
1.5
-
2.7
negligible -
0.1
Authorisation administration
1.2
-
2.1
negligible -
0.1
Approved Persons
0.9
-
1.3
negligible
-
0.1
High-level Principles and Conduct Standards
0.3
-
0.5
negligible
-
negligible
Supervision and Regulatory Reporting
1.3
-
1.8
negligible
-
0.1
negligible
-
0.1
negligible
-
negligible
Financial Promotions
1.4
-
2.1
0.1
-
0.2
Appointed Representative Regime
1.0
-
1.4
negligible
-
negligible
Retail conduct review
1.4
-
2.1
0.1
-
0.2
9.0
14.1
0.2
0.8
Total one-off costs
11.8
18.6
0.4
1.0
As % of consumer credit turnover
3.8%
5.6%
0.1%
0.2%
Complaints and Redress
On-going costs
Annual fees
1.5
-
2.7
0.3
-
0.6
Approved Persons
0.1
-
0.1
negligible
-
negligible
negligible
-
0.1
negligible
-
negligible
0.3
-
0.6
negligible
-
negligible
High-level Principles and Conduct Standards
Supervision and Regulatory Reporting
Complaints and Redress
negligible
-
0.1
negligible
-
negligible
Financial Promotions
1.3
-
2.1
negligible
-
0.4
Appointed Representative Regime
1.2
-
-
negligible
As % of consumer credit turnover
1.7
negligible
4.4
7.4
0.3
1.0
1.4%
2.2%
0.1%
0.2%
Motor intermediaries will incur a range of compliance costs. Fees and administration are the largest
component of this, followed by costs of training and familiarisation related to financial promotions (where a
process of re-education is likely to be necessary, at the least) and those associated with supervision and
regulatory reporting (where there is no prior experience).
The upper end one-off and on-going cost impact on small motor intermediaries is approximately five and
two per cent of consumer credit turnover respectively. The impact on larger firms is much less marked:
the one-off and on-going costs both represent approximately 0.1–0.2 per cent of consumer credit turnover
respectively.
Where such credit provision is more important to the rest of the business then a better benchmark for
comparison with the incremental compliance costs will be overall business revenues and profit: these firms
are likely to be able to sustain a larger cost increase.
- 65 -
Compliance Costs and Firm Behaviour
4.16.1 Behavioural impacts
Eleven motor intermediaries participated in the quantitative Policis survey (conducted prior to CP13/7). Of
these, seven were large, with the latter’s consumer credit turnover averaging around £4 million.
Table 4.22: Predicted Behaviour of Secondary Credit Brokers (Motor) in the Sample
Expected behaviour
Small firms
No change
Change Strategy
Exit
3
0
1
Behavioural drivers
No change
Exit
Small firms
No cost impact
Not unprofitable
Only coverable short term losses
Wider firm benefits offset losses
Can pass through to customers
Already exiting
Unprofitable for a number of reasons
Other reason for exit
0
3
0
0
0
1
0
0
Large firms
4
2
1
Large firms
0
3
0
1
2
0
0
1
Our model predicts that two firms will exit the market. One is already exiting; the other is already lossmaking. Whilst the model does not indicate any direct exit as a result of the regime, the qualitative
evidence information indicates that some exit is likely, at least for the more marginal players. These
marginal players are likely to be under some economic stress at the moment (as illustrated by the firm in
the sample that is already loss-making) and therefore some exit due to the regime is likely even if the scale
of incremental changes are relatively low.
In addition, evidence from the survey indicates that an apparent low tolerance for an increase in compliance
costs: for example six firms claimed they would no longer find it worthwhile to remain in the consumer
credit market if on-going costs increased by less than two per cent of costs — similar to the average ratio
found amongst smaller intermediaries. On the other hand, four of these six also indicated that remaining in
the consumer credit market was so business-critical that any cost (within reason) would be worth paying.
We note that the other five firms assessed the cost increase necessary for them to consider their
participation at 10–25 per cent, suggesting possibly a degree of polarisation in the market, or, indeed, the
difficulty in answering this question.
We have modelled a net exit as a result of the regime at 7.5–12.5 per cent of the small firms, with 0–5 per
cent exit of larger firms. This is in addition to 2.5–7.5 per cent exit due to natural wastage prior to the
transfer of the regime.
4.17 Secondary Credit Brokers (Non-motor Retail)
These are another category of secondary brokers. Typical constituents might be retailers in the furniture
or electrical sectors, but can also include opticians and dentists. There is a wide spectrum in the way credit
is used in the retail sector: retailers with large, in-house ‘captive’ lenders such as Next Direct; retailers
with formal relationships with finance houses/store card providers; and small retailers with no formal
relationships but reliant on customers accessing credit themselves (e.g. credit cards). Retail credit is
increasingly important for non-prime and low income consumers who have fewer credit alternatives.
The credit element is considered key for major purchases in retail markets and critical to profitability of the
primary business of retailers: 70-80 per cent big ticket retail transactions are on credit, and up to 90 per
- 66 -
Compliance Costs and Firm Behaviour
cent for mail order or catalogue credit. Some large retailers may rely more on the profits from credit than
on margins from product sales. Commissions are an important source of income for small retailers.
Qualitative comments indicate that large parts of the retail business would be unprofitable without the
financial services element. (It is also a fact that some sectors in high street retail — e.g. DIY, electrical —
are under increasing financial stress due ever higher penetration by internet-based retailers. The Centre
for Retail Research predicted 5000 high street shop closures in 2013.) We have assumed substantial
natural wastage in this segment (see Table 4.1).
The appointed representative regime has been highlighted by some stakeholders as a poor fit to the
structure and dynamics of POS retail credit. In any event lenders do not appear willing to take
responsibility for retail outlets, particularly small independents. In addition, retail outlets may need a range
of lenders to fit different credit needs and the multiple-principal model is thought to be unworkable in the
retail context. This regime should not be a problem for captive lenders where control is greater; but may
be much more so for small retail outlets. The latter are therefore likely to face a choice between obtaining
a limited permission themselves, or else taking the nuclear option of exit from the consumer credit market
(which may also imply exit from retail where this is the main driver of profitability).
One clear indication of the Policis survey (conducted prior to CP13/7) and our fieldwork is that there is
little appetite within the POS lenders to act as principals to retail (secondary) credit brokers. Therefore
we have modelled compliance costs and firm behaviour upon the assumption that the majority of these
intermediaries will either opt for limited permission or will exit the market for consumer credit, regardless
of the preferences indicated by the intermediaries or the potential incentive — from their perspective — of
an appointed representative regime. We have assumed that 15 per cent of small and five per cent of large
such intermediaries would be able to adopt the appointed representative regime. As with motor
intermediaries this is somewhat lower than preferences for the appointed representative regime evident in
the survey sample. We have scaled this proportion back to reflect the reasons cited above, and the limited
understanding at the time of the survey of the economic advantages of the appointed representative regime
compared with limited permission.
Our estimates of the compliance costs are presented in the table below.
- 67 -
Compliance Costs and Firm Behaviour
Table 4.23: Compliance Cost Impacts on Non-motor Retail Secondary Credit Brokers
Small
£m
Large
£m
£m
£m
Interim
Interim fees
2.1
-
Administration
0.6
-
Fees and administration
2.7
-
3.4
negligible -
1.2
negligible -
4.6
0.1
0.1
negligible
-
0.1
Other one-off costs
Authorisation fee
1.5
-
2.2
negligible -
negligible
Authorisation administration
0.8
-
1.8
negligible -
negligible
Approved Persons
0.5
-
1.2
negligible
-
negligible
High-level Principles and Conduct Standards
0.2
-
0.4
negligible
-
negligible
Supervision and Regulatory Reporting
1.0
-
1.6
negligible
-
negligible
negligible
-
0.1
negligible
-
negligible
Financial Promotions
0.7
-
1.8
negligible
-
0.1
Appointed Representative Regime
Retail conduct review
1.8
0.7
7.2
-
2.4
1.8
13.3
negligible
negligible
negligible
-
negligible
0.1
0.2
Complaints and Redress
Total one-off costs
As % of consumer credit turnover
9.9
17.9
0.1
0.3
6.6%
11.4%
0.1%
0.2%
On-going costs
Annual fees
1.5
-
2.2
0.1
-
1.1
Approved Persons
negligible
-
0.1
negligible
-
negligible
High-level Principles and Conduct Standards
negligible
-
0.1
negligible
-
negligible
0.2
-
0.5
negligible
-
negligible
negligible
-
negligible
negligible
-
negligible
Financial Promotions
0.4
-
1.8
negligible
-
0.1
Appointed Representative Regime
2.1
4.2
-
2.8
7.5
negligible
0.1
-
negligible
1.2
As % of consumer credit turnover
2.9%
Supervision and Regulatory Reporting
Complaints and Redress
4.9%
0.1%
0.6%
Fees are the largest element of cost for retail intermediaries, including interim fees and administrative costs.
The average cost impact on small retail intermediaries is very significant, with one-off costs ranging from
approximately 7–11 per cent of consumer credit turnover (of course, these firms should also have
significant non-consumer credit related turnover). The on-going impact is also non-trivial, with the
maximum on-going costs representing about five per cent of consumer credit turnover.
4.17.1 Behavioural impacts
Twelve retail intermediaries participated in the quantitative Policis survey (conducted prior to CP13/7).
These included dental practices, interior design firms, jewellers and electrical firms. The majority of the
sample is classified as small.
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Compliance Costs and Firm Behaviour
Table 4.24: Predicted Behaviour of Non-motor Retail Secondary Credit Brokers in the Sample
Expected behaviour
Small firms
No change
Change Strategy
Exit
9
0
0
Behavioural drivers
No change
Exit
Small firms
No cost impact
Not unprofitable
Only coverable short term losses
Wider firm benefits offset losses
Can pass through to customers
Already exiting
Unprofitable for a number of reasons
Other reason for exit
0
9
0
0
0
0
0
0
Large firms
3
0
0
Large firms
0
3
0
0
0
0
0
0
Our model predicts that no retail intermediaries would exit as a result of the new regime, as the additional
compliance costs would not make any unprofitable. However, on-going costs were substantially above the
average for three of the small firms, and it may be that for these the new regime has a more complex effect
than modelled. Against this, of the eight firms identifying a maximum cost increase above which they would
exit, seven matched the predictions generated by our model.
Where businesses across the market expect to experience substantial change or high cost and which do
not consider consumer credit provision at point-of-sale to be critical (because of low incidence or else ease
of substitution through other products) these are likely to look very closely at whether maintenance of
such offers continues to make sense. Indeed, in the Policis survey (conducted prior to CP13/7) although
seven firms considered consumer credit sufficiently important that they would be relatively cost-insensitive,
five firms indicated high cost-sensitivity. Two firms indicated that an authorisation fee at the level currently
envisaged would result in market exit; these and two more considered on-going annual fees at the levels
envisaged would be sufficient to trigger such a decision.
Where such credit provision is more important to the rest of the business then a better benchmark for
comparison with the incremental compliance costs will be overall business revenues and profit. Against
this backdrop the incremental cost levels are obviously less significant.
For smaller retailers for whom retail credit is not a large driver of profitability it may not be worthwhile to
continue to offer this form of credit, leading to an exit from the consumer credit market. We have
modelled market exit of 22.5–27.5 per cent of small retail secondary credit brokers, but only 0–5 per cent
of larger ones. Where this overlaps with the servicing of low income/below-prime consumers, who are
unlikely to be served by bank credit or other substitutes, then this may have adverse effects on those
consumers which we re-visit in the next chapter. In addition, we note that if retailers have to streamline
who they offer credit to (especially if under an AR regime with fewer principals than before) then it is likely
that the non-prime consumers would be most affected.
An important aspect to this question is what would happen to a retailer absent the ability to provide credit.
We assume that a retailer that considers such provision critical to its business but is operating at such a
marginal level such that the incremental costs of authorisation tip the business below economic
sustainability will exit the market. There may be market-led responses which may mitigate the impact of
such exits. Firstly, the increased availability of mobile applications of aggregators and lenders may mean
that consumers can compensate for the absence of credit at point-of-sale by arranging credit through other
means. This would mean an increased search cost for the consumer. The net impact on pricing and credit
- 69 -
Compliance Costs and Firm Behaviour
availability are more ambiguous: greater search effort may secure enhanced pricing (one can argue that POS
credit represents a trade-off for the consumer between convenience and price). On the other hand the
potential loss of the direct link between the loan and the purchased item — e.g. the lenders’ fraud risk
might increase — could imply a higher margin to be charged by the lender in compensation for this.
The above is likely to hold more for the smaller intermediaries. Larger secondary credit brokers are
expected to face a smaller percentage cost increase from the new regime. It is also likely that these would
have wider firm benefits to offering consumer credit to offset any losses (e.g. retaining customers who
would purchase both credit and non-credit related products).
Costs and systems changes are a key concern among retailers, but there is evidence (e.g. our own study on
credit intermediaries21) that considerable IT support is provided by lenders to POS credit brokers.
In terms of exit from the overall credit market, it is unlikely that profitable retail intermediaries that rely
heavily on POS credit will be able to cease to provide this type of credit, and will absorb any direct costs
that cannot be passed onto consumers. However, consumer appetite for this credit may diminish if the
requirements are too onerous. Where the retailers’ overall profitability is already under severe stress (due
to the current economic conditions or secular trends such as — for bricks & mortar retailers, at least —
increased on-line competition) then it is at least possible that an exit from retail would coincide with an
exit from consumer credit provision. The transfer to the new regime would effectively be acting as the
“straw that broke the camel’s back” in such a case.
4.18 Credit Brokers and Other Credit Intermediaries
This segment includes a variety of business models: these include independent financial advisers (IFAs),
insurance brokers, credit brokers, loan finders, and mortgage brokers. Credit brokers per se are a
relatively small component within this. There are a large number of small firms, many of whom are not
specialist in consumer credit (e.g. IFAs). This segment has been particularly adversely affected by the
current economic condition, e.g. secondary mortgage lending was important to this channel. It may also be
being substituted by either an increased focus by lenders on direct relationships with borrowers or else by
technological innovation (i.e. online introducers such as aggregators — claimed to be involved in 30 per
cent of credit card acquisitions — and lead generators).
The table below presents our estimate of the compliance costs for credit brokers.
21
Europe Economics (2009), “Study on Credit Intermediaries”, undertaken for the European Commission.
- 70 -
Compliance Costs and Firm Behaviour
Table 4.25: Compliance Cost Impacts on Credit Brokers and Other Credit Intermediaries
Small
£m
Large
£m
£m
£m
Interim
Interim fees
3.9
-
Administration
1.6
-
Fees and administration
5.6
5.6
2.3
-
7.9
0.1
-
0.2
negligible 0.2
negligible
-
0.2
Other one-off costs
Authorisation fee
2.0
-
3.0
negligible -
0.2
Authorisation administration
1.8
-
2.7
negligible -
0.1
Approved Persons
1.9
-
2.8
negligible
-
0.1
High-level Principles and Conduct Standards
0.4
-
0.5
negligible
-
negligible
Supervision and Regulatory Reporting
2.6
-
3.8
negligible
-
0.1
Complaints and Redress
0.1
-
0.1
negligible
-
negligible
Financial Promotions
0.9
-
1.3
negligible
-
0.1
Appointed Representative Regime
3.9
-
5.3
0.1
-
0.1
2.0
-
-
0.1
Retail conduct review
3.0
0.1
15.6
22.5
0.2
0.8
Total one-off costs
21.2
30.4
0.4
1.0
As % of consumer credit turnover
5.6%
7.7%
0.1%
0.2%
On-going costs
Annual fees
3.1
-
4.6
0.4
-
0.5
Approved Persons
0.2
-
0.4
negligible
-
negligible
High-level Principles and Conduct Standards
0.1
-
0.1
negligible
-
negligible
Supervision and Regulatory Reporting
0.9
-
1.3
negligible
-
negligible
negligible
-
0.1
negligible
-
negligible
Financial Promotions
0.9
-
1.4
negligible
-
0.2
Appointed Representative Regime
5.4
-
7.4
0.1
-
0.1
10.6
15.3
0.5
0.8
2.9%
3.8%
0.1%
0.1%
Complaints and Redress
As % of consumer credit turnover
Fees are again a significant compliance cost, driven by the large number of firms.
As with other intermediaries, costs associated with training, reporting and familiarisation are also significant,
representing a notable shift in requirements from the OFT-regime to the FCA regime.
The cost estimates from the top-down and bottom-up models are largely aligned, with the exception of the
authorisation fees for small brokers. Given that the bottom-up model includes a quantitative survey
response from only one small broker, we prefer the top-down cost estimate being the lower of the two.
Given this, one-off and on-going compliance costs represent approximately 6–8 and around 3–4 per cent of
small firms’ consumer credit turnover respectively. It is likely that credit brokers offering a range of
products in addition to consumer credit use credit offerings as a means of attracting and retaining clients,
even if these are unprofitable in themselves. Therefore for these firms a better benchmark for comparison
with the incremental compliance costs will be overall business revenues and profit.
- 71 -
Compliance Costs and Firm Behaviour
4.18.1 Behavioural impacts
Five firms in this segment participated fully in the quantitative survey conducted by Policis; only one is
classified as small, i.e. consumer credit turnover below £250,000. The larger firms have consumer credit
turnover ranging from just under £1million to just over £4 million.
Table 4.26: Predicted Behaviour of Credit Brokers and Other Credit Intermediaries in the Sample
Expected behaviour
Small firms
Large firms
1
0
0
2
0
2
Small firms
Large firms
0
1
0
0
0
0
0
0
0
1
0
1
0
0
0
2
No change
Change Strategy
Exit
Behavioural drivers
No change
Exit
No cost impact
Not unprofitable
Only coverable short term losses
Wider firm benefits offset losses
Can pass through to customers
Already exiting
Unprofitable for a number of reasons
Other reason for exit
Three of the firms (all “large”) have negative consumer credit profits (even before adjusting for a return on
assets), highlighting that the segment is already stressed. Two of these firms are predicted to exit the
market, implying a degree of market exit pre-regime change. Some exit due to the regime change seems
likely, particularly where the compliance costs make already negative profits unsustainable.
For one firm, wider firm benefits are predicted to offset losses. This may be the case to some extent
across the market where brokers offer other products in addition to consumer credit. Even if unprofitable
on its own, maintaining a presence in the consumer credit market may enable brokers to attract/retain
customers for more profitable product offerings.
Given the marginal performance of these participants and the qualitative evidence we have modelled a net
exit due to the regime of 17.5–22.5 per cent of small credit brokers and 2.5–7.5 per cent of large brokers.
This is in addition to exit due to natural wastage of 10–20 per cent prior to the regime transfer in this
segment.
4.19 Online Introducers: Lead Generators and Aggregators
Aggregators (e.g. price comparison sites) play a significant role with up to 30 per cent of new business in
credit cards alone through this channel. A few players dominate here. Lead generators are another aspect
of the online marketplace. These act as a source of business to various parts of the consumer credit
market, from mainstream lenders through to debt management, but appear to be focused primarily on
payday lending. There appear to be relatively few large players here also, and it is these that form the
gateway to the lenders, but with a long tail of smaller affiliated organisations which can in aggregate be
significant sources of leads. Packagers, electronic brokers and others populate this segment.
There is greater scope here for firms to be non-UK based due to the on-line nature of the market.
The table below presents our estimate of the compliance costs for this segment.
- 72 -
Compliance Costs and Firm Behaviour
Table 4.27: Compliance Cost Impacts on Online Introducers
Small
£m
Large
£m
£m
£m
Interim
Interim fees
0.1
-
Administration
0.1
-
Fees and administration
0.2
-
0.2
negligible -
0.1
negligible -
0.2
negligible
negligible
negligible
-
0.1
Other one-off costs
Authorisation fee
0.1
-
0.2
negligible -
negligible
Authorisation administration
0.1
-
0.1
negligible -
negligible
Approved Persons
0.1
-
0.1
negligible
-
negligible
High-level Principles and Conduct Standards
0.1
-
0.1
negligible
-
negligible
Supervision and Regulatory Reporting
Complaints and Redress
Financial Promotions
Appointed Representative Regime
Retail conduct review
Total one-off costs
As % of consumer credit turnover
0.1
-
0.2
negligible
-
negligible
negligible
-
negligible
negligible
-
negligible
0.1
-
0.1
negligible
-
negligible
negligible
-
negligible
negligible
-
negligible
0.2
-
0.3
0.1
-
0.1
0.8
1.1
0.1
0.1
1.0
1.3
0.1
0.1
2.0%
2.4%
0.2%
0.2%
On-going costs
Annual fees
0.2
-
0.3
0.1
-
0.2
Approved Persons
negligible
-
negligible
negligible
-
negligible
High-level Principles and Conduct Standards
negligible
-
negligible
negligible
-
negligible
Supervision and Regulatory Reporting
negligible
-
0.1
negligible
-
negligible
Complaints and Redress
negligible
-
negligible
negligible
-
negligible
0.1
-
0.1
negligible
-
0.1
negligible
-
-
negligible
Financial Promotions
Appointed Representative Regime
As % of consumer credit turnover
negligible
negligible
0.3
0.5
0.1
0.3
0.8%
0.9%
0.1%
0.1%
4.19.1 Behavioural impacts
The lead generators and aggregators who participated in Policis’ survey did not provide sufficient data to
support the bottom-up approach. The aggregators already have exposure to the FCA through other parts
of their businesses (e.g. all sell general insurance products), and the qualitative evidence that we have
indicates that at least some aggregators already align their compliance to the FCA-type standards: the cost
impact of the new regime should therefore be limited. Given recent growth and strengthening market
position the aggregators should be able to pass-through costs without a notable dampening effect on
demand (the incremental costs are in any case slight). We do not foresee any aggregators exiting as a
result of the regime transfer.
The diversity of the lead generator sub-segment makes it more difficult to analyse. The qualitative research
indicates that the larger generators should be able to cope with the new regime at relatively low
incremental cost, at least as far as their own businesses are concerned. Firms affiliated to the larger players
have less scale within which to absorb any costs increases and may have notably further distance to travel
- 73 -
Compliance Costs and Firm Behaviour
in order to become compliant with the new regime. The dynamics of the segment — and its apparent
importance to other participants — leads us to assume that there will not be net exit here as our base
assumption (i.e. some firms may leave, but new market entrants would replace them), but we recognise
that some degree of consolidation remains a distinct possibility.
4.20 Debt Management and Related Activities
Debt management is undergoing change. The trade associations have developed membership standards,
more robust voluntary codes and monitoring, with further tightening under development with a new
protocol (the Debt Management Protocol, sponsored by the Insolvency Service) launched. On the other
hand the debt management sector is highly profitable, with the key driver of profitability the scale and
quality of back book and associated annuity income. One in four customers is thought to proceed to some
form of debt solution. Apart from around 200 client-pays debt advice firms (this is after consolidation due
to natural wastage), this segment also includes not-for-profit debt advisers and some other activities, e.g.
insolvency practitioners with a consumer credit licence.
The draft policy mix includes element specific to debt management firms only (i.e. not the whole segment).
These measures are rules on client assets and uniquely prudential requirements. The application of more
stringent requirements to the debt management segment (and in the case of client asset rules, to a sub-set
of this) could have two unintended consequences:
Firstly, firms may seek to avoid the additional rules through re-defining themselves as either not debt
management firms, or else seeking to off-shore themselves (in which case these firms would not meet
the threshold condition for authorisation that a firm must be UK-based). It is not clear that the level of
additional costs would justify this — or, indeed, if it would be a practical solution. The promised
additional scrutiny from the FCA may increase the likelihood of self-policing by the market that would
limit this effect — e.g. a firm using a debt management firm may do additional background checks in the
future relative to now.
Second, it may have structural consequences: if the client asset rules were deemed particularly costly
or cumbersome to implement a debt management business outside the threshold could have — in
theory at least — an incentive not to grow or else to split the business into two parts. In practice, as
we have noted above, the larger firms appear to have the necessary procedures already in place.
This segment includes both profit-seeking and not-for-profit debt advice firms. The latter are expected to
be subject to a slightly modified regime (only the largest accept client monies, and only these would be
subject to the prudential rules).
The table below presents our compliance cost estimates.
- 74 -
Compliance Costs and Firm Behaviour
Table 4.28: Compliance Cost Impacts on Debt Management and Related Activities
Small
£m
Large
£m
£m
£m
Interim
Interim fees
negligible
-
negligible
0.2
Administration
0.1
-
0.1
Fees and administration
0.1
-
0.1
0.2
-
0.2
negligible -
0.1
-
0.3
Other one-off costs
Authorisation fee
Authorisation administration
Approved Persons
High-level Principles and Conduct Standards
Supervision and Regulatory Reporting
Complaints and Redress
Financial Promotions
3.1
-
4.7
2.1
-
5.4
negligible
-
0.1
0.1
-
0.2
0.2
-
0.3
0.3
-
0.5
negligible
-
negligible
negligible
-
negligible
0.3
-
0.4
0.1
-
0.3
negligible
-
negligible
negligible
-
negligible
0.1
-
0.2
0.1
-
0.3
Appointed Representative Regime
negligible
-
negligible
negligible
-
negligible
Debt Management-specific Policies
negligible
-
negligible
0.4
-
1.7
0.3
-
-
0.8
Retail conduct review
Total one-off costs
As % of consumer credit turnover
0.5
0.6
4.0
6.2
3.7
9.2
4.1
6.3
3.9
9.5
3.2%
4.4%
0.4%
1.0%
On-going costs
Annual fees
negligible
-
0.1
0.6
-
0.8
Approved Persons
negligible
-
negligible
negligible
-
0.1
High-level Principles and Conduct Standards
negligible
-
negligible
negligible
-
negligible
0.1
-
0.1
negligible
-
0.1
negligible
-
negligible
negligible
-
negligible
Supervision and Regulatory Reporting
Complaints and Redress
Financial Promotions
0.1
-
0.2
negligible
-
0.5
Appointed Representative Regime
negligible
-
negligible
negligible
-
negligible
Debt Management-specific Policies
negligible
-
-
2.0
As % of consumer credit turnover
negligible
0.4
0.2
0.4
1.0
3.5
0.2%
0.4%
0.1%
0.4%
The impact relevant to commercial debt managers in isolation would be above the range indicated above,
with smaller firms being particularly adversely affected (with one-off costs at 20–25 per cent of consumer
credit turnover, and on-going costs of 2–3 per cent.
No small firms participated in the quantitative survey carried out by Policis, which was focused on larger
firms. Therefore the cost estimates for small firms are based on our top-down model. For larger firms the
quantitative responses are of sufficient quality for us to use the results of the bottom-up model.
Similarly, the sample did not include not-for-profit debt advisers who have, as a concession, an exemption
from the various FCA fees.
The largest cost elements are the administrative costs and fees associated with the new regime. The client
asset proposals are particular to debt management firms, but this represents only a minor cost element —
based upon the results of the survey work undertaken in March we have assumed that all firms with client
- 75 -
Compliance Costs and Firm Behaviour
assets above £1 million complied with the proposed requirements already, keeping the cost estimates in
the bottom-up model down. Of course, as always, the participants in surveys are not likely to include the
worst performers in the industry. On the other hand, firms may have adopted remedial measures
subsequent to past investigations into this by the OFT.
The other proposal specific to debt management firms are the prudential requirements. Our approach to
modelling these is set out at 3.10.1 above. In this instance we had access to a larger data set provided by
the FCA in addition to the top-down and bottom-up approaches. This expanded data set — which
included the largest firms — had aggregate turnover of about two-thirds our estimate of debt management
as a whole. It also revealed that several debt management groups have various individual subsidiaries.
With respect to the latter, we focused upon the consolidated group situation rather than that of individual
subsidiaries. The estimates generated from this source were towards the middle of range indicated above.
The analysis above reflects our estimates of what would be required to achieve the proposal. In practice,
firms may wish to have a buffer between the level of capital held and the regulatory requirement. Even if
any desired buffer was 20–30 per cent above the requirement as modelled here, it would not make a
material difference to the number of firms affected.
The compliance costs represent a relatively high proportion of consumer credit turnover, in particular for
large firms compared with other sectors. However, it is likely that these costs can be borne, given the
profitability of the debt management sector.
4.20.1 Behavioural impacts
Twelve debt management firms (all client-pays — and therefore representative of only part of this grouping,
not its totality) responded in full to the quantitative survey conducted by Policis. All are classified as large
(i.e. revenues above £0.25 million), although three had turnover between £0.25–1million.
Table 4.29: Predicted Behaviour of Debt Management Firms in the Sample
Expected behaviour
No change
Change Strategy
Exit
Behavioural drivers
No change
Exit
No cost impact
Not unprofitable
Only coverable short term losses
Wider firm benefits offset losses
Can pass through to customers
Already exiting
Unprofitable for a number of reasons
Other reason for exit
Small firms
Large firms
0
0
0
10
0
2
Small firms
Large firms
0
0
0
0
0
0
0
0
0
10
0
0
0
1
0
1
In our model two firms are predicted to exit (although one is already exiting the market).
Despite the fact that the new regime requirements are more onerous for commercial debt management
firms than most other segments, they do not appear significantly so, at least for the larger firms. Further,
certain firms in the sample indicated that they would be able to sustain cost increases of up to 30 per cent
(an average of 20 per cent) before they considered leaving the market. (It should also be remembered that
other firms within this segment, e.g. not-for-profit debt advisers, are — with the exception of certain
policies applicable to those holding significant client monies — subject to a less onerous regime).
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Compliance Costs and Firm Behaviour
Those firms responding to the survey identified themselves as already compliant with the additional
regulations identified and as such may be more operationally efficient than other firms in the market and
the least impacted by the change. That said, a large number of firms left the market following OFT
intervention (and perhaps also in anticipation of the transfer in regime to the FCA) and as such the
variation in behaviour within the consolidated market may not be significant, at least amongst larger firms.
In addition, the commercial debt management firms participating in the survey are in general highly
profitable and able to sustain higher compliance costs: provided that this is typical then it is unlikely that
there will be much exit across the market as a result of the new regime.
One interpretation of the above analysis would be to model no net market exit as a direct result of the
regime, and we believe that exit amongst non-small firms will be low (0–5 per cent). It should be borne in
mind that commercial debt management firms are only a part of this segment: implicitly we expect these to
be more affected than this. Smaller firms could be more adversely affected (these were not in the Policis
survey — conducted prior to CP13/7 — sample) and the debt management specific policies (CASS, fees
and prudential) may well have a greater impact here. This would imply greater consolidation, at least
amongst commercial debt managers. On the other hand, the sector’s apparent profitability should attract
some new entrants, notwithstanding the fact that the additional regulatory proposals, if enacted, should
raise the barriers to entry here — nevertheless, additional consolidation is likely.
Given consolidation and the fact that demand for debt management services is likely to be relatively
inelastic (and apparent difficulties in comparing prices which will not be fully resolved by the FCA’s fees
proposal), a high pass-through of additional costs to commercial debt management customers is, we
believe, likely.
4.21 Debt Collectors and Debt Administrators
Our estimates of the compliance costs are presented in the table below.
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Compliance Costs and Firm Behaviour
Table 4.30: Compliance Cost Impacts on Debt Collectors and Debt Administrators
Small
£m
Large
£m
£m
£m
Interim
Interim fees
0.3
-
0.4
0.1
-
0.1
Administration
0.1
-
0.1
negligible
-
negligible
Fees and administration
0.3
-
0.5
0.1
-
0.2
Authorisation fee
1.5
-
2.4
1.4
-
1.9
Authorisation administration
0.1
-
0.2
0.1
-
0.2
Other one-off costs
Approved Persons
High-level Principles and Conduct Standards
Supervision and Regulatory Reporting
0.1
-
0.2
0.2
-
0.7
negligible
-
negligible
negligible
-
negligible
0.1
-
0.2
0.1
-
0.2
negligible
-
negligible
negligible
-
1.9
Financial Promotions
0.1
-
0.1
0.1
-
0.2
Appointed Representative Regime
0.7
-
0.8
negligible
-
negligible
Retail conduct review
0.1
-
0.2
0.3
-
0.5
2.7
4.1
2.2
5.6
3.0
4.6
2.3
5.8
2.3%
3.4%
0.3%
0.6%
Complaints and Redress
Total one-off costs
As % of consumer credit turnover
On-going costs
Annual fees
0.1
-
0.2
0.3
-
0.7
Approved Persons
negligible
-
negligible
negligible
-
0.1
High-level Principles and Conduct Standards
negligible
-
negligible
negligible
-
negligible
Supervision and Regulatory Reporting
negligible
-
0.1
negligible
-
negligible
Complaints and Redress
negligible
-
negligible
negligible
-
0.5
Financial Promotions
negligible
-
0.1
negligible
-
0.3
0.8
-
-
negligible
Appointed Representative Regime
As % of consumer credit turnover
1.0
negligible
0.9
1.4
0.3
1.6
0.7%
1.0%
0.0%
0.2%
The largest cost element is again due to the costs and fees associated with authorisation. The compliance
costs represent a notably lower proportion of consumer credit turnover than for debt management firms.
4.21.1 Behavioural impacts
Eight debt collecting firms participated in the quantitative survey carried out by Policis.
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Compliance Costs and Firm Behaviour
Table 4.31: Predicted Behaviour of Debt Collectors and Debt Administrators in the Sample
Expected behaviour
Small firms
No change
Change Strategy
Exit
2
0
0
Behavioural drivers
No change
Exit
Small firms
No cost impact
Not unprofitable
Only coverable short term losses
Wider firm benefits offset losses
Can pass through to customers
Already exiting
Unprofitable for a number of reasons
Other reason for exit
0
2
0
0
0
0
0
0
Large firms
6
0
0
Large firms
0
6
0
0
0
0
0
0
Again we do not predict any exit as a result of the direct costs incurred under to the new regime. The
additional compliance costs represent on average one per cent of operating costs. Firms in the sample
indicated they would be able to sustain cost increases of between 10 and 30 per cent before leaving the
market. This implies no net market exit as a direct result of the regime. However, as with other segments,
there are a number of firms only marginally attached to the consumer credit segment: specifically we
understand that various smaller firms are specialists, perhaps in B2B debt collection, and only marginally
utilise their consumer credit licences (although these do hold some value as a “regulatory badge”). We
anticipate at least some of the firms like this will exit the market (say 5–10 per cent of small firms).
4.22 Credit Reference Agencies
CRAs are small in number but provide a service that is built-in to the business models of many lenders and
other participants in the consumer credit market. Credit reference agencies gather credit information
from a wide range of sources and use it to build databases. Customers pay to access various reports within
the database. Credit reports are sold on a transactional basis, typically priced per report delivered. Pricing
is typically tiered, varying according to the volume of reports delivered to the client. Typically, revenue for
credit services recurs habitually.
In terms of the size of the market, data are patchy. Experian is the global market leader in credit reference
services, especially in the UK.22 Its credit services in the UK and Ireland generate about approximately
£150 million per annum.23 The EBIT margin on credit services in the UK and Ireland is 27.5 per cent. Data
on the current market share of Experian are not available — however it used to be believed to have at
least 40 per cent of the UK market, implying a market size of around £350–£400 million for the UK.
Impacts are likely to be largely limited to direct compliance costs (e.g. fees to the FCA). Our estimation of
the compliance cost impacts is that both one-off and on-going costs are below £0.1million (detail not
shown). This represents a small fraction of the estimated revenues in this segment.
Reference agencies deal in large volumes of small transactions, with sophisticated IT systems and processes
in place. These factors — and the small number of firms active in the segment — contribute towards the
low burden of incremental compliance costs other than in relation to fees. Our overall cost estimate is
trivial in the context of the sector’s overall revenues.
22
23
Equifax, TransUnion and Dun and Bradstreet are the next largest international players.
Experian Annual Report 2012 page 37
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Compliance Costs and Firm Behaviour
4.22.1 Behavioural impacts
Such compliance costs are probably capable of being passed on to customers (although — of course — the
consequent impact of this also needs to be considered, as this would increase the costs borne by
downstream market participants). We do not anticipate any exit from the market driven by the policy mix
under consideration in this study.
4.23 Impacts on the Distribution Chain and the Volume of Overall Lending
The segments where we believe that the most material exit is likely are: traditional credit brokers,
secondary retail intermediaries, non-bank POS lenders and payday lenders:
The evidence we have indicates that the traditional credit broker segment is already highly stressed,
with too many participants chasing revenues substantially below the levels of the recent past. Credit
brokerage’s importance as a distribution channel has reduced over the past few years, as volumes in
markets such as that for secondary mortgages have declined sharply and technological advances have
provided consumers and lenders with alternative choices (e.g. aggregators, or price comparison
websites). We contend that market exit here would not translate into any further reduction in lending
volume: the remaining participants should effectively pick up this “slack”.
Amongst the retail intermediaries (i.e. secondary credit brokers), both in the motor segment and
elsewhere, the situation would be different: whilst there could be some movement of consumers to
retailers remaining in the consumer credit market, or else towards substitute products (i.e. personal
loans, credit cards) we would expect a knock-on effect of reduced consumer credit activity here, i.e. a
reduction in lending volume, by removing a part of the distribution channel.
It follows from the previous point that this segment, which includes lenders operating through point-ofsale would also be affected, and we expect the reduction in the participants here (focused largely on
the smaller players) such that lending volumes would reduce by about three–four per cent based on the
typical consumer credit-related revenues of the exiting firms. (The banks provide a substantial share of
POS lending — whilst we note that these could substitute other products for loans facilitated at pointof-sale, we believe that this is not likely, at least in non-motor where the average loan values are low
and margins less attractive). That said we do not expect any exit would be forced through this channel.
In effect we are assuming that the non-bank POS lenders take the full brunt of this impact in terms of
players leaving the consumer credit market entirely. (NB even if the burden was more evenly shared,
the consequences — which are our focus here — would be broadly the same). New loans facilitated at
point-of-sale total are believed to total about £20 billion, being about 80–85 per cent motor-related.
Non-bank POS lenders are responsible for about 45–50 per cent of this (this share has been growing
recently, particularly with captive lenders increasingly important in motor loans).
We assume that there would be no substitution for any decline non-motor POS lending. A 3–4 per
cent decline (we assume that the exiting firms are largely focused on the most marginal participants)
here would reduce lending volumes by £80–£110 million. We would anticipate some substitution in
motor loans (this would probably not be from banks, consolidation by existing non-bank players or the
emergence of new entrants appear at least as likely). If the scale of such substitution was to be at a
reasonably high-level (say between 70–75 per cent) then the implied reduction in lending volume would
be £125–£200 million per annum — i.e. about £205–£310 million in total. This is about 0.13–0.19 per
cent of the total consumer credit advanced in 2012.
In payday lending a restriction on CPA-usage impacts on the ability of firms to retrieve cash from those
customers struggling to repay. Online and larger off-line payday firms are highly reliant on using CPAs,
often making requests multiple times if the first request fails. Data show that around 23 per cent of
loans (equivalent to approximately £600 million) were not re-paid on time, with 13 per cent being
repaid over a month after the original due date. This suggests that the use of rollovers and CPAs are
highly significant aspects of the payday business model. With the severe restriction of rollovers and
CPAs (compared to current market practice) it is unlikely that the original lending that is either rolled-
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Compliance Costs and Firm Behaviour
over multiple times or recovered through extensive use of the CPA facility will continue to take place.
A significant proportion of firms is likely to exit the market completely (which we estimate at 25–30
per cent) and the remaining firms will adjust their business models so as to ensure adequate revenue
recovery. This is likely to require significant re-engineering, including targeting different consumer
groups (possibly through the use of lead generators) and making use of increasingly robust affordability
assessments to ensure customers repay loans on time without the need for extensive rollovers or
CPAs.
The reduction in lending will be greater than simply that currently recovered through rollovers and
CPAs. Firms no longer able to operate profitably will exit the market, reducing the supply of lending
further as they cease to service customers who do not usually require rollovers or CPAs to repay their
loans. We expect a reduction in lending of £625–£750 million.
In other segments we do not anticipate an impact on lending volume as a direct consequence of the
transfer of the regulatory regime to the FCA. However, as we have noted previously, we believe there is
at least a possibility that there could be effects beyond those that we have modelled above: these would be
driven by the anticipation of future supervisory action, which remains undefined at this point in time. This
argument has been presented by a number of market participants and we discuss this in the next chapter
(please see 5.2).
4.24 Pricing Impacts and the Volume of Overall Lending
The accumulated cost impact on product pricing is contingent upon the rate of pass through by
intermediaries to lenders and from the lenders to end consumers (i.e. the borrowers).
We have considered the likelihood of such pass through in our discussion of each segment above. We
have then considered how and where intermediaries within the distribution chain would pass on such costs
(e.g. we have assumed that the credit reference agencies would be able to pass on such costs to lenders,
and we have pro-rated these additional costs to all of the lender segments, excluding credit unions and
home credit). Our interpretation of the pass-through is as follows:
Banks & building societies: notwithstanding that the banks tend to be taking a total customer
profitability perspective we have assumed that 50 per cent of the costs would be passed onto
consumer credit customers. (In the Policis survey (conducted prior to CP13/7), just one of the three
bank respondents considered it would be straight-forward to pass on any cost increases to customers.
On the other hand, none believed that a small price increase would reduce demand.)
Monoline card issuers: clearly there is less scope to look at customer profitability here and, given the
price competition indicated, we have assumed a pass-through of just 20 per cent. None of the survey
respondents considered it would be straight-forward to pass on any cost increases to customers,
although all also agreed that a small cost increase would not impact demand.
Traditional and bricks & mortar lenders, online payday and home credit: we have assumed 80 per cent
pass through in these segments. (In the Policis survey (conducted prior to CP13/7), nine from 23
respondents across these segments considered it would be straight-forward to pass on any cost
increases to customers. On the other hand, just three believed that a small price increase would
reduce demand.)
Other non-bank lenders and consumer hire: we have assumed 50 per cent pas through here (with
competition from the banks acting as a constraint here). In the Policis survey (conducted prior to
CP13/7), only three of the twelve non-bank lenders considered it would be straight-forward to pass on
any cost increases to customers. On the other hand, only forty per cent believed that a small price
increase would reduce demand.
Credit unions: restriction on pass-through due to price controls so that 50 per cent of incremental
cost burden would be passed on to consumers. (Our understanding is that the price control is not
currently biting for all credit unions).
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Compliance Costs and Firm Behaviour
Online introducers (aggregators and lead generators): 100 per cent pass-through to lenders.
Other intermediaries: 50:50 cost sharing with lenders.
CRAs and other market participants: 100 per cent pass through to lenders.
We have incorporated all incremental on-going costs and assumed that the recovery of one-off costs would
be spread over a period of four years.
The table below expresses in basis points the pricing impact arising from the application of these
assumptions. It describes the likely impact, based upon our work as described above, and also a maximum
pricing impact — here we assume that all the incremental compliance costs identified in this study are
passed onto the lenders — who in turn pass those costs onto the borrowers.
Table 4.32: Potential Price Impacts due to Pass-through of Incremental Direct Compliance Costs
Likely pricing impact
Maximum pricing impact
1 -2 bp
2 - 4bp
<1bp
1 - 2bp
Traditional bricks & mortar lenders (*)
14 - 29bp
18 - 36bp
Online payday (*)
15 - 33bp
18 - 41bp
Home credit
13 - 22bp
16 - 27bp
3 - 6bp
9 - 16bp
2bp
3 - 4bp
Banks & building societies
Card monolines
Other non-bank lenders
Credit unions
(*) NB The above excludes the consequences of any compensating measures by payday lenders in response to lost revenue. These could be
significant and are analysed at Section 8
Any price increase raises the possibility of demand reducing in response. Based upon the likely price
increases set out above we consider material change here to be unlikely. The larger price changes are in
product areas which exhibit a high degree of price insensitivity (e.g. home credit); in more mainstream
areas the potential impacts are relatively small.
Other non-bank lenders would be a possible exception, given the feedback about potential price sensitivity
here. The aggregate likely price impacts are just £22–£40 million (i.e. this is the sum of additional interest
payments that would be required).
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Wider Impacts of Regulatory Change
5 Wider Impacts of Regulatory Change
5.1 Form of Regulatory Change
The proposed changes to the regulatory framework for the consumer credit market imply a shift both at a
conceptual level as well as a practical level. At the conceptual level, the OFT and FCA differ in their rulemaking powers — the OFT and FCA operate under different legal frameworks (FCA under the Financial
Services and Markets Act 2000 (FSMA) and OFT under the Consumer Credit Act 1974 (CCA)). Broadly,
this means the FCA has more extensive powers under FSMA and is able to consult on, make and enforce
its rules, which have the force of secondary legislation. By contrast, the OFT does not have rule-making
powers (authority rests with Parliament) but can issue guidance.
Regulated firms have become accustomed to the regulatory process under the OFT, and have a close
understanding of the CCA, tested by case law. The new regime will combine aspects both of the CCA and
of FSMA. We believe that the FCA will have greater interpretive power than the OFT (although we
understand that the OFT has adopted a more “principles-based” approach in recent years). We also think
that the result will be an increase in regulatory uncertainty for firms that will extend beyond the simple
bedding in of the new regime: this is certainly the belief of the industry itself.
Meanwhile, the differences between the two regulatory regimes at the practical level include:
Enhanced reporting requirements — currently the OFT does not impose regular reporting
requirements, adopting a more reactive supervisory approach. In contrast the FCA will require firms
regularly to report data relating to their regulated activities (for example, the number of complaints
they receive, and notification of any appointed representatives).
Tighter regulation of individuals — the FCA operates an appointed person regime which requires
individuals carrying out regulated activities to be pre-approved by the FCA.
In this section we consider the implications of such changes on firms and the structure of the market. In
particular we will look at indirect effects on:
Product innovation
Products offered and customers served
Barriers to entry
Regulatory badging
The grey market
We will discuss what the areas of concern are, our hypothesis for why a change in regulatory regime could
have an effect on this area, and how well (or not) the available evidence speaks to this hypothesis.
5.1.1 Shift to a more robust regime
As described briefly above, the change in the regulatory framework has implications at the practical level
for firms: enhanced reporting requirements, and tighter regulation of individuals and firms operating in the
market. In addition the FCA will have greater resources (i.e. a bigger budget) to apply than has been the
case with the OFT.
On the reporting side the cultural and practical change is likely to be significant for those firms without
prior contact with the FCA. Firms will move from having no reporting obligations to being required to
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Wider Impacts of Regulatory Change
provide the regulator with data at regular intervals. In addition they are expected also to be obliged to
publish complaints made where the total number of complaints exceeds a certain threshold in a given
period (e.g. 1000 per annum, or 500 in six months).
The introduction of the approved person regime represents another of the key changes to the regulatory
framework. The introduction of such a system will improve the monitoring of individuals as well as firms,
ensuring scrutiny of individuals in key roles in firms and clarity of their responsibilities.
Firms operating in certain sectors will also be subject to sector-specific requirements. For example, debt
management firms will face additional requirements related to client assets.
Hypothesis of impacts
Such enhancements would be expected to improve compliance in the industry, although by and large the
framework around conduct is expected to remain unchanged — an important point since typically it is
changes in conduct rules that drive behavioural change and compliance cost. Whilst this might be so, the
new regime is likely to improve compliance with existing conduct rules.
Buccirossi et al (2009)24 argue that the costs of not complying are greater if the probability of getting caught
is high, showing the role of resources and investigative powers available to an authority. Supervision is a
key driver of the probability of being caught. The move to the FSMA regime, therefore, with its enhanced
resource for supervision, should increase compliance in the industry, even if the conduct requirements are
not fundamentally different than the old regime. This in turn should have a knock-on effect on the average
quality of service provision in the industry.25
5.1.2 Change in basis of regulation
The new regime will combine aspects both of the CCA and of FSMA. The hybrid regime will represent a
shift from a regulatory environment where an established legal framework and the build-up of case law have
created a well-understood framework to one that will have greater uncertainty. Table 5.1 presents a
typology of dimensions of a more objective regime based on a well-understood framework compared with
a more subjective regime. We consider elements of the proposed FCA regime to be analogous with the
more subjective regime (e.g. greater discretionary power, greater scope for ex post intervention and
greater flexibility in dealing with exceptional circumstances with the ability to quickly issue new rules and
guidance).
24
25
Buccirossi, P., Ciari, L., Duso, T., Spagnolo, G. and Vitale, C. (2009), ‘Deterrence in Competition Law’, Governance
and the Efficiency of Economic Systems (GESY), Discussion Paper 285
Though some firms may actually reduce their overall quality of service provision if they feel that the regulatory
standards imposed erode any benefit they currently enjoy from marketing themselves as a high quality provider, by
improving the basic standards required across the sector as a whole we would expect the average level of quality
to increase.
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Wider Impacts of Regulatory Change
Table 5.1: Characterisation of an Objective and a Subjective Regime by Dimension
Dimension
Objective Regime
Subjective Regime
Temporal
Ex ante
Ex post
Conceptual
Specific/particular/concrete
General/universal/abstract
Functional
Little discretionary power
Large discretionary power
Representation
Procedural (how)
Declarative (what)
Knowledge Needed
Relatively little
Quite a lot
Exception Handling
All or nothing (strict)
Allow for exceptions (defeasible)
Conflict Resolution
No conflicts possible
By weight (trade off)
Note: In developing this typology we have drawn upon what we consider to be an analogous comparison between “rules-based” (i.e. greater
certainty and objectivity) and “principles-based” regulation (i.e. relatively greater uncertainty for firms and scope for more subjectivity in application
by the supervisor). See Burgemeestre, Hulstijn, and Tan 2009.
Hypothesis of impacts
It is important to note that this typology above of a subjective regime represents possible sources of
uncertainty of the FCA regime compared with the OFT regime. We also note that this typology is not
static and can evolve over time. For instance, the FCA regime will become more certain once precedent
has been set as to how the regulations should be followed, knowledge of the rules and principles and their
interpretation become widespread among compliance departments and best practices for compliance
disseminate throughout an industry. Equally, well-understood, certain regimes may have more uncertain
elements such as scope for exceptions and qualifications.
5.2 Downside Risk due to Nature of the Regulator
The new regime raises fears in the industry of both unduly precipitate actions by the regulator and
uncertainty around the regulator’s interpretation of the high-level principles and rules. The main
consequence of such an impact from the new regime would be firms becoming more reluctant to innovate,
take risks and lend. Market participants like the relative certainty of the CCA regime. Whilst some
characterised the CCA as heavily gold-plated and over-complicated, everyone is used to it and familiar with
the case law that has been built up over time. At present — prior to the publication by the FCA of its
Consultation Paper — market participants’ knowledge and understanding of the new regime is imperfect: a
simple read-across from other areas already subject to FCA regulation may be resulting in an excessive
level of concern.
In addition the FCA is expected to be a more powerful regulator than the OFT and is expected to be more
interventionist. This is a cause for concern in parts of the industry (not limited to those less familiar with
the FCA), with several participants noting that the Ombudsman can have an important influence because it
can interpret what is “fair” in unexpected ways.
A key idea is that uncertainty (fear) over retrospective action or subjective interpretation by the regulator
means they may be more risk-averse and less willing to innovate. For the largest participants, such as the
banks, this is understood to be highly unlikely to mean complete exit from the consumer credit area, but
may result in the re-design of products or sales strategies. It is likely to be ‘business as usual’ for banks
whilst they become accustomed to the regulation and the banks do not expect to be the immediate focus
of regulator attention, although they accept that unauthorised overdrafts and introductory offers on credit
cards may attract future attention.
Other segments may be more significantly affected. Although the conduct rules are being mapped across
from the CCA, the overall approach may be less user-friendly and higher cost in the new regime. This is
likely to prompt a review of existing commercial relationships with marginal participants in the market.
The credit broker and secondary credit broker segments appear most at risk here: those generating low
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Wider Impacts of Regulatory Change
volumes of low value lending may find that, even if they wish to remain in the marketplace, the lenders with
whom they have a relationship no longer consider an on-going relationship worthwhile (at least on present
terms) due to the perceived increase in regulatory risk. This could drive a higher rate of exit in these
segments than we have modelled above, and would at least be partly attributable to the transfer of the
regime to the FCA.
The likelihood of this downside case is hard to judge, depending largely on the psychology of the sector.
We note that in the current depressed market conditions such sentiments may be more commonplace
than otherwise. We believe that most will adopt a “wait and see” policy. Others, though, may base their
decisions upon these perceptions — perhaps particularly where there is already evidence of a hardening in
approach by the existing regulator. For example, this may be driving some part of the consolidation within
debt management. Indeed how the FCA handles the transition to the new regime may make a significant
difference in not just cost terms — i.e. using ex-OFT people familiar with what has happened before will
ease transition costs — it may also have a bearing on any initial uncertainty around the new regime. Again,
the importance of the execution by the FCA makes robust conclusions about the scale and likelihood of
the downside risk impossible at this juncture.
As a final thought here, it is worth noting that if the industry does curtail the supply of certain products to
particular demographics, this will not necessarily mean that the there is a social cost attached. If the
products in question are actually a source of consumer detriment (which is outside the scope of our
research) then any costs incurred may only be private ones borne by the industry. On the other hand if
the industry’s premature response is effectively an over-reaction (i.e. removing beneficial products) then
the loss will be social.
5.3 Implications of Regulatory Regime for Innovation
Firms choose to innovate within their product portfolio by introducing new features to an existing product
or developing an entirely new product. Changes in the regulatory environment can introduce uncertainty
into a firm’s decision on the form and timing of innovation. When innovating in an uncertain regulatory
environment firms can choose to delay the innovation or forgo the innovation completely. The switch in
regime by itself creates uncertainty (e.g. “what will the FCA be like?”), although this driver of uncertainty
should dissipate over time. This would be further heightened by any shift to a more subjective regulatory
regime that, in the beginning at least, has little case law precedence.
Uncertainty associated with the change in regulator should reduce significantly over time as firms become
accustomed to the FCA. The nature of the transition –– for example the use of ex-OFT people –– may
help expedite this familiarisation with the new regulator. Uncertainty associated with the interpretation of
any principles-based elements of the regulation should also diminish over time, although more slowly as
firms’ expectations are influenced by actions taken by the FCA on specific issues.
Below we discuss in more detail the drivers for delays to innovation and for the potential for firms to
forego innovation.
5.3.1 Delays to innovation
Delays occur when there is a gap between when it is rational for a firm to execute an innovation and when
the innovation is delivered to market.
Hypothesis of impact
In the early stages of the transition to the new regime, the details of what compliance with regulation
means concretely and how to comply are likely to be incomplete and uncertain. This is especially true if
firms are accustomed to a well-known and tested regulatory approach that specified precisely what firms
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Wider Impacts of Regulatory Change
had to do to be compliant. Indeed, studies by Ashford, Ayers, and Stone (1985) and Birnbaum (1984)
found that regulatory uncertainty created by overly subjective requirements and regulatory change
retarded product innovation and the diffusion of innovative products in a number of industries.26
Innovation delays at the beginning of a regulatory transition could occur for a number of reasons. If the
regulation is open to interpretation, risk-adverse firms may spend more time conducting due diligence in
the innovation process to ensure that innovations are compliant. For example, whereas under a familiar
and well-understood system a firm’s compliance department could consult a list of rules or precedents to
ensure compliance, a more uncertain system might require additional resources to ensure compliance
under a variety of possible interpretations. The additional time spent on due diligence would delay an
innovation coming to market.
It may also be the case that, instead of spending resources conducting more robust due diligence checks,
firms simply postpone innovating until the interpretation of regulation becomes clearer. Regulation can be
clarified through a number of avenues such as legislative or regulatory precedent or an official statement
from the regulator. Risk-adverse firms may hesitate to dedicate resources towards an innovation without
the security these sorts of clarifications offer.
On the other hand, Jaffe and Palmer (1995) find modest evidence that a principles-based approach (which
we consider analogous to the anticipated FCA framework) has a positive net effect on innovation via R&D
expenditure, as firms have to find creative ways to comply with broader regulatory requirements while
remaining profitable.
Evidence
The quantitative survey conducted by Policis in late 2012/early 2013 shows that the majority of
respondents (63 per cent of those responding) felt that the new regime will result in a lack of clarity about
what the regulator expects, which may then drive a reduction in innovation. Only 30 per cent, however,
felt that this would be a ‘key’ impact of the new regime. The Policis survey (conducted prior to CP13/7)
shows that firms were then concerned about the influence of the regulatory change on innovation. The
table below shows that the majority of firms feel that the regime change will result in a less conducive
environment for innovation. This is most relevant for lenders and other firms (which include debt
management firms and purchasers) for whom product innovation is arguably more relevant than
intermediaries.
Table 5.2: Impact of Regime on the Innovation Environment
Less conducive to innovation
No change to innovation
More conducive to innovation
Lenders (44)
Intermediaries (30)
Others (22)
57%
27%
2%
40%
30%
10%
64%
32%
0%
Source: Policis survey (conducted prior to CP13/7) data.
Notes: Number of firms in the sample in brackets. Not all respondents replied to this question.
Qualitative feedback also revealed a high level of concern around regulatory risk, as discussed in our
‘downside case’ at 5.2 above. Firms were concerned both with uncertainty surrounding the new rules
(especially in cases where the exact changes have not been made clear), and with the ability of the regulator
26
Ashford, Nicholas A, Ayers, Christine, and Stone, Robert F. (1985) “Using regulation to change the market for
innovation” Harvard Environmental Law Review, Vol 9, No 2 (Summer), p 419-466. Birnbaum, Philip H. (1984), “The
choice of strategic alternatives under increasing regulation in high technology companies”, Academy of Management
Journal, Vol 27, No 3 (September), p 489-510. Industries covered by these studies were the environmental
management industry, the chemical, pharmaceutical, and automobile industries, and the medical technology (x-ray)
market.
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Wider Impacts of Regulatory Change
to change its interpretation of the new rules at some future date. Interestingly this appears to be of
greatest concern amongst larger firms.
The ‘wait and see’ approach that firms are likely to take before making decisions about leaving the market is
likely to extend to the innovation sphere, resulting in delays in the rate of innovation.
5.3.2 Forgone innovations
A second possibility is that the development of an innovation is foregone entirely.
Hypothesis of impact
Upon introduction of the new regulatory model, firms may wish to forgo releasing innovations that were
under development before. This would be the case if firms thought that given the investment already made
in the innovation, the cost of ensuring that these innovations satisfied the new regulatory framework
outweighed any potential benefits. Uncertainty during the transition to the new regime may cause firms to
operate under a wide estimate of the regulatory costs and therefore potentially forgo some innovations.
As the new regulatory framework becomes ingrained in the functioning of the market, there may be
forgone innovations that would have been realised under the previous regulatory framework. The extent
to which there are foregone innovation effects in this “fork-in-the-road” scenario depends on the amount
of difference between the two regulatory frameworks and the extent to which they alter the functioning of
the market.
Evidence
There is some concern among qualitative survey respondents that the new regime will make certain
product developments more difficult and may result in some forgone innovation. This is particularly the
case with products that rely in part on interaction with technology (for example, point-of-sale consumer
credit, or online payday loans, which can be accessed via smartphones). There are concerns that the levels
of information provision required, or the nature of consumer contracts, may change in such a way as to
make accessing these products via phone applications difficult or impossible. The ability of products to
interact with technology is becoming increasingly important in the consumer credit market.
It is possible that if the regulatory changes alter the competitive functioning of the market (i.e. through
increasing consolidation) then this might lead to less innovation. Based on the results of our modelling of
the quantitative survey, however, it does not appear that the new regime will have a notable effect on
competition in the market.
5.4 Impacts on Firm’s Appetite to Offer Products and Serve Consumers
5.4.1 New regime
There may be a tendency for risk-adverse firms to reduce the number of products they offer if they are
uncertain about how to comply in the new regulatory regime.
Hypothesis of impact
This homogenisation of products would reduce the variety of products on offer, perhaps making the
market more competitive though at the expense of consumer choice. Gardner (2003) finds that strict rulebased regulation in the — obviously very different — US agriculture market tended to make products
more homogenous as smaller firms feared larger firms levelling accusations of non-compliance against
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Wider Impacts of Regulatory Change
differentiated products.27 His research suggests that a more flexible system with elements of principlesbased regulation may actually encourage product differentiation.
Evidence
Results from the quantitative survey suggest that smaller firms in the consumer credit market value
regulatory flexibility more than larger ones. The majority of firms that view the potential for the new
regime to offer greater flexibility as a key benefit are intermediaries or small lenders/others.
5.4.2 Robustness of the regime
A change in firms’ expectations of regulatory intervention could affect the variety of products they offer
and consumers they serve. A key distinction would be whether the change in the regulatory regime would
increase firms’ expectations regarding the potential for regulatory intervention.
Hypothesis of impact
On the downside, the potential for increased intervention would potentially affect the expected profitability
of certain products and/or consumers. For example if increased intervention increases the probability of a
certain product line or consumer group generating negative profits, this could disincentivise firms from
offering those products or serving those consumers.
One consequence of a more robust regime may be that some upstream participants (e.g. loan providers)
seek additional control over downstream participants (e.g. credit brokers) in order to reduce perceived
exposure to regulatory risk. This effect would not simply be the result of switching to a principalappointed representative arrangement — where it is likely to be deemed essential — but rather be felt
more broadly. An increasingly important way of doing this is through the use of IT, which can facilitate
some aspects of compliance, such as documentation and its storage. This may also mean that
intermediation chains (i.e. the number of firms between the lender and the consumer) shrink in order to
facilitate such control. This may partly explain the indication of lenders to change customer acquisition
practices. On the other hand, it could equally be argued that some firms would seek additional distance
from non-compliant downstream commercial partners: however we would think that — particularly given a
more active supervisor — the natural response would be to either foster compliance or else to sever such
links.
Evidence
The majority of respondents to the quantitative survey (nearly 80 per cent of the 96 answering the relevant
question) indicated concern that a more intrusive and proactive regulator would impact the profitability of
their consumer credit business. Greater likelihood of regulatory intervention is also seen as a risk by the
majority of respondents, although it is identified as a ‘key’ risk by only 30 per cent.
The types of changes that firms might make to their product offerings are summarised in the table below.
As can be expected, lenders are the most likely to make changes to the products they offer. Serving fewer
high risk customers and modifying arrears management suggest a key driver for the changes is the desire to
improve the profitability of existing credit activity.
27
Gardner, Bruce (2003) “U.S. food quality standards: fix for market failure or costly anachronism?” American Journal
of Agricultural Economics, Volume 85, No 3 (August), p 725-730.
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Wider Impacts of Regulatory Change
Table 5.3: Changes to Products Offered/customers Served
Lenders (44)
Intermediaries (30)
Others (22)
Unlikely to make any major changes
32%
53%
64%
Move away from telephone sales or
distribution channels
0%
0%
5%
Move away from face to face sales or
distribution channels
9%
3%
5%
Reduce the emphasis on sales in staff
incentives
9%
7%
14%
Serve fewer high risk customer types
20%
7%
0%
Make fewer smaller loans
11%
7%
0%
Increase the transparency of product
structure or pricing
14%
7%
14%
Narrow product range
9%
7%
0%
Increase product innovation
14%
0%
9%
Change customer acquisition practice
16%
7%
5%
Introduce greater automation into
customer service
16%
7%
9%
Modify product development processes
18%
3%
0%
Modify arrears management / debt
collection
20%
0%
5%
Other
23%
13%
5%
Source: Policis survey (conducted prior to CP13/7) data.
Note: firms selected more than one option.
It is noted that the consumer credit market and the FCA’s policy package have both moved on since this
fieldwork was undertaken. We have specific remarks to make on the payday lending sector and its appetite
to serve customers. These have been described primarily at Section 8.
5.5 Implications of Regime for Barriers to Entry
One feature of competitive markets is the ability of firms to enter or exit the market. Firms should be able
to enter and exit the market without incurring substantial costs: any costs, monetary or otherwise, are
considered barriers to entering the market.
The existence of sunk costs would represent a key barrier to entry. As explained earlier, sunk costs tend
to equate to fixed costs. If we take it that compliance costs represent fixed costs — though there could be
elements that are variable in nature these are likely to be minimal — a key question in determining the
scope for the change in regime to create barriers to entry is whether or not the increase in compliance
costs — both one-off and on-going — would result in fixed costs being greater than expected profits from
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Wider Impacts of Regulatory Change
operating in the industry. This distinction was carefully drawn in the construction of the behavioural model
that sits within our “bottom-up” approach.
5.5.1 New regime
Dean and Brown (1996) have found that regulation can serve as a barrier to entry. Changing the regulatory
framework nearly always introduces a degree of uncertainty for firms, as they have to learn the new
regulatory requirements.
Firms looking to enter a market will face costs in learning and interpreting the new regulation (as they
would with the old regulation). The extent to which existing players are able to draw on their experiences
to minimize these costs will determine how much acquiring knowledge of and complying with new
regulation is a barrier to entry; the greater the benefit of existing firms’ knowledge of the existing regime,
the more the changing regulatory environment will represent a barrier to entry. In this case it does not
seem likely that the change in regime will represent a significant barrier to entry in terms of familiarisation.
Incumbent firms with prior FSMA experience would be at an advantage over other incumbent firms as well
as new entrants. It is unlikely that existing firms will have better access to information about the new
regulation than new firms (new firms can, for example, join trade associations which would be a key source
of information), at least in the short term.
5.5.2 Robustness of regime
The increased robustness of the regime, and the associated increase in compliance costs, may act as a
barrier to entry in sectors where these costs represent a relatively high proportion of profitability. In
particular, sectors such as secondary credit brokers and other credit brokers are likely to see some exit as
a result of increased compliance costs. As marginal firms in the market are expected to exit as a result of
the costs of the new regime, we expect an increase in scale economies and an increased barrier to small
start-ups in these sectors.
If the regulatory switch brings consumer credit activities into line with the regulatory burden faced by
suppliers operating in other markets this may reduce barriers to entry. In particular, there may be scope
for the change to create economies of scope; firms regulated in other markets who previously found
competing in the less rigorously regulated markets difficult, due to differences in the costs associated with
the higher regulatory burden, may find widening the scope of their market participation profitable. Such
firms may be able to apply their compliance resources to compete in newly regulated markets (or increase
their activity in these markets), in effect lowering barriers to entry in those markets.
5.6 Regulatory Badging
Firms subject to a regulatory regime may wish to make this information known to other players, e.g.
consumers, especially if this regime is considered robust. Regulatory badging occurs when a firm is publicly
certified as being regulated by the appropriate authority. The extent to which a change in the regulatory
framework affects regulatory badging depends on the quality and perception of the regulation. The
incremental effect here may be limited given that the OFT has been perceived by consumers to provide an
effective regulatory badge hitherto.
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5.6.1 Robustness of regime
Hypothesis of impact
A certain regulatory regime that is well understood and supported by case law might be seen as more
robust, since it provides exact rules for compliance and leaves less room for defensible non-compliance
than a more uncertain regime with more rapid rule-making powers. If this is the case, then a shift to a less
certain regime might even devalue the significance of the regulatory badge. On the other hand, moving
from a regulatory framework that is seen to be more reactive to a framework that is seen to be more
robust might increase the value of the regulatory badge.
Consumers may believe that the fact a firm is regulated means that they can avoid the cost of having to
assess the quality of the firm themselves. For example, Atkeson, Hellwig and Ordoñez (2012) find that if
the fact that the firm is regulated is visible, then firms who comply may be able to reap net benefits from
compliance over time through increased output.28 Regulatory badging can have risks for consumers if it
reduces their own due diligence in assessing the behaviour of firms.
Regulated firms may also wish to display their regulatory badge in the knowledge that, for example, highquality consumers may value the regulatory badge more than low-quality consumers. This would lower the
firms’ cost of assessing the consumers as well. In short, a regulatory badge would lower the costs
associated with locating the desired counterparty in a transaction. By doing so, the badge facilitates the
functioning of markets by matching consumers with producers for a given level of risk.
Evidence
The responses to the quantitative survey show mixed views on the robustness of the new regime. That
table below lists the perceived benefits of the new approach.
28
Atkeson, Andrew, Hellwig, Christian, and Ordoñez (2012) “Optimal regulation in the presence of reputation
concerns” NBER Working Paper No 17898.
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Wider Impacts of Regulatory Change
Table 5.4: Perceived Benefits of the New Regime
Lenders (44)
Intermediaries (30)
Others (22)
Increased consumer protection
45%
60%
82%
More orderly market
34%
27%
73%
Enhanced public trust in the sector
32%
37%
68%
Increased legitimacy for authorised firms
34%
33%
68%
Enhanced ability to attract funding
18%
10%
55%
Elimination of rogue firms
70%
67%
82%
Greater certainty for business planning
20%
10%
55%
Enhanced confidence to support
investment
25%
10%
55%
More stable business environment
34%
13%
64%
Clarity on regulator expectations and
standards
30%
20%
68%
Reduced risk of market crisis/failure
16%
17%
55%
Other
9%
3%
0%
None of these
11%
13%
5%
Source: Policis survey (conducted prior to CP13/7) data.
It is clear that the majority of firms at this time considered the new regime beneficial in terms of eliminating
rogue firms from the market and increased consumer protection. Our subsequent qualitative fieldwork
suggests that rogue firms and the associated bad publicity are seen as a significant hurdle by compliant firms
in the market, and that the new regime is hoped to ‘clean up’ the sector and significantly level the playing
field. It may be that this indicates that the firms responding to the debt management firms’ survey, in
particular, are considered to be at the upper end of compliance and thus likely to be particularly in favour
of a more stringent regime.
Benefits cited in the table above such as ‘enhanced public trust in the sector’ and ‘increased legitimacy for
authorised firms’ might enable some firms to “hide” behind the regulatory badge and place less emphasis on
compliance as a means of attracting customers. The key here is the importance of effective supervision and
enforcement processes by the regulator so as to reduce this particular risk.
The upshot of the above discussion of course depends on the extent to which consumers value regulation,
and believe there to be a tangible difference between the OFT’s and the FCA’s approaches. The views
expressed in the above table are the industry’s view on the effects on public perception may prove to
overestimate consumers’ actual ability to note and judge the value of regulation.
5.6.2 Access to funding
Hypothesis of impact
A more robust regime may affect the ability of regulated firms to access funding. Regulatory risk has an
impact on companies’ ability to raise finance. In a competitive market, the cost a firm faces when accessing
capital markets is known as the cost of capital and is defined as rate of return that a capital invested in that
activity could be expected to earn in an alternative investment of equivalent risk.
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Wider Impacts of Regulatory Change
The new regulatory regime represents a potential source of systematic risk for the sector given the related
uncertainty. Depending on the level of regulatory uncertainty (e.g. frequent policy debates concerning the
potential introduction of interest rate caps29), this risk could increase the costs at which firms are able to
raise capital.
On the other hand, a move to a more robust regime that increases sector quality (and the ability of firms
to demonstrate this through regulatory badging) could serve to reduce the cost of accessing finance for
companies.
Evidence
Table 5.4 shows that the industry as a whole does not believe that the new regime will improve access to
funding; although there is more support for the idea that the new regime may enhance confidence to
support investment, perhaps in areas such as peer-to-peer lending. On the other hand, there is little
support for the view that access to funding or investment would decrease as a result of the new regime,
and thus there is little perception that regulatory uncertainty would necessarily increase the cost of capital.
5.7 Extent of the Grey Market
The grey market is composed of activities that are not illegal but yet do not comply with the regulatory
regime.
Hypothesis of impact
On the one hand, a change in the regulatory regime might increase the incentive to stay in or move into
the grey market for particular services, especially if the change is in the direction of a more robust regime.
For example, Bouev (2002) and Loayza, Oviedo, and Servén (2005) find that regulatory burdens can drive
firms underground.30 However, for firms not to comply with a new regime, or to switch to being noncompliant altogether, due to the increased regulatory burden would necessitate a reduction or lapse in
oversight. Given the aim of this new regime to be more stringent and proactive, this appears less likely.
More stringent supervision under the new regime should mean that regulated firms are more wary of
engaging with the grey market. This would apply to firms that use regulated firms further down the supply
chain, such as a lender’s use of, say, lead generators or debt management firms. The new regime may
increase the level of self-policing that takes place within the market, with compliance departments
becoming more proactive.
Evidence
One area where the growth of the grey market might be facilitated is in online services. Qualitative
feedback suggests that in some sectors such as lead generation, the online market is particularly fluid, which
may mean that non-compliant firms could evade enforcement by exiting and re-entering the market at
regular intervals. Online services may overlap to a greater extent with offshore firms not under the
control of the FCA (since an offshore firm would be likely to fail to meet at least one of the threshold
conditions for authorisation and would therefore be in the grey — if not black — market).
29
30
Any move towards an interest rate cap for lenders, as was recently decided against by the OFT for the
pawnbroking, payday loans, home credit and rent-to-buy credit markets, would be likely to raise the cost of capital
for the relevant firms.
Bouev, Maxim (2002) “Official regulations and the shadow economy: a labour market approach” William Davidson
Institute Working Paper No 524; Loayza, Norman, Oviedo, Ana Maria, and Servén, Luis (2005) “The impact of
regulation on growth and informality cross-country evidence” World Bank Policy Research Working Paper No
3623.
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Implications for Consumers
6 Implications for Consumers
6.1 Introduction
The implications of any changes in firm behaviour and any wider impacts of the regulatory change for
consumers relate primarily to: consumers’ ability to access credit; the choice of credit products available to
consumers; and the cost of borrowing for consumers.
These are discussed in turn below (with the exception of payday lending, which we discuss in a discrete
chapter at 8.5.3 and present a summary analysis at 6.5. The assessment of these impacts draws on the firmand segment-level behavioural analysis and the analysis of the wider impacts in the previous chapters.
Throughout we pay particular attention to any evidence to suggest that vulnerable consumers would be
affected by the regulatory changes.31
6.2 Access to Credit
A prime way in which consumers may be affected would be in their ability to access credit. The key drivers
of any change in the supply of credit following the change in the regulatory regime would be:
A change in the company’s business strategy;
Market exit by firms;
A change in the appetite of firms to serve certain consumers; and
Any shrinking or expansion of the grey market.
Table 6.1: Mapping of Access to Credit Analysis
31
Vulnerable in this context refers to consumers that have a limited number of options in terms of accessing credit.
This could be due to a poor credit rating (e.g. consumers with bad debt history, low and variable income, high
levels of existing debt etc.) and the need for urgent access to credit.
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Implications for Consumers
6.2.1 Market exit
The number and nature of firms exiting the market may affect consumers’ access to credit: if serving the
consumer credit market becomes unprofitable we assume the firm would exit the market.
The segments where we believe that such exit is likely are: credit brokers, retail intermediaries (secondary
credit brokers) and non-bank lenders. We revisit the market impact of these here:
The evidence we have indicates that the credit broker segment is already highly stressed, with too
many participants chasing revenues substantially below the levels of the recent past. We contend that
market exit here would not translate into any further reduction in volume: the remaining participants
could effectively pick up the “slack”.
Amongst the retail intermediaries, both in the motor segment and elsewhere, the situation would be
different: whilst there would be some movement of consumers to retailers remaining in the consumer
credit market, or towards substitute products (i.e. personal loans, credit cards) we would expect a
knock-on effect of reduced consumer credit activity here, i.e. a reduction in lending volume.
It follows from the previous point that non-bank lenders, which includes lenders operating through
point-of-sale would also be affected, and we expect a reduction in the participants here (focused on the
smaller players) such that lending volumes reduce. We have assumed that there would be no
substitution for any decline non-motor POS lending. The 3–4 per cent decline that we expect here
would reduce lending volumes by £80–£110 million. We would anticipate some substitution in motor
loans (this may not be from banks, consolidation by existing non-bank players or the emergence of new
entrants appear at least as likely). If the scale of such substitution is at a reasonably high-level (say
between 70–75 per cent) then this implies a reduction in lending volume of £125–£200 million per
annum — i.e. about £205–£310 million in total. This is about 0.13–0.19 per cent of the total consumer
credit advanced in 2012.
Those consumers served primarily by these would experience reduced access to credit. The quantitative
Policis survey (conducted prior to CP13/7) obtained data on various categorisations of the customers
served, qualitative grading of risk and income quintiles. Focusing upon the latter, we observe that — at
least for those firms in this category responding to the survey — the customer mix is broadly comparable
to that of banks, the card monolines and online payday. This means that the top two income quartiles are
slightly overweight (i.e. over 20 per cent each), whilst the bottom two income quartiles are slightly
underweight (i.e. less than 20 per cent each).
As we have argued above, these changes would be driven in large part by exit from the consumer credit by
smaller, more marginal (in consumer credit terms) secondary credit brokers. It does not follow from this
that particular groups would be more or less badly affected than the average position in the first instance by
this. Nevertheless, as we have also argued in the previous chapter, it is those consumers in the lower
income quintiles that have markedly reduced ability to substitute in other consumer credit products.
6.2.2 Change in business strategy
Hypothesis of impact
Any change in pricing strategy might affect the supply of credit to individual groups. The extent to which
this manifests itself as a change in supply will depend largely on the relative price sensitivity of consumers
and supplier, which will determine the pass-through rate. If demand is relatively inelastic compared to
supply the pass-through rate is likely to be higher and the reduction in supply lower. This would imply that
— abstracting from any change in the firm’s appetite for risk or the firm’s ability to alter supply in the
short-run — those consumers less sensitive to price, such as those with fewer alternatives, would be more
likely to experience an increase in the cost of accessing credit rather than a reduction in the supply of
credit. Meanwhile those (possibly less risky) customers with access to a wider range of credit options
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Implications for Consumers
would be more likely to witness a reduction in the supply of credit on offer and more limited increases in
the cost of credit.
Evidence
As discussed in the previous section our analysis indicates that firms — at least in most segments — will
not materially alter their pricing or marketing strategies in response to additional costs of compliance.
6.2.3 Change in firm’s appetite to serve certain customers
If the risk of regulatory intervention increases, increasing the probability of profits being negative for certain
consumers, expected profitability associated with those customers may become negative. In this case the
firm may decide to stop serving those customers. Whilst this is an aspect of the downside risk described
above (see 5.2) it is not an impact we anticipate as directly driven by the proposed policy mix.
6.2.4 Grey market
Expansion or reduction of the grey market could also affect consumers’ access to credit. In markets where
a move to the grey market (as an alternative to complete market exit) is possible the impact on consumers’
access to credit may be more muted than anticipated. The scope for firms to operate illegitimately (i.e.
crossing over to a “black” market) if the additional regulatory burden makes it unprofitable for them to
continue to operate in the regulated arena, may reduce any negative impact on consumer access to credit
arising from the change in the regulatory regime.
We do not foresee substantial scope for the grey market to replace point-of-sale credit: whilst certain
secondary credit brokers might be willing, we expect that the banks and non-bank lenders in this market
would — bearing in mind the additional scrutiny expected from the FCA — be unwilling to explore such a
route.
6.3 Choice of Credit Products
The choice of consumer credit products available to consumers would be affected by whether certain types
of products would cease to be offered and/or new/different products be introduced, or the variety in the
quality of the products offered would change. The implication of any changes to the market (market exit
or entry) and any changes in product differentiation would be the amount of choice available to consumers
generally. A reduction in choice would reflect a cost to the consumer, and would typically be characterised
as an unintended — since likely to be damaging — consequence of the change.
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Implications for Consumers
Table 6.2: Mapping of Choice of Consumer Credit Products Analysis
6.3.1 Market exit
Our analysis indicates that the exiting firms would be focused upon the more marginal participants, either
with low volume of lending, or weaker control environments (or both). It is not clear, on the other hand,
that the exit from the market would affect the variety of credit products available to consumers as a whole.
6.3.2 Impacts on innovation
A change in the rate and scale of innovation would also affect the choice of products available to
consumers, and may act asymmetrically. The industry anticipates a slight slow-down in the rate of
innovation. We have described our thinking on this more fully in the previous chapter.
6.3.3 Change in firms’ offerings
Firms may have an incentive to diversify the products they offer or to cease offering products that carry a
greater risk of stimulating regulatory intervention. Equally if firms attach a greater probability of regulatory
intervention to certain types of consumers, a potentially unintended consequence of the transfer would be
to create incentives to cease offering credit to those consumers, limiting the choice of products available to
those consumers.
In our analysis in Chapter 4 the exit behaviour is largely driven by the impact by increased costs on already
marginal firms. Some small narrowing in the range of products currently offered appears plausible (this is
certainly the expectation of the industry).
6.4 Cost of Credit
Hypothesis of impact
Associated with any changes in the supply and choice of products would be changes in the cost of credit.
In particular, these changes could be driven by:
the extent to which the additional compliance costs are passed through to consumers, increasing the
cost of consumer credit products; and
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Implications for Consumers
the choice of products available and extent to which consumers find themselves diverted to product
types which are more expensive
Table 6.3: Mapping of Cost of Credit Analysis
The scale of any change in prices would be affected by:
The change in business strategy — i.e. the balance between price change and changes in the supply of
credit;
The impact on competition — reduced competitive pressure would generally be expected to result in
higher prices;
The impact of enhanced regulatory badging — any change in the ability to access funding, or rather the
cost of that funding would potentially affect the cost of borrowing for consumers.
The impact on consumers from a rise in the cost depends on the nature of the market. In a market where
consumers are relatively insensitive to price (e.g. the main driver of competition is availability of credit), the
consumers would suffer from a direct increase in the price they pay for that product. In a market where
price plays a more active role in competition, consumers may be able to minimise the cost effect by
switching to alternative products. The ability of individual consumer groups to switch in this way will vary.
However, the ability to switch would be unlikely to allow them to avoid additional cost entirely. One
determinant of this would be the scope for regulatory get-around (the incentives for which would increase
as the cost of compliance increases).
Evidence
Our analysis at 4.24 indicates that pricing effects may be quite limited. Combining this analysis with data
from the quantitative survey on the mix of customers served indicates that the total likely cost impact
passed through to consumers (i.e. £22–£40 million) would be allocated as follows:32
The top income quintile would prima facie be asked to absorb 26 per cent of this;
The second quintile 22 per cent;
The middle quintile 18 per cent
The next to bottom quintile 18 per cent; and
The bottom quintile would need to absorb 15 per cent (i.e. £3–£6 million) — this quintile may be least
able to substitute other consumer credit products (indeed, drawing on data from Policis we note that
access to credit here has become increasingly fragile, with perhaps as many as 20–25 per cent of
32
Absent data on the credit unions we have assumed that 50 per cent of the customers served were in the bottom
quintile, 40 per cent in the next bottom and the balance in the middle quintile.
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Implications for Consumers
borrowers lacking an alternative credit option — this would be where scope for increased financial
distress would appear greatest).
6.5 Impact on Payday Lending
The HCSTC-specific policies are likely to have a significant impact on the ability of these lenders to recover
revenue within their current business models and lending profile, leading to a reduction in lending volumes.
Lending may extend to new customers over time, but we expect a significant proportion of consumers
would lose out on access to payday credit, some of whom may not have access to any other forms. This
will impact a significant proportion–– we estimate between 18 and 30 per cent of current payday
customers would be denied access to credit. For some consumers this restriction in access to payday
lending is indeed the policy intent, and likely to be beneficial. This would be the case for those consumers
who are unable to repay their payday loans and are at risk of increased financial difficulty or debt spirals as
a result of rollovers and/or CPA use by lenders (i.e. consumers engaged in unsustainable borrowing).
However, the alternative options for these consumers may not always be positive. We develop scenarios
that include doing without, accessing debt management service, borrowing from friends, illegal lending.
In addition, there may be some consumers for whom payday lending is not unaffordable (or detrimental)
who would nevertheless suffer restricted access. The tighter the restrictions (in particular of rollovers and
CPA use) the more likely consumers who can afford to borrow will be constrained from doing so.
The HCSTC-specific polices may also restrict access to certain credit products. Payday loans of particularly
short duration (say less than two weeks) may be curtailed (e.g. only available to customers with an
established track record of paying back longer-term loans).
The payday policies are likely to result in a rise in the cost of credit (i.e. through default fees and related
charges) as remaining lenders seek to recoup lost revenues. These could be significantly higher than the
direct compliance costs — although it is difficult to assess how much can be passed through to consumers.
Whilst payday customers are frequently characterised as price insensitive, one would expect a profitmaximising payday lender to seeking an optimal balance between volume and price now. We therefore
consider that the revenues to be recouped from consumers could be around half of the additional profit
from loans rolled over three times (perhaps £10–12 million). Another form of alternative action could
involve switching the capital extended in rolled-over loans to new lending (provided that customers are
available in sufficient numbers).
A detailed discussion of the impacts of the HCSTC-specific policies on consumers is presented at 8.5.3.
6.6 Comparison to the March Report
The results presented above are broadly similar to those presented in our March Report, other than with
respect to payday lending — which we have just described. The main other change relates to the way in
which we have considered the substitutability of POS lending — however, the net result of the latter
change is not particularly consequential (i.e. the analysis has changed not the end conclusion).
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7 Benefits
7.1 Introduction
The transfer of regulation of consumer credit to the FCA is expected to give rise to benefits over and
above the OFT regime. This will achieved be through a number of channels. The primary channel to
secure benefit should be improved market functioning and business practices through greater compliance
with OFT guidance. This would be brought about by the enhanced supervision and enforcement powers of
the FCA. As set out in the FCA’s March and September consultation papers, many of the policies do not
vary greatly from existing OFT guidance, and therefore in these cases the key benefit will be the enhanced
enforcement powers of the policies as a holistic package.
In addition some OFT guidance is being translated into FCA rules. Benefits will also stem from the
additional details of some policies over and above OFT guidance that target specific sectors or particular
market failures.
In assessing the benefits of the regime transfer we divide our analysis into three main sections: the payday
lending and debt management markets, where particular detriment has been identified and for which
sector-specific policies have been developed by the FCA, and a general section comprising all other
consumer credit markets. This focusses the analysis on those markets with the most relevant detriment
and market failures, and on those polices which are expected to have the greatest impact.33
This chapter is organised as follows:
We begin with a summary of the types of consumer detriment evident in the consumer credit market
which the policy mix is likely to address, and the drivers of this detriment. We first provide a general
discussion of consumer detriment across all consumer credit markets, and then focus on the evidence
of detriment in the debt management and payday lending markets. This summary of detriment is
presented in detail in the Appendix at Chapter 11.
We move on to our qualitative analysis of the benefits of the new regime, which considers how the
policies might address the various types of detriment in our three main sections. To avoid undue
repetition we present a single discussion for all market sectors, highlighting where a policy is
particularly relevant for a certain market sector.
We then present our quantitative analysis of the benefits of the FCA regime. This is a sub-set of the
overall benefits as quantitative evidence is only available for ‘observable’ detriment (we discuss this
concept below). We emphasise the difference between real economic benefits arising from the
resolution of market failures and thus an overall increase in welfare; and benefits to consumers that
arise from changes in firm behaviour and which represent a transfer of welfare.
At the end of the chapter we present an overview of the benefits of the policy mix, identifying the main
areas of detriment across sectors and which sectors are likely to see the most benefits.
33
The analysis of the benefits of the payday lending policies is presented in full in the payday lending chapter (Section
8), and only a summary is presented in this chapter.
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7.2 Types of Consumer Detriment
7.2.1 Introduction
The FCA policy mix will lead to benefits through the reduction in consumer detriment, which we define as
negative consumer outcomes. We draw on the existing evidence of detriment in the consumer credit
market from a number of sources such as: the FCA’s own market failure analysis published in its March
consultation paper; the NAO’s report on the financial regulation of consumer credit regulation; the OFT
report on high-cost consumer credit; the OFT report of consumer detriment in the wider economy; the
BIS reports on the impact of the total cap on credit and ; HMT’s impact assessment of the consumer credit
regime transfer; the OFT payday lending compliance review; and the OFT’s debt management guidance
compliance review.
Consumer detriment in consumer credit can arise through a number of drivers:
Market failure: for example, limited competition which restricts consumer choice of products and/or
services; information asymmetries; misaligned incentives.
Firm behaviour: for example firms misleading consumers; engaging in aggressive debt-collection
techniques.
Consumer behaviour: behavioural biases that result in sub-optimal choices such as not switching
between products to get the best deal; or not realising the likelihood of not paying back a loan.
Life events: shocks to income, such as redundancy, and expenditure, such as illness.
These drivers are not mutually exclusive. For example, elements of market failure (e.g. information
asymmetries) could exacerbate firms’ non-compliance with good business practices and increase their
propensity to offer loans to consumers without conducting proper affordability checks. Firm behaviour
could exploit consumer biases, for example by having low-cost loans with very high penalties to take
advantage of the fact consumers might not consider penalty payments relevant to them.
The objectives of the FCA are concerned with detriment that arises from market or regulatory failures,
which may stem from the market structure or inappropriate behaviour of firms. Detriment caused purely
by life events and not the fault of the lender or the borrower should not be included in the assessment of
detriment relevant to the FCA. For example, if a consumer takes out a loan with the full expectation of
being able to repay it, and loses his or her job unexpectedly and is no longer able to repay the loan, then
although there is consumer detriment this is not a risk to FCA objectives. This is because no market or
regulatory failure is present. (However if, after this event, the lender engages in inappropriate behaviour
such as aggressive techniques to recover the loan, then the additional detriment caused by this would be
relevant to the FCA).34
Observable and unobservable detriment
For the purposes of our analysis it is useful to distinguish between observable and unobservable consumer
detriment. Observable detriment covers detriment that is largely the direct result of inappropriate firm
behaviour (which may of course be driven my wider market failures). Consumers are aware of the cause
of their suffering, and might lodge a complaint with a relevant body. It is more straightforward to quantify
this type of detriment, for example through complaints data.
Unobserved detriment does not have an obvious source for consumers and is thus not visible in complaints
(whether reported or unreported). This type of detriment includes sub-optimal outcomes for consumers,
34
For this reason, when evaluating evidence of consumer detriment care must be taken to assess the basis for the
detriment. For example, this may entail considering only consumer complaints that have been upheld.
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driven by market failures, about which they are not aware. We are not implying that consumers are not
aware that something is wrong (i.e. a consumer in financial distress resulting from a debt spiral will be
suffering, and know it) but they may not appreciate the ultimate cause of the problem (e.g. that they
unknowingly took out an unsuitable loan; or were unable to access credit) or aware that under a wellfunctioning market the problem would have been less likely to arise.
The ideal measure of benefit is economic benefit, i.e. a total increase in welfare. This will arise through
improvements in market functioning such that both firms and consumers benefit (or at least consumers do
not benefit at the expense of firms). For example, ensuring that consumers can afford to repay loans
benefits both lenders and consumers. As it is the ex ante loss in consumer welfare arising from market
failures that drives this type of detriment, it is likely that this measure of benefit will arise largely through a
reduction in unobservable detriment.35
Another measure of consumer benefit is the reduction in negative ex post outcomes that consumers
experience after having purchased or interacted with a product or service. This measure is generally a
transfer payment of some kind between consumers and firms, whereby firms incur costs from either
providing redress or improving compliance, and consumers benefit from the compensation or improved
behaviour. Whilst transfer payments increase consumer utility they do not necessarily represent true
economic benefits.
7.2.2 Detriment across all consumer credit markets
The main types of consumer detriment arising from market failures (and exacerbated by firm and consumer
behaviour) are summarised below. The Appendix at Chapter 11 contains a more detailed discussion of
consumer detriment in consumer markets.
Unaffordable borrowing/lending, debt traps or spirals
Consumers can have incentives to take out credit they cannot afford. This includes borrowers who believe
they can and will repay the loan when in reality they cannot. Consumers may be overconfident in their
ability to repay the loan, and lack awareness of the consequences of late repayment. Consumers may also
focus on their immediate credit need rather than whether they can repay the loan (present bias).
Distressed borrowing is more likely for borrowers who are already struggling financially and who may
overextend themselves when borrowing.
Lenders may provide unaffordable lending if it is profitable to do so, for example if the lender can extract
sufficient revenue from the borrower even if they eventually default, or if the costs of distinguishing
between borrowers of different credit worthiness are greater than providing the same credit product to all
of these borrowers.
There are also wider market failures which can drive or exacerbate firm behaviour which leads to
unaffordable lending. Information asymmetry between lenders and borrowers increases the cost to lenders
of distinguishing between borrowers of different credit worthiness and may lead to credit being extended
to all borrowers regardless of their ability to repay loan (adverse selection). It may also lead to lenders
mistakenly believing borrowers can repay loan.
Poor value credit or services
Consumers can suffer detriment where the price of a credit product or service is persistently more than its
competitive price. This indicates that the provider exercises some market power. As highlighted in the
FCA market failure analysis, it is difficult to conclusively determine whether some products are poor value.
35
This type of detriment looks at whether the market is working well when consumers make their decisions, and
therefore considered ex ante reductions in consumer welfare (i.e. a reduction in consumer surplus) rather than
negative outcomes that come to light after a consumer has purchased or engaged with a product or service.
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However, an OFT review did conclude that some credit suppliers in high-cost credit markets (pawnbroking, payday lending, home credit) appear to be charging higher prices than expected. 36
The underlying market failures of this type of detriment are:
Insufficient competition (particularly at the point of a loan rollover) and market power of firms
Information asymmetry can make it difficult for consumers to gather correct information on products
and services and thus to choose the most appropriate product or service.
Firm behaviour and consumer actions can arise out of, and exacerbate, these market failures.
Detriment arising from conflicts of interest
Consumers can face detriment if they lack information to adequately judge whether a product is provided
or a service is carried out appropriately and in their best interests. Conflicts of interest exist whereby
credit product and service providers act in a way that benefits them at the expense of the consumer. This
could have detrimental outcomes such as:
unsuitable advice or products being given to consumers; or
the loss of client money and assets.
Lack of access to credit
Consumers can experience detriment when they are unable to access credit, access sufficient credit, or
access a sufficient variety of credit products, where they would be in a position to manage the credit.
Consumers who are unable to access credit may suffer from having to do without, or may be incentivised
toward unregulated sources of credit, including illegal sources.
Lack of access to credit is a market failure in itself. This could arise from the market power of some
lenders (who could price some borrowers out of the market) and barriers to entry to new entrants who
would be willing to meet the credit demand.
Information asymmetries could also prevent consumers from being aware of all possible credit options.
For examples, users of home credit may be unaware of the possible credit options from cheaper sources,
such as credit unions. Customers may perceive that there are low degree of substitutability between
credits products and hence, reluctant to explore alternative sources.
Lenders can lack information about borrowers’ ability and willingness to repay loans and as such may
attract less credit worthy borrowers (adverse selection) which in turn may lead them to be overly
restrictive on lending criteria and to reduce access to credit.
Summary
The figure below presents a summary of the linkages between market failures and firm/consumer behaviour
and the main areas of consumer detriment.
36
OFT (2010), Review of high-cost credit, Final report
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Table 7.1: Drivers of consumer detriment
Evidence of these areas of detriment is now presented in more detail in relation to the debt management
and payday lending markets.
7.2.3 Detriment in the Debt Management market
The debt management industry has recently implemented voluntary conduct standards and it is possible
that some of the evidence of consumer detriment no longer occurs. However, the adoption of conduct
standards is likely to be limited to firms that are members of the two trade bodies – DEMSA and DRF.
Sales of poor value credit products or services
There was evidence suggested by Consumer Credit Counselling Service (CCCS) that consumers paid more
under the fee-charging debt management plans (DMPs) and hence, usually took them longer to clear their
debts as compared to the DMPs provided by CCCS.37 For example, CCCS indicated that for a typical debt
of £30,000, commercial debt management companies (DMCs) would charge almost £6,000 additional in
fees and this would extend the repayment period of the consumer by around 18 months. This could
increase the risk of default of the consumers and pro-long their period of financial burden.
An earlier independent study commissioned by Money Advice Trust also found that customers of feecharging DMCs usually have their plan terminated earlier than the planned duration, often due to poor
37
Business, Innovation and Skills Committee — Fourteenth Report Debt Management, February 2012
http://www.publications.parliament.uk/pa/cm201012/cmselect/cmbis/1649/164906.htm#note126
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service provided by the DMC.38 Some customers who cancelled their agreement felt that their financial
situation was worse than before they engaged with the services and that the DMP was no longer affordable
for them. Some customers even found themselves in serious financial difficulties, falling behind their regular
payments such as household bills.
There are also examples of bad practices in financial promotion of the DMCs found by the OFT.39 For
example, DMCs use misleading mailing consumers, adopt a similar layout of their websites to the not-forprofit debt advice and engage in cold calling activities. Such advertising and marketing materials may
provide misleading information to consumers and encourage them to accept unsuitable DMPs.
Detriment arising from conflicts of interest (unsuitable advice and loss of client money)
Concerns have been raised that the profit-maximising model of commercial DMCs is not in consumers’
best interests, and could increase the risk of repayment plans failing.40 Debt management firms can frontload client fees in order to ensure the recovery of set-up costs, regardless of whether the plan fails within a
few months. The front-loading of fees can negatively impact clients if the majority of the initial payments go
towards the debt managers rather than towards paying off the debts. This would have the effect of
extending the period of the client’s indebtedness whilst interest and charges continue to accrue. If the plan
fails, the DMC would remain profitable.
This practice may also reduce the incentives for debt managers to design sustainable debt management
plans for their clients, as their revenues would remain intact even if the plan fell through.
Research in the United States on the credit counselling sector identifies the above-mentioned incentive
alignment problems with upfront fees.41 In particular the work notes that credit counsellors that rely on
initial plan set-up fees have an incentive to indiscriminately place consumers on debt management plans, and
have less incentive to ensure that the consumer remains on plan. The higher fees charged to financially
stressed clients could also increase the likelihood that these consumers will default from the plan. The
work notes that (in 2005, the time of writing) there was a movement by the market towards performancebased remuneration schemes to increase incentives to provide sustainable debt management plans.
The OFT has also reported that many of the debt advisers surveyed in its 2009 review failed to provide
information on the full range of debt remedy solutions available, and firms were found to give advice or
solutions driven by profitability rather than the best interests of consumers.42
In relation to loss of client money, the Debt Resolution Forum (DRF) has highlighted the problem of
insufficient audit of client accounts held by DMCs. The insolvencies of two DMCs are examples of poor
audit of client accounts and resulting large losses of clients’ money and assets.43
Also, none of the websites assessed by the OFT in its compliance review had provided information on the
complaints handling services of the Financial Ombudsman Service and its role in redress requests.44 This
38
39
40
41
42
43
44
Money Advice Trust (2009), An independent review of the fee-charging debt management industry. In the survey
conducted, the average duration of a plan was 36 months or less while the projected plan was supposed to be
between 60 and 120 months.
OFT (2010), Debt management guidance compliance review,
http://www.oft.gov.uk/shared_oft/business_leaflets/credit_licences/OFT1274.pdf
Debt advice of the Debt management – Business, Innovation and Skills Committee,
http://www.publications.parliament.uk/pa/cm201012/cmselect/cmbis/1649/164906.htm#note126
Staten, M (2005) ‘The evolution of the credit counselling industry’ in Bertola, G et al ‘The Economics of Consumer
Credit’ Chapter 8, The MIT Press
OFT (2010), Debt management guidance compliance review,
http://www.oft.gov.uk/shared_oft/business_leaflets/credit_licences/OFT1274.pdf
Debt advice of the Debt management – Business, Innovation and Skills Committee,
http://www.publications.parliament.uk/pa/cm201012/cmselect/cmbis/1649/164906.htm#note126
OFT (2010), Debt management guidance compliance review,
http://www.oft.gov.uk/shared_oft/business_leaflets/credit_licences/OFT1274.pdf
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would reduce consumers’ awareness of the alternative dispute resolution process operated by the Financial
Ombudsman Service and reduce the likelihood in claiming back compensation for the losses incurred.
7.2.4 Detriment in the Payday Lending market
A detailed discussion of consumer detriment in the payday lending market is presented at 8.3. The main
type of detriment relates to unaffordable lending, whereby consumers’ biases incentivise translate into
taking out loans they believe they can repay but which in fact lead to multiple rollovers and financial
difficulties. Payday lending has been criticised by some commentators for exploiting these consumer biases
and not conducting appropriate affordability assessments at the time of extending new loans or refinancing
existing loans. The use of continuous payment authority (CPA) and (arguably to a lesser extent) rollovers
enable payday lenders to secure revenue even from consumers who cannot afford to repay the loan.
These practices create a risk that the consumer falls into a debt trap and that payday loans become a longterm source of credit.
There is also evidence of poor service in the payday industry, such as aggressive revenue collection
(including the abuse of continuous payment authority, by which lenders bombard customers’ accounts with
requests so that funds can be collected as soon as they arrive in the customer’s account) and poor
treatment of customers in financial difficulty.
Inappropriate advice is a further type of detriment in this market, for example customers in repayment
difficulty being offered multiple rollovers instead of being advice to seek debt solutions.
7.3 Qualitative Benefits
Before considering the ways in which individual policies could secure benefits, we make some general
comments about the FCA’s approach compared to the OFT. First it is worth noting that various OFT
guidance, including guidance on irresponsible lending, debt management and credit repair service, are
transformed into rules which firms are obligated to comply under FCA supervision. This should incentivise
firms to execute the rules more closely into their day to day practices than they were before under the
guidance of OFT. It would hence improve the general level of standards in the industry and address areas
of detriments, such as unaffordable lending and misleading information via inappropriate financial
promotion.
The FCA will have a stronger authorisation regime, which we discuss at 7.3.1 below. It will also have the
power to issue new rules and guidance quicker and more flexibly in its rule-making process, meaning that
the FCA could address problems quicker and more effectively. It also has greater powers to impose
sanctions for breaches of the rules which would incentivise greater compliance among firms and lead to
improved outcomes for consumers. We have noted in the previous section that parts of the consumer
credit industry are supportive of a tighter and more robust regime with enhanced standards, more
proactive monitoring of firm behaviour and more effective enforcement.
The FCA has greater enforcement powers and resources compared to the OFT, e.g. it can enforce against
breaches in approved persons, the threshold conditions and other areas of the regime. Such powers as
bringing criminal, civil and disciplinary proceedings to withdraw authorisation, and banning individuals from
financial services among other actions would apprehend non-compliant firms directly and indirectly
incentivise a better level of compliance in the industry.
Notwithstanding that it is the combined policy package and FCA approach which will underpin improved
consumer outcomes, we nevertheless describe the key mechanisms by which the individual policies should
lead to benefits by addressing particular areas of consumer detriment, such as unaffordable lending, poor
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value products or services, unsuitable advice and loss of client money. The more concrete and targeted a
policy proposal is, the more likely it will lead to improved outcomes in specific areas.
7.3.1 Authorisation and Appointed Representatives
The stronger authorisation process should allow FCA to assess the business information of the potential
entrants to ensure that their business model and strategy are suitable for their regulated activities. It would
also introduce more scrutiny of higher-risk firms before they are allowed to operate via the assessment
procedure. There would be drivers of improved outcomes:
Prevention of rogue firms entering the market which would improve overall standards of the market.
This should address all areas of detriment identified in Section 7.2 above and discussed in detail in the
Appendix at Chapter 11.
A reduction in harmful business models should directly impact on business conduct and the elimination
of sub-standard offerings. This should target the sale of poor services/products and unsuitable advice.
Detriment in this area includes consumers who may overextend themselves when borrowing. For
example, credit products that can easily be rolled over can be a concern for consumers who are prone
to procrastination or who focus more on the immediate need for the loan than on their ability to repay
it long-term. These loans can accumulate charges and interest and increase the risk that the borrower
will be unable to repay. Other detrimental lender business practices include downplaying long-term
costs of loans, or having low up-front charges to entice consumers and exploit present bias. Lenders
may also levy significant upfront charges to recover revenue even if borrower defaults; design products
to secure repayments even if borrower is struggling (e.g. through continuous payment authority); or
not carry out proper affordability checks due to cost and therefore lend to borrowers who are unable
to replay loans. Other examples of harmful practices are discussed on the Appendix at Chapter 11.
The impact of these policies would differ in magnitude depending on the characteristics of different credit
markets. Authorisation would only have direct benefits in markets with firms that have to be directly
authorised by the FCA, including lenders,45 debt managers and debt collectors.
That said, the appointed representatives regime should transmit similar benefits (it is hoped in a
proportionate way) from the authorised firms acting as principal to the representatives. Therefore,
consumers should benefit the same from the enhanced authorisation of the principal firms. The appointed
representative regime should have the largest impact in market sectors consisting largely of intermediaries
and markets with agency models.46
We have assumed that the incremental impact of Authorisation would be much less significant in sectors
where the majority firms are already regulated by the FCA and thus familiar with the FCA’s approach, e.g.
the banks and building societies sector.
7.3.2 Approved persons
The supervisory approach for approved persons would provide more scrutiny of the integrity and
competence of individuals in key positions responsible for significant influence functions, such as client asset
oversight function for debt management firms and money laundering reporting functions for most lenders.
45
46
Lenders include banks and building societies, credit card monolines, online payday lenders, mainstream and brick
and mortar lenders, home credit lenders, non-bank lenders and credit union.
Under the agency model, a principal which would be directly authorised by FCA could employ more than one
agent to carry out its consumer credit activities. The agent would need to be supervised by the principle to
ensure appropriate business standards and complied with the appointed representative regime. Agency model is a
common used in the home credit and debt collector markets.
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All approved persons would be vetted by a “fit and proper” test to ensure they are fit for purposes. The
approved person proposal will increase individual accountability and possibly reduce conflicts of interest,
identified as a key source of unsuitable advice. This would also improve the level of integrity, competency
as well as the compliance standards of the firm and the industry as a whole.
The policy may have a differential impact according to the size of firms. For example, small firms are likely
to have senior person in charge of more than one of the specific functions due to resource constraints.
For debt management firms, the regime on client asset oversight function would help to improve standards
in the management of client assets and reduce the loss of client money in case of default of the debt
management firms. This may particularly address detriment arising from the insufficient audit of client
accounts, as highlighted by the Debt Resolution Forum. The insolvencies of two DMCs are examples of
poor audit of client accounts and resulting large losses of clients’ money and assets.47
For secondary credit brokers (such as those at point-of-sale), consumer hire firms and lower risk lenders,
there would be an individual pre-approved by the FCA for the general oversight of the consumer credit
business to ensure the compliance of the firm and good standard of practice. Given the lower risk nature
of these markets, the policy would be more light-touched to ensure the cost of compliance to the firms are
minimised with the same level of benefits. This may address the risk of detriment arising from misaligned
incentives, e.g. if intermediaries’ incentives are not dependent on whether the credit they arrange is
affordable or not.
7.3.3 High-level standards
The Principles for Business (PRIN) along with the General Principles (GEN) and the Systems and Controls
Sourcebook (SYSC) would be actively enforced under the FCA regime. Improved consumer outcomes
could be driven by the following mechanisms.
Better conduct standards (combined with increased resources for supervision and enforcement) should
lead to reduced incentives for firms to engage in misleading advertising48 or threatening behaviour. This
would address consumer detriment related to unaffordable lending, particularly where linked with
consumer biases which are exploited by misleading advertising (which, for example, downplays the longterm cost of loans), and with aggressive revenue-collection methods (which can be used to support
business models that provide unaffordable lending).
Clear guidance for business practices which should improve general standards for business operating in the
consumer credit industry. This should reduce the extent of detriment in all areas through the enforcement
power of FCA.
With reference to the Principles, especially customers’ interests and customers’ relationships of trust, it
would encourage firms to provide transparent and fair contract agreements to consumers and reduce
consumers’ losses from “hidden costs” or unfair contract agreements. This policy may address detriment
arising from consumers’ lack of understanding of products, in particular the inability to compare products
as a result of complex charging structures which could limit competition and result in poor value
products.49 This policy may also address detriment arising from, unsuitable advice being given to consumers.
47
48
49
Debt advice of the Debt management – Business, Innovation and Skills Committee,
http://www.publications.parliament.uk/pa/cm201012/cmselect/cmbis/1649/164906.htm#note126
For example, retailers tend to advertise their credit offering facilities such as “interest-free” which could be
misleading and do not take into account of the premium price incorporated in their bundled price of the product
as compared to market price. This may induce the consumer to make a suboptimal choice if they only rely on the
APR figure for the cost of borrowing. See OFT (2010), Review of high-cost credit, Final report.
For example, The OFT found that the home credit market is dominated by one large player and together with its
market structure (networks of agents and personal relationships between agents and the customers) there is a lack
of price competition and barriers to entry. The Competition Commission also found that profits in the home
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For example, the OFT found evidence that some credit brokers were charging upfront fees to search for
credit for high-risk borrowers, but either not finding any credit solutions or offering unsuitable credit.
Given the upfront fee payment, the brokers had no further incentive to provide a good service. In the debt
management sector, Money Advice Trust has argued that some of the DMCs’ assessments of consumer
debts were inadequate and could therefore, lead to unsuitable advice or inappropriate solutions being
provided to consumers.50 Some of the fee-charging DMCs’ websites used a 30-second debt test to assess
the eligibility of consumers for a Government-backed IVA while such assessment would take 15 minutes at
National Debtline, a government debt advice service to work through with its consumers. Consumers who
are provided with an inappropriate plan may take longer to repay their debt due to inadequate assessment
of their financial situation and may even increase the risk of debt traps if their DMPs failed.
The policy may also address the lack of transparency in the debt management industry found by the OFT.51
Unlike the requirement for lenders to state the APR of their products, cost information of DMCs is often
unclear, making it difficult for consumers to choose the best available plans between competing firms or
even to distinguish between fee charging debt management business and charitable advice providers. The
absence of adequate information could lead consumers to choose an unsuitable plan without being fully
aware of the fees this would entail. For example, a research conducted by R3 found that 10 per cent of
individuals in commercial DMPs were not told the fee they would be charged until after they had engaged in
their plan.52
This policy may also address detriment arising from misuse of client assets (for example where client
money held by debt management firms is used to reimburse the start-up costs of a plan significantly before
creditor payments are made).
7.3.4 Supervision and Regulatory Reporting
The enhanced supervision and reporting requirements of regulated firms to the FCA would transmit
benefits via the following mechanisms:
Improved information collection, in particular product sales data (PSD) reporting:

Should allow the FCA to be pro-active in its supervision approach, in particular its event-driven
supervisory work to be carried out on the appropriate firms. It would help to ensure that
emerging/recent problems are dealt with promptly and compensation secured for consumers. It
would help to reduce the sale of poor services/product and unaffordable lending. Secured
compensation could also reduce the risks of losses of client money and assets.

Reflecting on the market data collected, the FCA would be able to make new rules targeted at the
vulnerable consumer groups or market failures. The enlarged information collection would allow
FCA to deal with problems earlier than OFT and reduce extent of detriment in all areas.
Enhanced supervision such as event-driven work as well as issues and product supervision would
impose a deterrence effect on non-compliance and improve overall standards of the industry.
50
51
52
credit market had been “persistently and substantially in excess of the cost of capital for firms that represented a
substantial part of the market.” See OFT (2010), Review of high-cost credit, Final report and Competition
Commission (2009): ‘Home credit market investigation’, page 7.
Debt advice of the Debt management – Business, Innovation and Skills Committee,
http://www.publications.parliament.uk/pa/cm201012/cmselect/cmbis/1649/164906.htm#note126
OFT (2010), Debt management guidance compliance review,
http://www.oft.gov.uk/shared_oft/business_leaflets/credit_licences/OFT1274.pdf
Debt advice of the Debt management – Business, Innovation and Skills Committee,
http://www.publications.parliament.uk/pa/cm201012/cmselect/cmbis/1649/164906.htm#note126
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Two to four yearly risk assessments would provide the FCA with more information to monitor and
deal with problems earlier. As such, detriment would be likely to continue for a shorter period of
time.
Relationship management with large authorised firms and oversight of smaller firms could improve
general level of compliance through better communication between the “nominated supervisors” and
the regulated firms.
The requirement of PSD reporting for payday lenders and home credit providers would provide in-depth
market information to the FCA which could then be used to closely monitor these markets and be proactive in its supervision role. With data on both consumer information and credit products, the FCA
would be able to accumulate evidence, identify potential risks in the market that would lead to consumer
detriments and be more effective in carrying out event-specific actions. With enhanced supervision, this
should reduce all area of consumer detriments in both these markets.
7.3.5 Complaints and Redress
Firms would be required to publish complaints received if the number of complaints exceeded 1000 in a
year (or 500 in six months). The requirement to publish complaints may have a significant effect,
particularly in sectors where lenders rely on reputation to attract and retain customers (e.g. where
consumers pay less attention to price and focus more on the ease and speed of loans). This would provide
more information about quality of companies and could result in:
Improved consumer choice: consumers with better understanding of the market would choose better
firms with more suitable products. This would help to reduce the risk of sales of poor product/service.
Enhanced competition on quality: reputation is a key factor to the success of firms in the consumer
credit industry, especially in high-cost credit segment. The revealed information on firms’ service
quality should drive improvements in the quality of products and services. For example, in payday
lending, brand proliferation is found to be a more important selling-point than price and this may be
threatened with the publishing of complaints. However, it is uncertain if the threat of complaints would
be great enough to change the behaviour of firms as it is unclear how firms would link complaints to
specific business practices.
Higher rate of shopping around: with more information available to the public, consumers could be
encouraged to search for better deals and more suitable products.53 This should improve financial
literacy and address behavioural biases such as “rules of thumb”.54
The reporting requirement would increase senior management focus on complaints since it would affect
the reputation of the business and could influence customers. This would encourage improvements in
business process to reduce the number of complaints.
On the other hand, one can argue that general consumers would find it difficult to judge a firms’ quality
based on the number of complaints since this is to a degree linked to a firm’s size, i.e. bigger firms are likely
to have a larger number of complaints. Also, if firms believe that consumers are not concerned or remain
unaware of the complaints, they can then consider the trade-off between actions needed to reduce the
overall complaints against lower costs or higher profits of keeping with the current business model.
However, even if this analysis is correct it does not necessarily imply that complaints’ publication would be
53
54
Research shows that a consumer’s willingness to shop around depends in part on search costs. These can be
affected by the level of information available. Salop and Stiglitz (1977), later refined by Sadanad and Wilde (1982)
and Rob (1985), shows that if search costs are low for a sufficiently high fraction of consumers, then shopping
around activity would increase and the competitive price would prevail.
Whereby consumers use short cuts when choosing between competing products and may not choose the best
products. For example, by sticking with the status quo or choosing the most familiar product/brand.
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redundant: firms can observe the nature of settled complaints amongst their peers and, as a consequence,
potentially the trade-off between profit and conduct standards that they seek to strike.
These policy proposals might be particularly beneficial in the debt management market in terms of
addressing unfair loss of client money. The policy proposals on redress in particular would support benefits
to more vulnerable consumers who are unaware of other mechanisms of redress such as the Financial
Ombudsman Service. None of the DMC websites assessed by the OFT in its compliance review had
provided information on the complaints handling services of the Financial Ombudsman Service and its role
in redress requests.55 This would reduce consumers’ awareness of the alternative dispute resolution
process operated by the Financial Ombudsman Service and reduce the likelihood in claiming back
compensation for the losses incurred.
7.3.6 Financial promotions
Under the financial promotion regime, there would be more stringent regulation of advertising, more
flexibility of FCA rules compared with legislation and stronger enforcement power. This would allow FCA
to proactively monitor adverts in high-risk sectors and ban inappropriate financial promotions. It would
result in fewer misleading advertisements and better information for consumers. It may also address the
exploitation of consumer biases such as present bias and overconfidence bias. As such, consumers could
benefit from being more aware of the implications of taking out credit and thus accessing more appropriate
products.
The financial promotion policy will be an important component of the new regime in addressing the risk of
consumer detriment in debt management and payday lending sectors. Given the significant evidence of
misleading advertising and marketing materials found in both sectors, the new regime would help to
address the risk of detriments due to such marketing practices. In the debt management sector, this could
promote fairer competition between fee-charging DMCs and not-for-profit DMCs with correct and clear
information on the terms and conditions of their plans. This would help the consumers to search around
the market to identify the best solution for their debt problems and reduce the potential risk of poor
services and unsuitable advice. In the payday lending market inappropriate advertising that conceals the
true cost of loans could be reduced, potentially leading to a reduction in unaffordable lending.
Although the policy may target the exploitation of consumer biases, these biases may in fact undermine the
effectiveness of the policy. For example, if consumers are over-confident in their ability to repay a loan
they may not pay attention to information on default/late payment fees, even if these are not intentionally
hidden within an advertisement. Similarly, consumers may value certain product features over others to
such an extent that they would not pay benefit from better financial promotions. For example, speed and
ease of access of the loan rather than the cost tend to be the main drivers of demand for payday lending.
Improved financial promotions with appropriate cost information may not be effective in reducing the risk
of unaffordable lending in the market.
7.3.7 Sector specific policies — Debt Management
Prudential standards
These would ensure firms hold suitable financial resources against the risks they face. It would incentivise
firms against acting imprudently and aid orderly wind-down in case of insolvency. This would reduce the
likelihood of consumer losses in case of a firm’s insolvency which has been highlighted as a particular area
55
OFT (2010), Debt management guidance compliance review,
http://www.oft.gov.uk/shared_oft/business_leaflets/credit_licences/OFT1274.pdf
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Benefits
of detriment in debt management.56 However, the minimum requirement of £5,000 in itself offers only
limited protection in case of wind-down and may not be enough to discourage any “fly-by-night” firms from
entry.
Client asset requirements
CASS would specifically protect client assets held by debt management firms with additional requirements
on firms that hold assets above a threshold level. This would increase the likelihood that client assets
would be ring-fenced in the event of insolvency and hence reduce potential losses of client money and
assets.
Debt management fees
Requiring fees to be reasonable, consistent and structured towards the sustainability of the Debt
Management Plan would address the concern that debt managers may provide clients with unsustainable
plans and avoid any risk of the plan’s failure by recovering all set up costs through the initial payments.
Current OFT debt management guidance emphasises the need to ensure that plans are sustainable, but
does not specifically link this to the structuring of fees. This policy could therefore add additional benefit
by addressing a key source of detriment that arises from the upfront fee model.
The policy also addresses another source of detriment – the delay in repayment of creditors – by requiring
that fees charged should not prevent substantive creditor distributions starting in the first month of the
Plan. This is not currently addressed in OFT guidance and as such could represent a significant additional
benefit of the FCA regime. Benefits to consumers would include reduced interest and default fees for by
money paid by them arriving at their creditors more quickly because of the spreading of fees — or, if
moving to the not-for-profit sector, by removing the fees element completely. (The latter assumes some
spare capacity in the latter — this is constrained by the ability of the charitable sector to raise funds and
apply them to their main mission).
There may be unintended consequences of the policies. Debt management firms may increase their overall
fees to clients who complete a plan to cover the costs associated with plans that fail before all set up costs
could be recovered (if part of this set up cost recovery is postponed to enable creditor distributions from
the start of the plan). Debt management firms may also attempt to recover set up costs and make
substantive creditor payments through higher initial payments. Clients could suffer detriment from making
higher payments, and the disincentive to design sustainable plans would remain.
The majority of DEMSA and DRF members intend to sign up to the Protocol that stipulates that initial fees
charged to set a plan are distributed evenly over the first six months of the plan. DEMSA expects all of its
members to spread the cost of upfront fees over six or more repayments, and most of its members have
already made changes to their payment systems to enable this to happen. DRF expects most of its
members to sign up to the Protocol. This policy would have greatest effect among debt management firms
not belonging to a trade body.
7.3.8 Sector specific policies — payday lending
Our analysis at Section 8 describes in detail the potential benefits of the HCSTC-specific policies. In
summary, the policies relating to affordability assessments and limiting rollovers and CPAs are designed to
incentivise payday lenders to grant loans only to those consumers who can afford to repay them.
Restricting access to credit among consumers who are not able to sustainably repay loans is considered the
key benefit of the policies. These policies seek to change the structure of the market such that lenders face
56
For example, the insolvencies of two DMCs are examples of poor audit of client assets and resulting large losses of
client money and assets. See Debt advice of the Debt management – Business, Innovation and Skills Committee,
http://www.publications.parliament.uk/pa/cm201012/cmselect/cmbis/1649/164906.htm#note126
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Benefits
the correct incentives to lend affordably. As such, improved outcomes stemming from these policies can
be considered ‘real economic’ benefit from improved market functioning.
7.3.9 Summary Tables
The tables below summarise our analysis of the extent to which the individual policies address the main
types of consumer detriment found in consumer credit markets. The first table covers the consumer
credit market as a whole, and the remaining two cover debt management and payday lending respectively.
Table 7.2: Summary of qualitative benefits — consumer credit markets
Poor sales of
products and
services
Unaffordable
lending
Authorisation and Annual Fees
Appointed Representatives
Approved Persons
High-level Standards, reinforced by
increased enforcement
Supervision and Regulatory
Reporting
Complaints and Redress
Financial Promotions


Unsuitable
advice
Loss of client
money and
assets




















Policy effectiveness: (Strong = , Good =  or otherwise Negligible)






Table 7.3: Summary of qualitative benefits — debt management
Poor sales of
products and
services
Unaffordable
lending
Authorisation and Annual Fees
Appointed Representatives
Approved Persons
High-level Standards, reinforced by
increased enforcement
Supervision and Regulatory
Reporting
Complaints and Redress
Financial Promotions
Debt management fees
Prudential Standards for Debt
Management Firms
Client Asset Requirements for Debt
Management Firms
Unsuitable
advice
Loss of client
money and
assets








































Policy effectiveness: (Strong = , Good =  or otherwise Negligible)
Table 7.4: Summary of qualitative benefits — payday lending
Unaffordable
lending
Poor sales of
products and
services
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Unsuitable
advice
Loss of client
money and
assets
Benefits
Authorisation and Annual Fees




Approved Persons






High-level Standards, reinforced by
increased enforcement


















Appointed Representatives
Supervision and Regulatory
Reporting
Complaints and Redress
Financial Promotions
Health Warnings
Affordability assessments
Limit rollovers
Limit CPA usage




Policy effectiveness: (Strong = , Good =  or otherwise Negligible)












7.4 Quantitative Estimation of Benefits
The above qualitative analysis of benefits sets out how the new consumer credit regime is designed to
address the various types of detriment across consumer credit markets, with a focus on the markets with
the greatest evidence of detriment such as payday lending and debt management.
In this section, we present our quantitative estimation of the benefits of the transfer and of the proposed
policy mix. The quantitative estimation of benefits is limited due to restrictions imposed by the available
data. Importantly, as we explain below, the quantitative estimate of the benefit developed here is the
reduction in the observed detriment. Unobserved detriment and any reduction in that due to the FCA’s
policies are excluded from this calculation.
In our qualitative discussion of the benefits, we highlight that the main driver is firms becoming more
compliant with OFT guidance. However, we do not include a specific cost estimate for this in our cost
model (i.e. the costs of raising compliance to OFT levels).
7.4.1 Alignment of qualitative and quantitative analysis
As far as possible we attempt to align the quantitative estimation of benefits with our qualitative analysis.
However, such alignment will not be complete due to two limitations in the available data.
First, the data on observable detriment which form the basis for our analysis do not cover all the relevant
types of consumer detriment identified. Our main source of data is consumer complaints data which does
not capture unobserved detriment. A large element the detriment identified in our qualitative analysis is
likely to be unobserved, such as unsuitable advice resulting from conflicts of interest; unaffordable lending;
debt spirals; or prices that are too high but not noticed as such.
Second, the available data are not disaggregated across the same market sectors used in our analysis.
Whilst we attempt to correct for this, it is likely that we will not capture the actual detriment suffered in
each sector and thus the true extent of benefits in each sector.
A related issue is that some sectors may be under-represented by the available data due to the nature of
the majority of detriment in that sector. For example, market failures and inappropriate firm behaviour in
the payday lending sector are likely to largely result in unaffordable lending and debt spirals and debt traps,
which are less obvious for consumers to identify and complain about. Consumers most susceptible to
detriment in the payday lending sector may also be less likely to complain about detriment suffered if they
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are more vulnerable, less financially literate and able to judge inappropriate firm behaviour.57 Similarly,
detriment arising in the debt management sector may not be straightforward to identify if consumers do
not know what to expect.
It is therefore important that the quantitative estimation of the benefits is considered alongside the detailed
qualitative analysis so that a full picture of the benefits of the new regime is obtained. The summary at
Table 7.8 draws together the qualitative and quantitative evidence to illustrate the sectors where the
benefits are likely to be most significant.
7.4.2 Estimating quantitative benefits
A detailed description of how we estimate the quantitative benefits can be found in the Appendix at Section
12. Here we summarise our methodology and the final results.
Our approach consists of two main steps:
We estimate and monetise unaddressed observable detriment across the consumer credit markets.
We then assess the extent to which the new policy mix is likely to reduce this detriment.
Estimating unaddressed detriment
The NAO report provides a good starting place for estimating observable detriment. The report uses
complaints data from the OFT’ Consumer Direct database. As we are estimating the additional benefits of
the FCA regime over and above the OFT regime, we focus on detriment that the OFT did not address.
The Appendix provides a description of the NAO’s methodology. In brief, the methodology estimates a
total number of ‘incidents’ by taking complaints recorded in the OFT’s Consumer Direct (CD) database
and uplifting these by a multiplier of 59.3 to reflect the fact that not all incidents would have been
complained about. This total number of incidents is then multiplied by an assumed consumer detriment
figure per complaint, to arrive at a total unaddressed detriment of £450 million, broken down by market
sector.
Our methodology is broken down into three stages. We first combine complaints data from the OFT’s
CD and Financial Ombudsman Service (FOS) databases, and allocate complaints to the market sectors
defined in this study.58 The breakdown of complaints by sector is shown in Table 12.1 in the Appendix.
The NAO report introduced a multiplier to account for the fact that databases contain only reported
complaints, and that there will be other incidents that are not reported. With our incorporation of the
FOS as an additional channel for complaints, it is likely that this multiplier would be smaller. To reflect on
this potential uncertainty, we adjust the multiplier down with ranges.
We then calculate an average consumer detriment (ACD) per complaint, weighted by each market sector.
We make the assumption that the ACD does not vary according across reported and unreported
complaints. The weighted average ACD across sectors is presented in Table 12.2 in the Appendix.
The final step calculates the total consumer detriment from reported and unreported complaints. This
ranges from £194 million (low multiplier) to £353 million (high multiplier). The total detriment across
market sectors is shown in Table 12.3 in the Appendix.
57
58
For example, in a recent news report on the payday lending market, Citizens Advice said it saw 665 cases of
consumer complaint, of which 76 per cent could have been forwarded to the Financial Ombudsman Service. See
BBC News ‘Payday borrowers 'could complain about lenders'’, 5 August 2013
http://www.bbc.co.uk/news/business-23547884
The NAO report only used complaints from the OFT’s CD database.
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Estimating the reduction in this detriment
We then estimate the extent to which the FCA policy mix will reduce this detriment. The first step is to
assess how the identified detriment falls within the FCA’s regulatory ambit. HM Treasury and BIS
attempted a similar exercise as part of their Impact Assessment (which the NAO subsequently used). We
provide our own analysis in Table 12.4 of the Appendix.
In order to link the OFT and FOS complaints data to our analysis of detriment, we re-classified the
complaints categories to align them with the areas of detriment arising from market failures that we
identified in Section 7.2, namely unaffordable lending, poor sales of products and services, unsuitable
advice/products and loss of client money and assets.
We then assess the effectiveness of each policy in reducing the number of complaints (and hence
detriment) in each category of detriment. These assessment matrixes align with the summary of qualitative
benefits presented earlier in the chapter, i.e. Table 7.2, Table 7.3 and Table 7.4. We have assumed that
each policy has an equal effect in addressing the consumer detriment behind each type of complaint in all
sectors, except for the policies specific to debt management and payday lending.
We evaluate each policy against three level of effectiveness: strong, good and negligible in three scenarios
of low to high efficacy. Where the effect is expected to be “strong”, we have attributed a reduction in
detriment of 5–10 per cent of the total; a “good” effect reduced detriment by 2.5–5 per cent. These
figures are clearly judgments, and the results need to be considered carefully in that light.
The table below summarises our estimates of the reduction in detriment in each market sector that the
policies might bring about. The low and high ranges reflect ranges in the reported/unreported multiplier
and ranges in the efficacy of the policies.
Table 7.5: Summary of reduction in detriment
Reduction
in Detriment
Low
High
Benefit (£m)
Low
Central
High
Banks & Building Societies
16%
to
32%
16.9
35.7
61.4
Card Monolines
16%
to
32%
1.3
2.8
4.8
Payday
27%
to
55%
1.1
2.3
4.0
Mainstream & Bricks and Mortar
19%
to
37%
0.4
0.8
1.3
Home credit
19%
to
37%
0.8
1.6
2.8
Non-Bank Lenders & Consumer Hire
18%
to
36%
6.1
12.9
22.1
Credit Unions
16%
to
32%
0.1
0.1
0.2
Secondary Non Motor Retail
18%
to
36%
-
-
-
Secondary Motor
18%
to
36%
-
-
-
Traditional Credit Brokers
16%
to
33%
0.7
1.5
2.6
Aggregators & Lead Generators
13%
to
26%
-
-
-
Credit reference agencies
13%
to
26%
0.1
0.1
0.2
Debt Managers and Related
21%
to
41%
1.8
3.9
6.7
Debt Collectors and Related
14%
to
28%
3.3
6.9
11.9
32.4
68.6
118.0
Total
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Benefits
The estimated quantified benefit of the new FCA policies is therefore between £32 million and £118
million.
A limitation of the reference data is apparent from the above — namely that the benefits analysis does not
map across closely to the segmented costs analysis (the same would be largely true of a similar exercise
considering the benefits by policy and the cross-industry costs of each of these). It may be that the
complaints do not map across well to perceived detriment (e.g. payday gets few complaints, whilst debt
collection is inherently — and perhaps unsurprisingly — “unpopular”), or that the perception of detriment
(e.g. the focus on payday) is itself open to challenge.
In addition we note that some part of the benefits estimated above represent a transfer, in other words,
consumers are gaining and become better off because business have lost through changing their business
models. The ideal benefits of the regime would be the improvement of consumer welfare through
improved market functioning, driven by better authorisation, supervision and enforcement of firms. Our
benefit model is built on the complaints data which represents the cost to consumers imposed by poor or
inappropriate business activities. As such, the benefits calculated from the model merely reflect the
reduction in detriment from a consumer perspective rather than a social one.
On the other hand, there may be true economic benefits gained for the whole market through improved
market efficiency. For instance, the tighter policy regime would lift the standards of the industry and hence,
improve market confidence in lending and boots the volume of lending. As such, combined with
affordability assessments and improved quality of services and products, consumers would not fall into debt
traps and more likely to choose high quality products/services that suit their needs. There would be a rise
in market borrowing once the firms internalised the compliance requirements of the new regime and build
a business model that is more customer-oriented.
7.4.3 Unobserved detriment
There is also likely to be consumer detriment that is not observed by consumers or visible in complaints
(whether reported or unreported). This type of detriment could include sub-optimal outcomes for
consumers about which they are not aware, resulting from market failures. These could include:
Unaffordable loans
Debt spirals
Prices that are too high but not noticed as such (i.e. consumers not getting the best deal)
For example, OFT has estimated that (in 2008) more than £120 million could have been saved by
consumers if they shopped around for the right deal in pawn, payday lending and home credit.59
These estimated potential savings could be seen as a proxy for the value of switching from “over-pricing”
or “not getting the best deal” due to information asymmetry. Whilst there are aspects of FCA policies that
would help to improve such information asymmetries, such as publication of complaints data and the
principle of treating customers fairly, it is difficult to assess its impact on consumer behaviour in shopping
around. Historical trends of consumer behaviours have shown that consumer bias is likely to exist in the
consumer credit industry and the policy regime is not likely to improve shopping around behaviour directly.
Consumers — particularly in these segments — tend not to shop around, or may even lack the
opportunity to do so (i.e. they face a lack of meaningful alternatives).
59
The OFT used a counterfactual scenario of the lowest APR or lowest charge per £100 of loans, and holding all
other things equal, they compared the actual payment and calculated the potential savings that would result if all
consumers had chosen the best deal, i.e. the payment of a loans at minimum APR.
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Benefits
Unobserved detriment is particularly relevant to the detriment identified in payday lending that is related to
unaffordable lending. Payday users, who take out loans which they cannot afford, and subsequently fall into
a cycle of refinancing /rollovers and even debt spirals, may not be able to identify the source of their
difficulties and lodge complaints. The payday-lending specific policies seek to change the structure of the
market such that lenders face the correct incentives to lend affordably. As such, improved outcomes
stemming from these policies can be considered real economic benefits from improved market functioning.
These are discussed in detail in Chapter 8.
It is challenging to quantify other types of unobserved detriments, such as stress and emotional pain since
this is likely to be subject to individual characterises and vary from individuals to individuals. With limited
information available, we have not attempted to quantify or monetise unobserved detriment, and instead
discuss these qualitatively in Section 7.3 and in Chapter 8.
7.5 Overview of the Benefits of the New Regime
The new consumer credit regulatory regime will enable the FCA to address the areas of consumer
detriment described above through two broad mechanisms:
Greater powers/resources for authorisation, supervision and enforcement of guidance from the OFT
regime, leading to improved market functioning and business practices (i.e. similar actions to the OFT
but on a larger, more rigorous scale). This is likely to be the key driver of improved consumer
outcomes.
Additional policy details over and above OFT guidance to target specific sectors or particular market
failures.
Our analysis has considered the evidence of detriment across consumer credit markets, and how the
policies might address this detriment. T
The scale of benefits across the various consumer credit sectors will depend on first the level of detriment
in a sector and second on the effectiveness of the policy mix in addressing that detriment. For example, if
there is little evidence of a certain type of detriment then the overall benefit of the policy mix will be low.
Sectors where there is substantial detriment which the policies are likely to address will see the greatest
benefit.
Table 7.6 below illustrates the level of detriment across the various sectors according to the four main
market failures. 60 Our assessment of the level of detriment is based on both the quantitative evidence from
OFT consumer complaints data (used in section 7.4) and the qualitative evidence presented in section 7.2
above, and therefore covers both ‘observable’ and ‘unobservable’ detriment.
60
We do not explicitly consider lack of access to credit as there was limited evidence of this market failure.
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Table 7.6: Categorisation of detriment across sectors
Poor sales of products and
Unaffordable lending
services
Loss of client money and
Unsuitable advice
assets
Banks & Building Societies
Card Monolines
Payday
Mainstream & Bricks and Mortar
Home credit
Non-Bank Lenders & Consumer Hire
Credit Unions
Secondary Non Motor Retail
Secondary Motor
Traditional Credit Brokers
Aggregators & Lead Generators
Credit reference agencies
Debt Managers and Related
Debt Collectors and Related
Key: Red = high qualitative evidence or quantitative detriment; Amber = medium qualitative evidence or quantitative detriment; Yellow = low
quantitative or qualitative detriment; Clear = no strong qualitative or quantitative evidence; Grey = particular type of detriment not relevant for
that sector.
As can be seen, there is significant detriment related to unaffordable lending and poor sales in the payday
lending sector, and similar levels of detriment related to poor sales and unsuitable advice in the debt
manager and debt collector sectors. In the non-bank lending sector, there is significant detriment
associated with poor product sales.
Evidence of detriment in the payday lending and debt management sectors is not reflected in the OFT
complaints data and our analysis here is correspondingly largely qualitative. This is likely due to the nature
of the detriment (as described in sections 7.2.3 and 7.2.4) which is largely ‘unobservable’ and thus unlikely
to appear in complaints statistics. Detriment in the debt collector and non-bank lender sectors, on the
other hand, is largely evident in the complaints data.
Table 7.7 below summaries our analysis of the effectiveness of the policy mix on the types of detriment.61
We have made adjustments for whether firms are already subject to FCA regulation (in which case the
incremental benefit of the new regime is likely to be lower) and for whether they are likely to follow the
directly authorised or appointed representative regime. The effectiveness of the policies is largely similar
across the general credit sectors, with payday lending and debt management being greater due to the
specific policies.
Table 7.7: Effectiveness of policy mix on areas of detriment
Unaffordable
lending
Poor sales of
products and
services
Unsuitable
advice
Loss of client
money and
assets
Banks & Building Societies




Card Monolines








Mainstream & Bricks and Mortar




Home credit




Non-Bank Lenders & Consumer Hire




Credit Unions




Payday
61
This analysis is based on the qualitative benefit summary tables Table 7.2, Table 7.3and Table 7.4and the
quantitative assessment of the reduction in detriment in 7.4.
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Benefits
Unaffordable
lending
Poor sales of
products and
services
Unsuitable
advice
Loss of client
money and
assets
Secondary Non Motor Retail




Secondary Motor




Traditional Credit Brokers




Aggregators & Lead Generators




Credit reference agencies




Debt Managers and Related




Debt Collectors and Related




Policy effectiveness: (Strong = , Good =  or otherwise Negligible)
As shown above, the policy mix will have a good effect on most areas of detriment for the majority of
sectors. The policies may have a proportionately stronger impact on poor product sales in the mainstream
and bricks and mortar and home credit sectors. The results of our analysis were at the lower end of the
‘strong’ category and the driving factor behind this slightly greater impact is that a greater proportion of
firms in these two sectors are not currently subject to any FCA regulation, resulting in a greater
incremental impact of the polices than for sectors where some firms are already exposed to FCA
regulation. Sector-specific policies in payday lending and debt management are likely to have a strong effect
on most types of detriment.
Table 7.8 below presents the overall beneficial impact of the policy mix by sector. This combines our
analysis of the nature of the detriment and the effectiveness of the policy mix in addressing this detriment.
Given the limited evidence of detriment the benefits are categorised as low for many sectors. Evidence of
detriment in relation to loss of client money and assets is particular lacking and so benefits will be weakest
in relation to this type of detriment for all sectors except debt management.
The beneficial impact in payday lending and debt management for certain types of detriment is expected to
be high, a combination of effective policies and evidence of significant detriment. However, these benefits
could be offset in part by the negative impacts on consumers from a reduction in the volume of lending and
restricted access to credit.
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Benefits
Table 7.8: Benefits of the new regime by sector
Unaffordable
lending
Banks & Building Societies
Low
Poor sales of
products and
services
Medium
Limited
Loss of client
money and
assets
Limited
Unsuitable
advice
Card Monolines
Low
Low
Low
Limited
Payday
High
High
Medium
Limited
Mainstream & Bricks and Mortar
Low
Medium-high
Low
Limited
Home credit
Low
Medium-high
Low
Limited
Non-Bank Lenders & Consumer Hire
Medium
Medium-high
Medium
Limited
Credit Unions
Low
Medium
Low
Limited
Secondary Non Motor Retail
Low
Low
Low
Limited
Secondary Motor
Low
Low
Low
Limited
Traditional Credit Brokers
Low
Low
Low
Limited
Aggregators & Lead Generators
na
Low
Low
Limited
Credit reference agencies
na
Low
Low
Limited
Debt Managers and Related
na
High
Medium
Medium-high
Debt Collectors and Related
na
Medium-high
Medium-high
Limited
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Payday Lending
8 Payday Lending
8.1 Introduction
This chapter presents our analysis of the impact of the HCSTC-specific policies on the industry and
consumers. The analysis of the rest of the policy mix on payday lending is incorporated more generally in
the rest of the report, in particular compliance costs (Section 4.11 and 4.12), modelling approach (Section
3.14), and quantitative and qualitative benefits (Sections 7.3 and 7.4 respectively).
8.1.1 Payday lending policies
The policy proposals specific to the payday lending sector are:
Health warnings on advertisements to emphasise the risks of being unable to repay the loans, and
provision of free debt advice at point of rollover;
Requirement for firms to assess potential adverse impacts on the customers’ financial situation.
To limit the number of times a loan can be rolled over to two
To introduce a limit of two unsuccessful attempts of CPAs per loan (and for the full amount)
Given the uncertainties (particularly over the effectiveness of CPA as currently used) we consider a range
of outcomes due to the policy mix.
8.1.2 Our methodology and data sources
Our methodology for assessing the impact of the HCSTC-specific policies consists of the following steps:
We qualitatively assess the benefits of the policies in terms of how these might address existing
detriment in the sector.
We assess the impact of the policies on payday industry revenues. We focus on the rollover cap
(where we model the effect of a cap of one, two and three rollovers) and the CPA restriction.
We then analyse how the potential reduction in revenue from these policies could affect firm
profitability, and in turn market exit, lending volumes and business models.
We then analyse how the reduction in lending and change in business models may affect payday
customers, identifying which types of customers are most likely to experience a reduction in access to
credit.
The final stage is to assess a range of possible outcomes for consumers who are denied access to
payday credit, to illustrate how the policies might translate into benefits or dis-benefits.
We also used data collected by the OFT from a survey of 21 payday lenders. 62 The sample represents 85
per cent of the payday market. The data collected includes total payday revenue; revenue from loans rolled
over various number of times; default rates; and CFA membership. We also use data collected by a retail
bank on CPA use by a selection of payday lenders (about 10-12 overlap with the OFT sample, depending on
the bank’s analysis). These data provide insight into the importance of rollovers and CPAs and the likely
62
We note that individual lenders within the OFT dataset may not be representative of the industry as a whole and
as such the analysis based on individual firms’ lending practices should be considered illustrative. However, these
firms are thought to represent about 85 per cent of the payday market. On the other hand, these firms may have
amended their business practices subsequent to participation in the OFT’s work.
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Payday Lending
impact on revenues from the restrictions. Whilst the OFT data enable us to quantify the likely impact on
revenues from rollovers, the data from the bank are not sufficiently detailed to enable this level of analysis
for CPAs.
Information about the impact of the policies on firm behaviour (e.g. exit and lending volumes) is also drawn
from the OFT data (which enable us to assess how the policies might affect firms’ profitability). Our
analysis is complemented by our own behavioural model, published information on the payday market,
discussions with stakeholders and survey data gathered by Policis for the previous cost-benefit analysis.
Our analysis of the impact on consumers draws on the report by for BIS by Bristol University which sets
out research into alternatives to payday credit,63 and work by Policis and Toynbee Hall which categorises
payday users into various customer types. We also draw on other literature in assessing the qualitative
benefits.64
We note that our analysis is partly limited by data availability and information, in particular the importance
associated with the use of CPAs (specifically, we were not able to access data on the effectiveness of CPA
use — and abuse — relative to other payment forms); the link between rollovers and financial difficulty;
and the outcomes for consumers denied access to payday credit. We flag these limitations where relevant
in the report and present our analysis within ranges to reflect the associated uncertainty.
Data and information limitations mean that it is not reasonably practical to quantify all the relevant benefits.
We remind the reader of our consolidated quantitative benefit analysis in Chapter 7 which considers
benefits related to improved ‘observed’ detriment in payday lending together with other credit sectors.
Ideally, quantification of all benefits would entail assigning a value to the scale of detriment currently
suffered by payday users, and assessing the degree to which the payday policies would reduce this
detriment. The resulting value of the benefits would then be adjusted to take into account any negative
outcomes of the policies (such as restricted access to credit leading to worse outcomes for consumers).
However, we are unable to estimate the full value of detriment related to payday lending due to an absence
of detriment data (i.e. data are only available for the scale of complaints, and not for unobserved detriment
which is likely to be high). There is also not sufficient data to robustly estimate the extent to which
negative alternative outcomes might reduce the benefits of the policies for consumers.
Nevertheless, our analysis makes full use of the available information and enables us to draw conclusions on
the likely benefits of the policies on a qualitative level. In addition, the relative level of these benefits is
estimated where data allow.
8.1.3 Structure of the chapter
This chapter consists of the following sectors:
An overview of the payday market, including insights gained from the OFT data, to provide context for
our analysis.
A description of consumer detriment in the payday lending market, aligned with the main types of
detriment and market failures discussed earlier in the report.
63
64
‘The impact on business and consumers of a cap on the total cost of credit’, Personal Finance Research Centre,
University of Bristol, March 2013
These include National Audit Office (2012) “Regulating consumer credit”, December 2012 and National Audit
Office (2012) “Regulating consumer credit: Technical paper”, December 2012; OFT (2010) “Review of high-cost
credit, Final report”, June 2010; OFT (2008) “Consumer detriment: Assessing the frequency and impact of
consumer problems with goods and services”, April 2008; BIS (2013) “The impact on business and consumers of a
cap on the total cost of credit” conducted by the Personal Finance Research Centre, University of Bristol, March
2013; HM Treasury (2013) “A new approach to financial regulation: transferring consumer credit regulation to the
Financial Conduct Authority”; OFT (2013) “Payday Lending: Compliance Review, Final Report”, March 2013; OFT
(2010) “Debt management guidance compliance review”, September 2010
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Payday Lending
Qualitative analysis of how the policies could address these areas of detriment and thus bring about
benefits.
The analysis of the wider impacts of the policies on the payday industry and consumers.
8.2 Market Overview
In this section we present an overview of the payday lending market, covering market trends, lenders’
business models, methods of raising revenue, and competition. This provides useful context to our analysis
of the impacts of the policies.
Payday lending is a type of financing that is:
unsecured (borrowers are required only to be employed and to have a bank account);
short-term (the typical length for these loans is approximately 30 days); and
high cost (the average cost is approximately 25 per cent per month)
The OFT estimated that the market was worth £2.0 to £2.2 billion in 2011/12, which corresponds to
between 7.4 and 8.2 million new loans; this is up from an estimated £900 million in 2008/09.65 We believe
that this is likely to be now approaching £2.5 billion. It is estimated that there are approximately 2 million
payday customers.66
There are multiple business models within this industry. The original suppliers of this type of loans were
high street shops, referred to traditional or bricks and mortar payday lenders. In the last several years an
increasing fraction of payday loans have been extended online.67
Payday lenders also vary significantly in size. Some lenders, particularly bricks and mortar, can be small,
family run and consist of a single shop. Some online payday lenders are part of large multinational
corporations. The market is believed to be concentrated, with the three largest lenders accounting for 55
per cent of the market by turnover and 57 per cent by loan value. Many payday lenders belong to trade
associations (TAs), such as the Consumer Finance Association (CFA) and, in the case of smaller lenders,
the BCCA.
The available literature tends to focus on the USA where payday is most advanced. Some studies have
looked at the profitability of payday lenders, typically in the United States.68 These studies have not found
significant differences in the profits of large payday lending companies and similar firms, compared with the
financial and other sectors, at least in the USA.
The industry has experienced a very high growth in the UK, Australia and the United States in recent years.
In the UK only, payday lending grew from £900 million in 2008/09 to between £2 and £2.2 billion in
2011/12, equivalent to an annual growth rate of approximately 30 per cent. It is unclear how long is the
market expected to grow at these rates until it reaches maturity.
The online payday market has experienced rapid growth in the past few years, largely due to shrinking
availability of credit in the mass mid-market; significant investment in marketing activity; and the explosion
of internet-based credit infrastructure. Many firms in the market, particularly small and medium sized ones,
are in the start-up phase (i.e. losing money until they build scale). The online payday business model
65
66
67
68
OFT “Payday Lending: Compliance Review”, March 2013
Department for Business, Innovation and Skills Committee – Fourteenth Report: Debt Management, February
2012. Available at: www.publications.parliament.uk/pa/cm201012/cmselect/cmbis/1649/164902.htm
Prior to 31 December 2004 all online loans required a physical signature.
See for example: Shapiro, R. “The Consumer and Social Welfare Benefits and Costs of Payday Loans: A Review of
the Evidence”, March 2011 and Huckstep, A., “Payday Lending: Do Outrageous Prices Necessarily Mean
Outrageous Profits?”, Fordham Journal of Corporate & Financial Law, Vol. 12, No. 1, January 2007.
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Payday Lending
generally has a higher risk profile with a higher incidence of loan roll-overs than bricks & mortar payday
lenders. Customers tend to be more upmarket with greater use of other types or credit.
8.2.1 Rollovers and refinancing
A common practice in the payday lending market is the use of rollovers or refinancing. The OFT notes
that lenders obtain a substantial proportion of revenue from sources other than the initial cost of the loan,
such as revenue from rolling over or refinancing loans and other fees and charges such as administration
fees and charges for default or late payment. The OFT estimates that 28 per cent of loans are rolled over
or refinanced at least once, providing 50 per cent of lenders’ revenues. It is also commonplace to have
loans rolled over four or more times. These loans represent over 19 per cent of total payday lending
revenue.69
It is the case that several lenders actively promote rollovers at the point of sale (approximately a third,
according to the OFT). Rolling over might not be advisable for some borrowers, given its high cost.
Actively promoting rollovers might be considered irresponsible lending according to OFT guidance and a
source of consumer detriment. Recently the Consumer Finance Association (CFA), one of the largest
trade associations for payday lending, has introduced in their Charter a limit of no more than three
rollovers. We understand that this charter is to be audited independently — in this case, it is reasonable
to expect a high level of adherence to it.
The OFT recognises that rolled over and refinanced loans might need to be considered together in order
to account for the different naming practices of different lenders. Given that these two concepts are
difficult to distinguish in practice, any policy aimed at revenue collection should probably cover both of
them simultaneously. Moreover, it could be argued that refinancing and charging penalty fees are materially
equivalent for lenders and borrowers. The FCA’s definition of rollovers for the purpose of the policies
therefore covers a range of possible treatments of loans that are not repaid on time, including refinancing
and new loans.
We note that it is difficult to determine the extent to which rollovers create or increase financial difficulty
for borrowers. In the case of a borrower unable to repay a loan due to financial difficulty and therefore
rolls it over, then this most likely will increase his financial difficulty, e.g. by postponing his repayment
problems and increasing the overall cost that would need to be repaid. The more times the loan is rolled
over, the worse his financial situation will become in the long run, even if a rollover may alleviate the
immediate problem.
However, we do not have insight into the motivation of the borrowers in seeking an additional roll-over,
e.g. we cannot rule out cases where borrowers experience an unexpected shock which prevents them
from repaying the loan. In this case rolling the loan over could be a rational decision (in spite of the cost)
as it gives them more time to overcome the shock and prevents them from resorting to other, less
preferable options (such as going without, or forgoing other more essential payments). This could be
particularly relevant with very short-term loans (i.e. one or two weeks), but would not necessarily be
limited to such cases, i.e. there is significant ambiguity about the scale of this group.
The greater the number of rollovers, the more likely it is that the borrower in question is not acting in a
rational manner or is in financial difficulty, with little hope of repaying the loan in the long run and with a
worsening financial situation with each successive rollover.
69
Based on Europe Economics’ analysis of OFT data on the payday lending market
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Payday Lending
8.2.2 Competition
It is not clear the degree to which competition exists among payday lenders. The OFT points out that
borrowers tend to emphasise speed and the simplicity of obtaining the loan over its cost. Therefore,
borrowers may be largely insensitive to changes or differences in the price of payday loans. This would
diminish the incentives for competition in price among lenders. However, it is believed that the barriers to
entry to this market are low and that there has been significant new entry in recent years. 70 The OFT
believes that there has been little competition between lenders at the point the ‘rollover’ is agreed with the
borrower. However, no clear evidence is offered about the competition for new loans.
The Competition Commission has begun its market review of the payday sector and an equivalent
assessment of the degree of competition in the payday lending market is beyond the scope of this report.
8.2.3 Affordability assessments
Affordability assessments can take the form of income and expenditure checks (used predominantly by
brick and mortar payday lenders) or consulting with a credit rating agency (mostly by online payday
lenders). Stakeholders representing PDLs claimed that prior to the OFT’s investigation, PDLs focused on
income — but they are now increasingly looking at expenditure with trade association members building
appropriate disclosures into their processes. Manual verification would be another matter, as this can be
labour-intensive and expensive. It’s not seen as necessary in all cases. In Australia, PDLs access online bank
accounts of customers which they data scrape to automate the assessment of I&E.
One of the key costs for the payday lending industry is the cost of acquiring new customers. Online
lenders usually rely on intermediaries, such as lead generators, that usually charge a (possibly substantial)
fee per customer.71 Therefore, each individual loan has to recover this ‘fixed’ cost to be profitable and may
not do so unless the loan is refinanced. In this case, payday lenders may have an incentive to encourage
rollovers, even if it is detrimental for borrowers. Some payday lenders are concerned about the
dependence on lead generators and in consequence direct selling is growing, but the balance between this
and dependence on third parties is not known. LGs are brokers with no interest in relationship-building
and with incentives not well aligned to either customer or lender. Payday lenders would tend to have
service level agreements which partly mitigate problems but do not wholly solve.
8.2.4 Use of CPAs
A significant fraction of payday lenders, particularly those that operate online, rely on continuous payment
authorities (CPAs) as their main mechanism for collecting payments.72 CPAs allow lenders to send
requests for payment to their bank accounts. The lender can choose the amount and the timing of these
requests without giving notice to the borrower. It appears that the use of CPAs is widespread. It is our
understanding that CPAs are the main collection instrument for online payday lenders, but not necessarily
for brick and mortar lenders (smaller ones are least likely users). According to the data collected by
Policis, six out of eight online payday lenders collect at least 85 per cent of their loans via CPA. Three
respondents gave 100 per cent as an answer.
Unfortunately, CPAs have been subject to abuse by payday lenders, posting several requests per day for
different amounts. The objective of this practice is to identify the amount and the timing of arrival of funds
70
71
72
OFT “Payday Lending: Consultation on a market investigation reference”, March 2013
The details of this mechanism were given to us by the FCA on behalf of the Debt Managers Standards Association
(DEMSA)
We note that this method is not frequently used by small brick and mortar lenders. These usually accept cheques
and debit cards as payment.
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Payday Lending
into the borrower’s account and to collect them as soon as they are available in order to maximise the
recovery of loans. The trade associations recognise that problems exist.
There is also a technical dimension: the system whereby merchant acquirers (like Barclaycard) notify
lenders with a refusal code (which would indicate whether due to lack of funds or because a fraudulent
account) has partly broken down in PDL. PDLs need to clean up data and ensure that they get the right
codes in the future. In conjunction with that, PDLs would need to re-think how they use CPAs, restricting
to those times when there’s a real probability of receiving payment. Visa, the acquirers and PDLs are
looking at solutions to this, but this remains work-in-progress at present.
Alternatives to CPAs are direct debits and standing orders. These two mechanisms introduce less
flexibility on the part of the lender. Direct debits allow the lender to change the amount of the payment to
be requested only after adequate notice has been given to the borrower. Standing orders would not allow
lenders to change the timing or amount of their payment requests without the expressed agreement of the
borrower. Limits on CPA use would likely put their effectiveness somewhere between the current
position and these alternatives.
One hypothesis is that CPA “abuse” is linked to better business performance. Data on the links between
CPA use and cash collection are not available. To speak to our hypothesis, we have combined calculations
drawing on data from the OFT’s survey on revenue achieved per £100 lent with data available from a
clearing bank on the number of requests (indexed by the total number of customers that the PDL has).
This should be seen as illustrative at best, since there are a number of caveats — the data are from
different time periods, customers of the clearing bank may not be representative of a particular PDL.
Nevertheless, these are presented below.
We note that individual lenders within the OFT dataset may not be representative of the industry as a
whole and as such the analysis based on individual firms’ lending practices should be considered illustrative.
Figure 8.1: PDLs making more than three requests per day
Source: OFT, CPA usage data accessed from a retail bank
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Payday Lending
Figure 8.2: PDLs making more than seven requests per week
Source: OFT, CPA usage data accessed from a retail bank
There is no apparent pattern here — if there is any link to business performance then it is not a straightforward one. An alternative hypothesis — which we are not able to test even in as a crude a way as this
— would be that the most intensive CPA use is correlated to the demographic served, e.g. more marginal
customers (i.e. those less likely to be able to repay in full or on time) are targeted by such PDLs. Many of
the firms included in the above charts (all of whom the clearing bank, at least, would count as abusers of
the system) achieve very high returns on every £100 lent (well in excess of the benchmark of £25 often
quoted by the industry).
Given the widespread use of CPAs, it is possible to infer that these are highly effective and preferable to
repayment plans from the point of view of the lender. This might be due to a higher recovery rate and/or
to a lower cost of implementation.
8.2.5 Market insights from OFT data
We complement the published information on the payday market discussed above with an analysis of
survey data collected by the OFT.
The objective of our analysis is to find whether different business models can be identified depending on
the characteristics of the payday lender. We considered the type of lender (online or brick and mortar, as
assessed by our own review of the participating lenders); their size (small with revenue below £2m, large
above £50m and medium in between — defining small below £0.25m would have got no traction here); and
membership (or not) of TAs. Participants in this work had total lending equal to about one-third of the
market so the stylised facts discovered (whilst not necessarily representative) are likely to be revealing.
We have identified the following:
Large firms (PDL revenue >£50m) have longer loans than small firms (PDL revenue <£2m). For online
firms, the difference is 38.3 days compared to 27.5 days.
Large online firms have lower cost per £100 loaned than small online firms. The difference is £25.1
compared to £36.
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Payday Lending
The fees for late repayment is several times larger for small firms (15 times larger in the case of online
lenders and twice as large in the case of brick and mortar), but the fee for rollovers are about half.
Proportion of repayment (and also of repayment on time) is lower for online firms and for mediumsized firms.
The proportion of rollovers are highest for medium sized firms (45-51 per cent), followed by large firms
(33-37 per cent) and it is lowest for small firms (14-18 per cent).
The revenue generated is from loans that were refinance/rolled over more than 3 times is £139m, about
19 per cent of total PDL revenue.
In addition, we have conducted a simple statistical analysis to evaluate the correlation between some key
indicators of the payday lending market. We found a clear positive correlation between default rates and
the cost per £100 loaned and the PDL turnover per loan. The correlation with the number of complaints
is also positive but less clear (the data regarding complaints is suspect, as it has many zeros). Surprisingly, it
appears to be a negative correlation between default rates and the limit (as a proportion of income) that
can be borrowed.
Our statistical analysis suggests the following features of the payday lending market in the UK:
Large firms rely more on revenue from rollovers, whilst smaller firms obtain significant revenues from
late repayment fees.
Large firms have lower rates. Together with the degree of market concentration in the face of low
barriers to entry, it would suggest that there are significant economies of scale.
Lenders that charge higher rates tend to have higher default rates, suggesting that competition drives
down prices to the extent that the level of risk allows it.
Using a fixed proportion of income as a limit for the amount that can be borrowed might not constitute
an effective assessment of affordability.
8.3 Consumer Detriment in the Payday Lending Market
In this section we describe the evidence of consumer detriment in the payday lending market, based on the
types of detriment defined in Section 7.2.
Unaffordable lending
Consumers who take out payday loans are generally those with no access (at the time of the loan) to
mainstream credit or alternative forms of high-cost credit, and who want credit quickly. Therefore they
are likely to focus predominantly on the speed and accessibility of payday loans rather than say, the cost of
the loan. As described at 7.2.2, consumers can have incentives to take out credit they cannot afford.
Research shows that consumers can suffer from over-optimism bias, whereby they do not consider the
possibility that they will fail to repay the loan on time. This further reduces the consideration they give to
the total cost of a loan including the risk of default and the associated costs. Consumers also suffer from a
‘hyperbolic discounting’ bias, by which they place a much greater value on money now than on costs later.
For these reasons consumers may have incentives to take out loans which they then struggle to repay.
Payday lending has often been criticised for exploiting these consumer biases and not conducting
appropriate affordability assessments at the time of extending new loans or refinancing existing loans.
There might be a number of explanations for this. First, current business models favour large volumes of
loans over the quality of the loan book (i.e. having customers with a low risk of default). Under this
business model, affordability checks would not play a large role as the focus of the lender is to increase the
volume of lending rather than to ensure the ability of the customers to repay the loan. Second, affordability
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Payday Lending
assessments can be time consuming and expensive. Third, there can be insufficient information to conduct
adequate assessments, e.g. numerous commentators have highlighted the lack of a real-time database,
whereby lenders can obtain information about the outstanding loans of existing and prospective customers.
This is further exacerbated by the fact that not all home or payday lenders share information with credit
agencies despite consumers using multiple suppliers.
Citizen’s Advice found that only 35 per cent of respondents were asked questions about their personal
finances and their general situation to check whether they could afford to pay back the loan. On the other
hand, it is possible (even likely) that the creditworthiness of the majority of these customers would have been
assessed through third-party credit checks — this process would have had lower visibility to the
customers.
Insufficient affordability assessments would lead to the approval of loans to borrowers who cannot afford
to repay them. These consumers could fall into debt traps or spirals as they repeatedly fail to repay the
loan, incurring additional fees and charges at the same time.
The use of continuous payment authority (CPA) and (arguably to a lesser extent) rollovers enable payday
lenders to secure revenue even from consumers who cannot afford to repay the loan. Moreover, some
payday lenders charge fees to borrowers for each declined request to their accounts, which might
substantially increase their existing debt. These practices create a risk that the consumer falls into a debt
trap and that payday loans become a long-term source of credit.
The lack of adequate information about cost and hidden charges (or transparency of disclosure) could also
exploit consumers’ biases and increase their likelihood of taking out unsuitable loans that they cannot
afford. For instance, important information on risks to the borrower are downplayed or omitted so that
borrowers can be taking on a payday loans with less information than they should have available. The
extent of this problem varies across the sources. For example, Citizens Advice found that 22 per cent of
respondents to their survey were not clear about the total repayment costs.
However, the OFT notes that borrowers tend to focus on the speed and simplicity of obtaining a loan over
its costs. Therefore, borrowers may be largely insensitive to information about the cost of the loan and
take out unaffordable loans to meet their needs.
Sale of poor value credit products or services
There is evidence of poor treatment of customers in repayment difficulty. Citizen’s Advice found in its
survey that only 16 per cent of those who had repayment problems were offered a freeze on interest and
charges if they made payments under a reasonable repayment plan. Only eight per cent of respondents
who had repayment problems were told about the availability of free debt advice.
Aggressive debt collection practices are also an example of poor service. For example, the practice of
repeatedly sending messages to borrowers who are behind in their payments may amount to harassment.
Citizens’ Advice found that only 18 per cent of those who had repayment problems felt the lender dealt
with them sympathetically and positively. As such, majorities of the respondents were dissatisfied with the
services they received under the aggressive debt collection practices.
The abuse of CPAs is another example of poor business practices. Some lenders continually bombard
customers’ accounts with requests so that funds can be collected as soon as they arrive in the customer’s
account. We are aware of instances where request to a particular account have been repeated at intervals
of less than five minutes. For customers in financial difficulty or with other creditors to pay, this practice
severely imposes on their ability to control their finances and can create extreme emotional stress.
To maintain high quality services, effective complaints handling systems are vital. However, there is a
notably failure of payday lending firms to put in place effective complaints handling systems. This might also
provide lenders with perverse incentives to treat borrowers unfairly and might lead to additional detriment.
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Detriment caused by conflict of interest — unsuitable advice and loss of client money
There is evidence of inappropriate advice being given to customers with repayment difficulty. Once a
consumer cannot meet the payment of the loan, payday lenders often provide options of rollover or
refinancing. This is detrimental if lenders encourage this behaviour when it is not in the best interest of the
borrowers (e.g. the customer cannot afford to repay now — hence the roll-over — and is not likely to be
able to repay at the end of the roll-over period, potentially tripping the customer into a debt spiral).
Citizens’ Advice reports that only 27 per cent of surveyed customers extended their loan without feeling
pressurised by the lender (although, since the roll-over likely represents an inability by the customer to
repay in full, some pressure from lenders is not surprising). Research indicates that a major obstacle to
understanding the real costs for those who roll-over their debt are consumers’ behavioural biases towards
‘over-optimism’ and ‘hyperbolic discounting’ bias. Consumers do not believe they will fail to pay off the
loan on time so do not consider the risks/costs of doing so, and, consumers value the money now over the
costs later.
The abuse in CPAs automatically gives preference to payday loan repayments over other expenses or
repayment of other debts (i.e. disenfranchising the borrower from this decision). If other expenses or
debts with higher priority cannot be paid as a consequence of the abuse of CPAs, this practice would be
detrimental.
8.4 Benefits of HCSTC-specific Policies
The payday lending policies relating to affordability assessments and limiting rollovers and CPAs are
designed to incentivise payday lenders to grant loans only to those consumers who can afford to repay
them. Restricting access to credit among consumers who are not able to sustainably repay loans is
considered the key benefit of the policies. These policies seek to change the structure of the market such
that lenders face the correct incentives to lend affordably. As such, improved outcomes stemming from
these policies can be considered ‘real economic’ benefit from improved market functioning.
Scope for regulatory get-around
The impact of the policies will depend on their effectiveness. It is possible that firms and consumers would
be able to get around strict restrictions on rollovers, thus reducing the efficacy of the policy. Evidence
from Australia and the USA suggests that limits on rollovers are widely circumvented by lenders, often via
back-to-back transactions whereby the loan is paid off and immediately a new loan is taken out, or through
consumers accessing multiple lenders.
In order to put in place this policy in an enforceable way, it may be necessary to introduce a database that
provides real time information about the outstanding debts (including payday loans) for all borrowers. If
this policy is put in place without a real-time database that reports all outstanding payday loans, it is not
unlikely that lenders will find a way to circumvent it. One possible way would be by transferring customers
from between different PDLs that are associated with each other. However the following analysis largely
assumes that the policy would be implemented.
8.4.1 Health Warnings
Health warnings would help potential borrowers make a more informed decision on whether to take on a
payday loan. In particular, there would be a requirement for:
a health warning on all high cost short term credit loan adverts highlighting the probability of not being
able to repay the loan on time and the cost implications of rolling over/default;
a requirement for high cost short term credit providers to provide information on free debt advice at
point of rollover.
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This could drive benefits by reducing unaffordable lending if consumers make more informed judgements
on whether payday loans are affordable to them given the implications of late payments, defaults and
rollovers.
Any reduction in lending would stem from consumers’ choices not to take out payday loans (presumably as
they realise these are not suitable for them) and as such would represent an improved market outcome
rather than just a transfer payment. However, the success of the policy would depend on the following:
the extent to which borrowers take payday loans as a consequence of misinformation about the costs
or risks of being unable to repay; and
the extent to which health warnings could correct for these failures.
Overconfidence bias may mean that consumers might still not consider it likely that they would end up not
being able to repay the loan and suffer the consequences even if this information was included in an
advertisement (e.g. they may think that warning does not apply to them).
In addition, given that the drivers of demand for payday loans are largely the speed and accessibility of
credit, consumers may disregard warnings in their desire for the loan. This is likely to be particularly the
case with consumers who have no other credit choices and, even if they do realise that payday loans are
not suitable for them, would nevertheless need to take out a loan. The payday consumers analysed by
Policis/ Toynbee Hall indicate that around 15 per cent of payday users can no longer borrow anywhere
else. Of these, consumers who really needed credit would have few other options besides the payday loan,
and would pay little attention to warnings.
Finally, payday lending is based largely on the speed and ease of access to loans. Policies that would slow
down and/or increase the cost of acquiring customers (i.e. if health warnings do discourage some
consumers from taking out payday loans) will present a significant incentive for non-compliance among
firms. This effect is likely to reduce the effectiveness of the policy, although this would depend on the
degree of compliance achievable by the FCA.
8.4.2 Affordability Assessments
Under this policy, payday lenders would be required to conduct affordability assessments before extending
loans. This might be required for new loans as well as for every loan that is rolled over or refinanced.
Affordability assessments can take the form of Income and Expenditure (I&E) assessments (used
predominantly by brick and mortar payday lenders) or the use of credit rating agencies (mostly by online
payday lenders). Stakeholders representing PDLs claimed that prior to the OFT’s investigation, PDLs
focused on income — but they are now increasingly looking at expenditure with trade association
members building appropriate disclosures into their processes. Manual verification would be another
matter, as this can be labour-intensive and expensive. It’s not seen as necessary in all cases. In Australia,
PDLs access online bank accounts of customers which they data scrape to automate the assessment of I&E.
This policy would not be a departure from current OFT guidance on responsible lending, as it represents a
movement of OFT guidance into rules. The main difference is that, as rules, the FCA can take enforcement
action in respect of these. The FCA’s approach can be described as principles-based as the rules set out
that affordability assessments should be carried out, rather than prescriptively setting out the steps a firm
would need to undertake to make an assessment.
Appropriate affordability assessments would prevent highly risky borrowers from obtaining loans. Since
these borrowers are likely to be heavily indebted already, this policy might reduce the chances of them
entering into debt spiral, and result in earlier engagement with a debt advice process. Hence, this would
help to reduce the risk of unaffordable lending in the industry.
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An indirect benefit could be that the industry risk profile would be lower. Therefore, the cost of extending
a loan would be lower on average as the risk-profile of customers dropped. Against this, one would expect
PDLs to have done this already (although this may be a motivation for the trend towards more work on
affordability). Payday lenders are also highly effective at extracting a return from borrowers who are not
immediately able to repay, and thus may not have the incentives to rigorously assess affordability. (This
would of course change in light of parallel policies to restrict rollovers and CPAs and, as such, the policy
mix as a whole is likely to increase the use of affordability assessments and achieve the aim of reducing
unaffordable lending).
The magnitude of the benefits would depend on the implementation of the policy by the market. Given the
FCA’s principles-based approach, it might be difficult for payday lenders and trade associations to
implement this policy consistently. Some lenders might be able to put in practice largely ineffective
affordability assessments in order to capture a large volume of borrowers. This practice would be a way to
circumvent the policy and to continue with their current business models.73 To the extent that some
lenders conduct suitable affordability assessments, there would be stronger incentives to other lenders to
capture the very high-risk segment that would become underserved.
8.4.3 Limit Rollovers
The benefit of this policy is to avoid having borrowers converting payday lending into a medium- or even
long-term source of credit. The high cost of payday loans makes it likely that a borrower that rolls over his
loans multiple times will exacerbate financial difficulties and fall into a debt spiral. If this policy achieves its
desired objectives, debt spirals would be prevented for some borrowers.
Limiting rollovers to two should also have the effect of improving affordability assessments as lenders,
denied a key source of revenue recovery, seek to ensure a greater likelihood of repayment from their
customers. The corollary of this, however, is that there is likely to be a proportion of customers who
make use of more than two rollovers but who do not find the loan unaffordable and for whom the
restriction of rollovers would represent only a restriction in access to credit with no accompanying
benefit.74
We note that it is difficult to determine the extent to which rollovers create or increase financial difficulty
for borrowers. The greater the number of rollovers, the more likely it is that the borrower in question is
not acting in a rational manner or is in financial difficulty, with little hope of repaying the loan in the long
run and with a worsening financial situation with each successive rollover. In these cases limiting the use of
rollovers will be more likely to create long-term benefits.
The ambiguity regarding the extent to which rollovers increase financial difficulty means that it is not
possible to calibrate a rollover cap that perfectly captures only detrimental rollovers. However, it is likely
that the more restrictive the cap, the more ‘rational’ rollovers will be prevented and consumers will be
denied payday loans without the associated benefits of reducing financial difficulty.
8.4.4 Limit on CPA Usage
The limit on CPA usage would change the nature of CPA away from a continuous payment mechanism.
Borrowers would benefit as those lenders affected would be less able to access monies arriving in the
73
74
International evidence from Japan, Australia and the United States in the implementation of affordability
assessments suggests that some payday lenders might be able to circumvent this policy and continue with their
current business models unless there is a very strict enforcement of it.
I.e. those consumers who experience an unexpected shock(s) that makes them unable to repay the loan on time,
and for whom rollovers provide a rational means of managing their finances, despite the increased cost,
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customers’ bank accounts after the initial payment’s due date — borrowers would have increased control
(but will also need to engage with PDL creditors directly earlier).
Non-PDL creditors would also benefit. This would lead to improved outcomes such as a reduction in
credit stress (consumers would have more control over which creditors they repaid when) and the
emotional strains of not knowing when a payday lender might take money from the account.
An additional benefit would be the reduction in the current cost put on the electronic fund transfer system
for banks and Visa. Moreover, the reduction of high frequency request would eliminate a source payment
data contamination for the detection of debit card fraud.
Indirectly, this policy should reduce unaffordable lending as lenders, denied this key source of revenue
collection, go to greater lengths to ensure the ability of customers to repay the loans.
8.5 Wider Impacts of HCSTC-specific Policies
The analysis of the direct compliance costs of the new regime to online payday lenders is discussed in
Section 4.11; bricks and mortar payday lenders are included in the analysis of Traditional Bricks and Mortar
lenders in Section 4.12. We do not repeat this analysis here, but note that the compliance costs of the new
regime do not drive the profits of any firm below zero, and thus our model predicts that no firms will exit
as the sole result of complying with the new regime. However, this analysis does not include the wider
impacts of the HCSTC-specific policies, which are likely to be significant. We now turn to the analysis of
the wider impacts and behavioural impact of these policies.
Together, the HCSTC-specific policies are likely to have a significant impact on firm strategies and
behaviour, including exit. The following analysis covers both online and bricks & mortar lenders (although
we distinguish between the two where appropriate). The impacts are largely due to the restrictions on the
number of rollovers and the limitations on the use of CPAs. The policies relating to health warnings and
affordability assessments on their own are unlikely to have noticeable impacts on payday lenders, although
the use of affordability assessments would be enhanced by the policies on rollovers and CPA use.
In this section we present our analysis in three sections:
The impact of payday policies on firm revenues
The consequences of this on the payday industry in terms of firm exit, lending volumes and competition
The subsequent impact on consumers
8.5.1 Impact of policies on firm revenues
We begin by analysing the impacts of a restriction in rollovers. Although the policy entails a limit of two
rollovers, we assess the likely impacts of a limit of one and three rollovers as well. As mentioned in Section
8.2.1 above, rollovers are a widespread practice in payday lending. The table below shows the revenue
associated with rolled over loans taken from our analysis of the OFT data (which represents around 85 per
cent of the market).
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Table 8.1: Revenue associated with rolled over loans, 2011/2012
Proportion of payday revenue
Total market revenue (£M)
New loans rolled over once
15.7%
135.1
New loans rolled over 2-3 times
14.0%
120.9
New loans rolled over 4-5 times
7.9%
68.3
New loans rolled over more than 5 times
11.5%
99.2
Source: Europe Economics analysis of OFT data
We note that as the OFT survey did not distinguish between revenue from loans rolled over two and three
times (and instead has a combined category for loans rolled over 2-3 times) we have estimated a
breakdown within this category. The table below presents the more disaggregated picture of revenue
associated with rollovers.
Table 8.2: Revenue associated with rolled over loans, 2011/2012 (disaggregated)
Proportion of payday revenue
Total market revenue (£M)
New loans rolled over once
15.7%
135.1
New loans rolled over twice
8.8%
75.5
New loans rolled over 3 times
5.3%
45.3
New loans rolled over 4-5 times
7.9%
68.3
New loans rolled over more than 5 times
11.5%
99.2
Note: Based on the trend of revenue from loans rolled over different numbers of times, we estimate that revenue from loans rolled over twice is
40 per cent greater than revenue from loans rolled over three times.
Source: Europe Economics analysis of OFT data
The cumulative proportion of revenue is shown in the table below.
Table 8.3: Cumulative proportion of revenue from rollovers, 2011/2012
Proportion of payday revenue
Total market revenue (£M)
New loans rolled over more than once
33.5%
288.42
New loans rolled over more than twice
24.7%
212.87
New loans rolled over more than 3 times
19.4%
167.55
New loans rolled over more than 5 times
11.5%
99.24
Source: Europe Economics analysis of OFT data
Rollovers are an important element of revenue recovery for payday lenders. All three rollover limits imply
a significant impact on firms’ revenues. A limit of one rollover would affect around £288 million of market
revenue; a limit of two rollovers would affect just over £200 million of market revenue and a limit of three
rollovers would affect around £168 million of market revenue.
Between 19 and 34 per cent of payday revenues would therefore not be recovered if rollovers were
restricted and business models/lending profiles remained unchanged.
Recently the Consumer Finance Association (CFA), one of the largest trade associations for payday lending,
has introduced in their Charter a limit of no more than three rollovers. We understand that this charter is
to be audited independently — in this case, it is reasonable to expect a high level of adherence to it.
According to our analysis of the data gathered by the OFT (which precedes this move by the CFA), for
CFA members, loans that were rolled over more than three times represented 24.1 per cent of total
revenues in 2011/12 (a higher proportion than the total market average of 19.4 per cent). It is noteworthy
that a group of lenders that benefited from rolling over loans more than the market average has decided to
self-impose a limit to this practice. We consider this highly suggestive that the lenders believe that
compensating measures (e.g. increasing default fees or the base cost of credit, or collecting revenue via
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other means) could be introduced. Therefore it is likely that in isolation a limit of three rollovers would
have a smaller impact on revenues than a limit of two and in particular one. It is important to note,
however, that this analysis is based on current membership of the CFA — i.e. any firms that left the CFA
because of the charter’s provisions would be excluded –– and therefore we cannot assume the impact of a
three rollover limit would be the same across the market.
A limit of one or two rollovers implies a more drastic change in business models. Loans rolled over more
than once or twice represent around 34 and 25 per cent of payday revenue respectively and it is not likely
that lenders would be able to recover this scale of revenue from compensating measures.
The relative impact of a limit of one, two or three rollovers is, we believe, significantly compounded by the
CPA cap. We consider that current practice around CPA use is an effective cash collection tool, at least
for lenders; CPA use is widespread, with only smaller bricks & mortar lenders not using this mechanism,
and with many online firms 100 per cent reliant on CPA — which is highly suggestive of its efficacy. The
CPA policy significantly undermines any scope for changing business models to collect revenue via other
means. Support for the CFA’s rollover limit was not influenced by any policy to restrict CPAs, and it is
highly unlikely that the same conclusions regarding the impact of a three rollover cap can be drawn if
considering the additional CPA policy.
Given the reliance on CPA use, even this policy on its own would have significant impacts on payday
revenues. Unfortunately data availability does not enable us to estimate the efficacy and contribution of
existing CPA use, although we do believe it to be substantial.
The combined CPA and rollover policies could be expected to reduce payday revenues in line with the
corresponding revenue generated from loans rolled over more than one, two or three times, depending on
the particular rollover cap (i.e. £288 million, £213 million and £168 million respectively). This impact could
be seen as a lower bound, as it does not consider revenues generated more exclusively from CPA use.
Revenues may recover in part if firms change their lending profiles to no longer include customers for
whom rollovers and CPAs are required to recover revenue.75 This redefinition in the customer base will
have implications for credit access for many consumers, as we discuss in Section 8.5.3.
8.5.2 Impact on payday industry
The impact on revenue from the rollover cap and CPA restriction will significantly affect lenders’
profitability. Given the scale of revenue potentially affected by the policies and the fact that together
rollovers and CPA use represent important means of cash collection, it is unlikely that the revenue impact
could be simply absorbed into firms’ current profit levels or passed wholly onto consumers. We do
consider there to be some scope among firms to introduce compensating measures to collect revenue (e.g.
through additional charges and fees).
Industry feedback in the UK is that payday lenders require around £25 revenue per £100 lent in order to
remain profitable. We note that the median ratio in the US is $15 per $100 lent (for retail payday lending;
online lending would be somewhat higher reflecting a higher risk of default).76 This might suggest that
payday lenders in the UK are lending more unsustainably. From the OFT data we constructed estimates of
revenue per £100 if revenue from rolled-over loans was no longer available to lenders. Limiting rollovers
75
76
Experience in the USA provides some evidence for this. In Kentucky, since 2010, a one-time fee is charged for
taking out a payday loan, and "rolling over" loans in Kentucky is illegal. Kentucky law also restricts people from
taking out more than two payday loans at any one time totalling no more than $500. The regulations initially
impacted negatively on the volume of loans. However, they returned to their original levels within a year.
However, this rollover policy was in isolation of any further restriction on revenue collection. See Veritec (2011)
“Report on Kentucky Payday Lending Activity for April 30, 2010 through April 30, 2011”
Consumer Financial Protection Bureau ‘Payday loans and deposit advance products, April 2013
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to one, two or three would reduce average revenue per £100 lent from £29 to £18, £21 and £22
respectively. The figure below shows the impact on firms’ revenue per £100 lend with a restriction of
rollovers.
Table 8.4: Impact on revenue per £100 lent of rollover restrictions
Source: Europe Economics analysis of OFT data
The analysis above calls some business models into question. With a restriction of one rollover — without
any countervailing action (e.g. increasing default fees) — nine firms (43 per cent) would be left with revenue
per £100 of less than £15, and 76 per cent of firms would have less than £25 per £100. The impact is
similar for a restriction of two rollovers, whereby eight firms (representing 37 per cent of lending in the
OFT sample) would be left with revenue per £100 of less that £15.
With a restriction of three rollovers, this would reduce to six firms with revenue per £100 of less than
£15, which represent 16 per cent of lending in the OFT sample.
The policy’s cap of two rollovers potentially eliminates up to £200 million in payday revenues and
jeopardises the profitability of around 38 per cent of firms, responsible for 37 per cent of payday lending in
2011/2012 in the OFT sample. As shown by the CFA members’ adoption of a limit of three rollovers there
may be some scope to rearrange charging structures to partially compensate for such apparently substantial
revenues. Price elasticity is generally considered very low in this sector (which is supported by the type of
consumer using payday services — the majority of the firms’ customers were between the middle and
highest risk quintiles).
However the corresponding restriction on CPA use firms will have even less recourse to recover revenue
from loans, and the resulting revenue per £100 lent could be even lower, further undermining profitability.
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Market exit
This analysis implies that between 25 and 30 per cent of firms might exit the market as a result of a cap of
two rollovers and the restrictions in CPA use if they cannot change their business models sufficiently to
recover revenue from loans that ordinarily would have been rolled over or would have required CPAs to
collect revenue. We consider that the scope to change business models is likely to be limited. This
judgement is consistent with the recent exit of 14 firms following OFT crackdown, which implies that exit
is a realistic option for those firms unwilling or unable to change their business models.
The exit assumption of 25-30 per cent is informed by our analysis above around the impact of the rollover
cap on the profitability of the lenders in the OFT sample. This is adjusted down to take account of the fact
that the OFT data were collected before the CFA’s adoption of a three rollover cap and that some of these
firms may be able to sufficiently re-orientate their business models to adjust, in part, to this cap (i.e.
through changes to charging structures). On the other hand, this could be seen as a lower bound as our
analysis does not consider the impacts on revenue per £100 lent of the restriction in CPA use which could
be substantial.
Impact on lending volumes and access to credit
We consider it likely that there will be a weak link between firm size and the likelihood of exit in this case,
with more small firms leaving — but we also expect a reduction in volume by players remaining in the
market. We assume that the exit of between 25 and 30 per cent of firms would lead to an initial reduction
in lending volumes of a similar magnitude, i.e. between £625 and £750 million. Our analysis indicates that
firms follow heterogeneous strategies — at least some firms appearing to target customers who will
struggle to repay a loan first time around. In other words, rollovers and default charges are embedded in
their business models. These firms are more likely to leave the industry. Other firms that do not
necessarily target marginal customers but nevertheless make use of multiple roll overs and CPAs to
recover loan revenue will also be negatively impacted by the restrictions and would exit the market.
Although exit is likely to be more concentrated among smaller firms that are less able or willing to reengineer themselves, some of the exiting firms may be large and therefore a corresponding or even greater
reduction in lending is possible.
The marginal consumers serviced by exiting firms would lose out on access to credit, as would those
marginal consumers served by other firms who change their business models to avoid lending to those
consumers who require multiple rollovers or CPAs to be profitable. These consumers are unlikely to have
access to other forms of credit.
The initial shock to lending volumes may partially recover in time as surviving lenders re-orientate their
business models away from multiple rollovers and CPA use and begin to serve new customers (e.g.
substituting for customers previously accessing credit through point of sale channels for small value white
goods). Other firms might also enter. There is evidence that this has happened in the USA when rollover
limits for payday lending have been imposed (e.g. Kentucky State), with new lenders eventually emerging
focused on higher quality loan books.77
However, it is unlikely that payday lending will remain accessible to many users who are currently marginal
(i.e. cannot afford to repay loans sustainably). This is the policy intent. However a significant proportion of
consumers who are not marginal in this sense but still make use of multiple rollovers would also lose out
on access to payday lending.
77
For example, the rollover ban in Kentucky was associated with a decline in the number of loan write-offs. See
Veritec (2011) “Report on Kentucky Payday Lending Activity for April 30, 2010 through April 30, 2011”
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Impacts on competition
The payday lending industry is already concentrated: the Competition Commission notes that the top three
firms have a market share of 70 per cent, with the top 15 having a 90 per cent share. 78 Exit of smaller
players would make the situation even more concentrated (somewhat perversely, if the one of the larger
firms reduced its operations significantly or even exited, these ratios could reduce).
It is important to avoid regulation that increases barriers to entry. There are businesses from the USA,
Scandinavian and East European looking at UK — they are not put off by the fact of the FCA taking over
from the OFT, but are waiting to see the detail — so new entry remains possible, but their response to the
new policies is key.
8.5.3 Impact of payday lending policies on consumers
In section 8.4 we discussed the benefits of the policies on consumers. Restricting access to credit among
consumers who are not able to sustainably repay loans is considered the key benefit of the policies.
However, assessing the benefits of a restriction in access to payday credit is a complex issue. Key factors
to this assessment are the types of consumers who are denied access and how the restriction affects them.
For example, based on USA payday experience, Melzer (2011) identifies that “for some low-income
households, the debt service burden imposed by borrowing inhibits their ability to pay important bills”.79
More ambiguously, another recent study finds that “changes in access to payday loans would have limited
effects (positive or negative) on financial well-being”.80
In this section we consider how the policies affect consumers’ access to credit and what the implications of
this restriction might be. Given the ambiguities here, to illustrate the range of possible outcomes we have
created impact scenarios based on indicative consumer groups and responses to a restriction in payday
credit. We also consider the impacts on product choice and the cost of credit.
Impact on access to credit
Our industry analysis indicates that between 25 and 30 per cent of payday lenders might exit the market as
a result of the sector-specific policies. These will include those firms who target marginal consumers who
cannot afford to repay loans sustainably, and thus whose profitability depends on the use of multiple
rollovers and CPA use to collect revenue.
In addition, firms that remain in the market would most likely cease to lend to users who would require
more multiple rollovers and CPAs to repay their loans — i.e. remaining lenders reduce volumes. It is likely
(and is the aim of the policy) that firms will invest more effort in conducting affordability assessments to
ensure the ability of consumers to repay the loan within no more than two rollovers. This might vary by
loan length: if very short-term loans (say seven days) remain on offer, one might expect additional scrutiny
here.
Consumers who are not considered marginal but nevertheless make use of multiple rollovers and/or CPAs
could also be denied access to credit as firms adjust their business models. Lending may extend to new
customers, but a significant proportion of consumers would lose out on access to payday credit, some of
whom may not have access to other forms.
The diagram below presents a simple illustration of how we conceptualise the shift in consumer access to
payday credit.
78
79
80
Competition Commission, 14th August 2013, “Payday Lending Market Review: Statement of Issues”.
Brian T. Melzer, "The Real Costs of Credit Access: Evidence from the Payday Lending Market", The Quarterly
Journal of Economics (2011) 126, 517–555
Neil Bhutta, Paige Marta Skiba and Jeremy Tobacman, "Payday Loan Choices and Consequences", October 2012,
Vanderbilt Law and Economics Research Paper No. 12-30
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Figure 8.3: Conceptualisation of Shift in Access to Credit
In order to illustrate the types of payday consumers who could be affected by the restriction in access to
credit, we make use of consumer analysis developed by Policis in work for Toynbee Hall and Friends
Provident.81
“Low-risk borrowers” (25 per cent of users): These have ready access to mainstream credit and are
coping. They are lower income than other payday users. No adverse credit history, but prefer payday
loans as they are wary of revolving credit and overdraft models. They are likely to have a more
considered approach to lending; making rational payday choices and are less likely to be influenced by
biases such as optimism or be hasty and value speed over cost. Probably have no problem getting or
repaying payday loan, and thus at a low risk — within the context of payday lending — of borrowing
unaffordably or being denied access to payday credit.
“Moderate-risk borrowers” (41 per cent of users): These have maxed out credit cards and increasing
credit refusals, with payday seen as safer, and also potentially cheaper, than revolving credit. These are
often relatively high income and less critically credit dependent. They have some (albeit limited)
potential to escalate credit card debt, with poor credit rating from low level delinquency. These could
be those who could ‘do without’ if no access the payday lending. Affordability assessments that just look
at income would probably classify these consumers as able to repay loans. However, these are classified
as having increasing credit refusals and poor credit rating from low-level delinquency. CRA checks may
therefore be less forgiving. Face a moderate risk of borrowing unaffordably or being denied access to
payday credit.
“High-risk borrowers” (34 per cent of users): Their finances are finely balanced and are credit dependent,
with payday critical to managing credit flow and commitments. These users correspond most closely to
the profile of those most likely to become enmeshed in long term mainstream credit debt traps. They
are critically dependent on cycling credit to make ends meet (with payday lending playing a role in this).
A large proportion of these unlikely to have other credit options, and face a high risk of borrowing
unaffordably or being denied access to payday credit.
From the above typology, it seems likely that those consumers most vulnerable to unaffordable payday
lending are those in the “high-risk borrowers” group. The typology identifies these users as most likely to
become enmeshed in long term credit traps. Any difficulties these users have in repaying payday loans
81
Ellison, A and Whyley, C (forthcoming), “The consumer dynamics of problem debt”, Policis/Toynbee Hall/Friends
Provident Foundation. This uses a dataset of 500 payday customers. The above categorisation and elements of
the associated description draw directly on categories of payday borrower, being “Payday copers”, "Pressured
mainstream cross-overs", and "Stressed credit-dependent jugglers" respectively.
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would most likely be escalated through the use of rollovers and CPAs, leading to significant financial
difficulty, emotional stress and hardship. Restricted access to payday credit is likely to have the greatest
benefit among these consumers. However, research suggests that these consumers (including those who
are able to repay payday loans) are significantly reliant on payday credit for essential income (i.e. for
household essentials or bills).82 With little alternative access to credit, a restriction in payday lending may
have complex outcomes in this segment.
Users in the “moderate-risk borrowers” group appear less obviously marginal and less likely to fall into
financial difficulty as a result of unaffordable payday loans. However, their heavy credit use increases this
risk and there may well be a proportion of users in this group who would benefit from a restriction in
payday credit. Their relatively high income and the fact they are less critically credit dependent suggests
that if faced with a restriction in payday credit these users would not be at risk of doing without essentials.
However, access to alternative forms of credit may still be difficult.
The users in the “low-risk borrowers” segment do not appear to be at risk of getting into financial
difficulties as a result of payday loans. There would be no obvious benefits of restricting access to payday
credit for these consumers.
The policy mix will have a significant impact on the payday industry. To recap we estimate that at least 25
per cent of firms will exit as a result of the policies, and that this will be accompanied by a shift in business
models among remaining firms away from consumers that require multiple roll overs and CPAs to repay
loans. Lending volumes could decline by up to £0.75 billion.
It is possible that nearly all marginal consumers will be underserved by the payday market –– we estimate
this would be up to 30–50 per cent of the “high-risk borrowers” group.
In addition, a proportion of other consumer types will also become underserved –– those who would
ordinarily require three or more rollovers in order to repay a loan or with whom lenders were required to
use CPAs. Given the greater emphasis on affordability assessments and credit checks, it is likely that many
consumers would be denied payday credit on the basis of poor credit scores even if they would not
automatically require the lender to use rollovers or CPAs to recover the loan. Given the fact that the
“moderate-risk borrower” group is characterised by those with poor credit ratings, it is likely that a
proportion of this group would be denied access to payday credit as a result of more stringent affordability
tests. We estimate that around 20–30 per cent of the “moderate-risk borrowers” group would lose out
on payday lending.
Together with the more marginal consumers, this amounts to approximately 18-30 per cent of all payday
customers.
Impact on product choice
One consequence of the policies is that payday loans of particularly short duration (say less than two
weeks) may be curtailed (e.g. only available to customers with an established track record of paying back
longer-term loans).
There may also be a movement among payday firms towards the provision of instalment credit.
Impact on the cost of credit
The impact of the direct compliance costs of the regime change is not highly significant in the context of
the cost of payday lending. These costs are discussed at 4.11 and 4.12, and include the direct costs
associated with the HCSTC-specific policies (i.e. the costs associated with health warnings and financial
promotions). The implications of all direct compliance costs on the cost of credit are discussed at 6.4.
82
The University of Bristol survey showed that of those payday users who would do without if they were unable to
access a payday loan, retail payday users were most likely to do without everyday essentials and household bills.
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The indirect costs of the policies are likely to be more significant. We consider there to be a material
likelihood that the limiting of roll-overs and the restrictions in CPA usage will not only mean a reduction in
lending volumes but is likely to also see default fees and related charges rise as those participants remaining
in the market seek to recoup lost revenues. It is difficult to assess the size of these shifts and there is an
obvious potential interaction between the two. As a benchmark we consider the introduction of the CFA’s
voluntary cap of three rollovers. The voluntary nature of this suggests that a significant proportion — at
least the profit element — of revenue from loans rolled over more than three times (around £167 million
across the whole industry) could be recouped (although even then it is difficult to assess how much can be
passed onto consumers.)83 However, in the context of the new policies some of that revenue would be
associated with firms now leaving the market. With the CPA cap as well, firms may not be able to pass as
great a proportion of costs onto consumers as before. Combining these effects we estimate that the
revenues that would be recouped from consumers would be around half of the additional profit from loans
rolled over three times (perhaps £10–12 million).84 Another form of alternative action could involve
switching the capital extended in rolled-over loans to new lending (provided that customers are available in
sufficient numbers).
Possible outcomes for consumers
As discussed above, the key benefit of the payday specific polices will be to reduce unaffordable lending and
related consequences (payday lending becoming an unintentional medium-long term form of lending with
high continuous costs; consumers falling into debt traps and spirals from constantly rolled-over loans;
consumers doing without essentials as they either try to pay off loans and charges or have their accounts
drained through CPAs). From our analysis of consumer types this restriction in access largely includes
those from the “high-risk borrowers” group, but may also include consumers from the “moderate-risk
borrowers” group.
The policy package is intended to shift those consumers who cannot afford payday lending away from the
industry. However, a non-trivial proportion of consumers who can afford payday lending (albeit those who
would require the use of multiple rollovers in order to do so) would also face a restriction in credit access.
It is not clear that this latter group would achieve significant benefits.
The customers affected are likely to be split between those able to borrow elsewhere (from mainstream
providers, other high-cost lenders or from friends and family) and those who cannot. To illustrate possible
outcomes, we present a number of scenarios below.
Other forms of mainstream credit (including cash advances on credit cards)
We also consider this scenario beneficial, as consumers would access lower-cost credit from markets with
less evidence of poor firm behaviour. It is uncertain how many affected consumers would have access to
this credit alternative. Research on payday users shows that although these consumers do use other forms
of mainstream credit, at the point of demand this is often not a feasible alternative. 85 The University of
83
84
85
Whilst payday customers are frequently characterised as price insensitive, one would expect a profit-maximising
payday lender to seeking an optimal balance between volume and price now.
The volume of lending in 2011/12 is around 7.4–8.2 million loans. It has been indicated in press reports that
Wonga achieves a profit of about £15 per loan (see for example The Independent, ‘Payday lender Wonga rakes in
over £1m in profits a week’ 3 September 2013). Whilst we recognise that this may not be representative, it is
suggestive of profits in the order of £110–120 million. Revenues from over three roll-overs represent about 20
per cent of revenue. We have assumed profitability is constant across lending.
For example, the BIS/University of Bristol study’s Consumer Survey found that 62 per cent of retail payday users,
and 76 per cent of online payday users had access to some form of mainstream credit (agreed overdrafts, credit
cards or mainstream fixed-term credit).
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Bristol survey found that that only 24 per cent of online payday and 12 per cent of retail payday customers
might have been able to borrow the money from a mainstream lender.86
The Policis/Toynbee Hall analysis indicates that 45 per cent of those we term “high-risk borrowers” can no
longer borrow elsewhere, and that the majority of the “moderate-risk borrowers” have maxed out credit
cards and turn to payday lending as an alternative to mainstream credit. We would expect these customer
types to feature disproportionately in the customers facing credit constraints. It is unlikely that a large
proportion of the affected consumers would be able to access alternative mainstream credit — perhaps
1.5-3 per cent of existing payday customers (i.e. 6-10 per cent of those facing credit constraints).
Forms of lower cost credit (albeit still potentially “high-cost”), such as home credit or credit unions
Affected consumers may access other forms of high-cost credit such as home credit or credit unions. This
would be beneficial as these, although high-cost, are lower cost than payday credit. Home credit usually
targets a different demographic to payday (being more focused on the lowest income groups and
fundamentally different in nature, being door-step based as opposed to online or through a retail outlet).
This does not appear to be a very credible alternative to payday credit, especially for the higher-income
consumer groups, although for the lower income “high-risk borrowers” group credit need might create a
demand.
Credit unions are generally not able to lend profitably below £100087 and is thus unlikely to be a viable
alternative for payday lending.
It is possible that the remainder of the affected “high-risk borrowers” group (15 per cent of the whole
group, 45 per cent not being able to borrow elsewhere) and possibly ten per cent of the affected
“moderate-risk borrowers” would consider alternative forms of high-cost credit. This would equate to
around 10 per cent of the affected payday consumers, and approximately 2.5-4 per cent of existing payday
customers.
Grey lending, from friends and family
This scenario would be beneficial as it is cheaper than payday lending, although it is likely to entail social
costs (e.g. embarrassment; strained relationships; etc.). The University of Bristol survey shows that this is
the most common non-credit alternative for retail and online payday users (39 and 44 per cent
respectively). Therefore it is possible that up to 40 per cent of the affected consumers in the “moderaterisk borrowers” and “high-risk borrowers” would resort to this form of lending, approximately 9–14 per
cent of existing payday customers.
Repayment/debt management plans and eventual recovery from financial difficulty
This scenario would be potentially beneficial to consumers affected. Consumers in financial difficulty who
would have resorted to payday loans to manage their credit repayments (although all the while increasing
their indebtedness) could be pushed towards debt management plans if denied access to such credit. This
would be particularly likely if they had no access to alternative forms of credit. Around 45 per cent of the
“high-risk borrowers” are no longer able to borrow from elsewhere. Some part of this group should
gravitate towards a debt management solution.88 This would be aided by the information on debt advice to
be provided at roll-over (clearly, provision at a refusal of roll-over would also be beneficial).
86
87
88
‘The impact on business and consumers of a cap on the total cost of credit’, Personal Finance Research Centre,
University of Bristol, March 2013
Wright, J (2013) ‘Credit Unions: a solution to poor bank lending?, Civitas
Our fieldwork suggests that debt management plans are generally seen as a last resort for consumers and a
significant level of indebtedness would be required to make these attractive. For example, around two-thirds of
the individuals with payday debt on debt plans with StepChange have contractual commitments of over 100 per
cent of their income. Therefore the proportion of affected payday users who pursue this route is likely to be
lower.
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Do without
Consumers no longer able to access payday loans or other forms of credit may have to resort to doing
without whatever the loan would have been used for. Where loans would have covered essential
expenditures such as household bills, doing without would not be beneficial and may even cause the user
more hardship than the implications of an unaffordable payday loan. Even where a user went without nonessential items there would still be detriment suffered if the expected utility from what the loan was
intended for was greater than the costs of the unaffordable loan. The University of Bristol survey showed
that around 29 per cent of payday users would do without if they were unable to access a payday loan, and
that retail payday users were most likely to do without everyday essentials and household bills. Another 24
per cent of payday users would consider selling something if they did not have access to a payday loan.
From our consumer typology, consumers in the “high-risk” group would arguably be more likely to do
without essentials than consumers in the “moderate-risk” group, as the latter are relatively high income
and not as credit dependent as the former. It is uncertain whether doing without essentials represents a
net disbenefit. If the consumer can ultimately afford the payday loan, and must do without essentials due to
restricted access, then this represents a clear disbenefit of the policy. If the consumer cannot afford the
loan then the disbenefits of doing without the essential expenditure in the short term may be outweighed
by the long-term benefits of not falling into greater financial difficulty. However, we cannot know if the
latter argument applies in all cases and there may be instances where doing without the essential
expenditure in the short term could have even worse longer-term detrimental impacts than the financial
difficulties caused by the unaffordable loan.
We estimate that around 25-29 per cent of affected consumers would do without, representing
approximately 5-9 per cent of existing payday customers.
Unregulated credit from online offshore providers
This scenario would undermine any benefit of the reduction in unaffordable lending. Unregulated lenders
would presumably make similarly unaffordable products available to consumers, with possibly higher
charges and overall costs and no recourse on the part of the consumer to any regulatory intervention. It is
not clear the extent to which this scenario would manifest.
Illegal lending
It is possible that consumers with restricted access to payday credit, no mainstream of other high cost
credit options and no non-credit alternatives may turn to illegal money lenders. This scenario would at
least undermine the benefits of the policies as these consumers would still have access to unaffordable
lending, most likely at a much higher cost than regulated payday lending. At worst, with no regulatory
scrutiny of the firms these consumers may become victims of detrimental business practices, leading to
significantly worse outcomes in terms of financial hardship and emotional stress. It is not certain the extent
to which payday users would resort to this scenario. The University of Bristol survey shows that for the
majority of respondents illegal lending was not an option in the event of restricted access to credit, with
only one per cent of payday lenders even considering this. Judging from the characteristics of people using
illegal money lenders (poor and disadvantaged; low level of full-time work; deprived communities) and the
nature of the lending (operates using social networks with agents serving housing estates) it seems unlikely
that consumers unable to get a payday loan would automatically resort to illegal lending.
A research study directly compared the levels of illegal money lending in countries (Policis, 2004). It found
higher levels of illegal lending (in France and Germany) which had less legal high-cost credit (due to interest
rate restrictions) than in the UK. However, there has been much criticism of the report’s conclusions that
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a restriction on credit drives illegal lending.89 A study for the European Commission found inconclusive
evidence that interest rate restrictions led to a substantial illegal market in credit.90
In Australia, some
states had price caps and rollover limits and others did not. Consumer advocates in price cap states did
not experience an “increase” in illegal lending.91
Summary of possible outcomes
The figure below illustrates the possible outcomes that consumers who are denied access to payday credit
may face (using maximum values). We note that for some outcomes there is insufficient information to
estimate the proportion of consumers affected. We flag these with a dashed box around the label.
Figure 8.4: Summary of possible outcomes for payday consumers
Mainstream
Credit, 3%
Other High-cost
Credit, 4%
Grey
Lending,
12%
Illegal Lending,
1%
Do Without, 8%
Debt
Management
Programme, 2%
No restricted
access, 70%
Unregulated
Lending, 1%
Key:
Better outcomes
Wors e outcomes
Unclear whether better or wors e
We expand this summary in the table below, bringing together our discussion of consumer impacts to draw
conclusions on the impacts of the policies on different consumer groups.92
Table 8.5: Consolidated consumer impacts
Consumer
group
Estimat
ed % of
payday
users
Judgement of
risk of
borrowing
unaffordably
Estimated
% denied
payday
credit
Likely alternative
scenarios
Judgement on net benefit
/ net detriment
Low risk
borrowers
25%
Very low
Negligible
Na
Na
Moderate
risk
borrowers
41%
20–30%
Do without (up to
30%)
Friends, family, grey
lending (up to 40%)
Most will do without or
borrow from families. This
would be largely beneficial.
Those who get alternative
89
90
91
92
Moderate
See for example Consumer Action Law Centre (Australia) ‘Payday loans: helping hand or quicksand?’ September
2010
Iff/ZEW (2010) ‘Study on interest rate restrictions in the EU Final Report’, Project No. ETD/2009/IM/H3/87
See for example Griffiths University Centre for Credit and Consumer Law ‘Interest Rate Caps: protection or
paternalism?’ December 2008
Where there is sufficient information (i.e. in the description of consumer types) to estimate the likelihood of
particular alternative scenarios for each consumer type we have done so; otherwise we have assumed that the
likelihood of alternative scenarios are the same across groups. For example, we have no information to suggest
that grey lending would be more/less likely among high-risk borrowers compared with moderate-risk borrowers.
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High risk
borrowers
34%
High
30-50%
Do without (up to
30%)
Friends, family, grey
lending (up to 40%)
Other high-cost
credit (up to 15%)
credit would still benefit from
credit access, although this
could include higher-cost
revolving credit. A proportion
of this group may be denied
access to payday credit even if
they can borrow affordably
(either because rollovers
represent a rational choice for
them or because firms’
stricter affordability
assessments deny them
access), and thus would not
benefit from the policies.
Most will do without (which
may not be beneficial if this
includes essentials) or
borrow from families, which
would be beneficial compared
to falling into further financial
difficulty. May also access
other high-cost credit, but
accessing mainstream credit
unlikely. Dependence on
credit could mean greater
propensity of
unregulated/illegal borrowing.
8.5.4 Unintended consequences
The policy mix is likely to result in a non-negligible proportion of consumers being underserved by the
payday lending market who are not at risk of unaffordable lending and on whom this restricted access to
credit would confer no benefits. There is some ambiguity about the extent to which consumers who roll
over loans more than two times are in financial difficulty (indeed, even three or four rollovers may not be
indicative of lending that cannot ever be repaid), and therefore we cannot rule out this possibility. The
tighter the lending restrictions, the more ‘non-marginal’ consumers will be caught in the impacts.
These consumers will not experience any benefit from the policy mix and, depending on the type of
consumer they are and the range of alternative options, may suffer additional detriment. In particular, if the
credit restriction drove them to engage with either unregulated or illegal money lending. However, based
on our analysis above it is not likely that the latter two negative outcomes would be common.
It is also possible that lenders will attempt to get around the restriction on rollovers by lengthening loan
durations (e.g. no more seven day loans) to increase the likelihood of customers repaying small loans on
time. This may make borrowing more expensive for consumers with only very short-term needs.
8.6 Summary and Conclusions
The HCSTC-specific policies of a cap of two rollovers and a restriction in the use of CPAs are likely to
have a significant impact on the ability of lenders to recover revenue within their current business models
and lending profile. The cap of two rollovers suggests revenues of up to £200 million of revenues (around
24 per cent of total market revenues) could be affected.
We do not believe that the policy impacts will simply be absorbed by industry profits or passed wholly
onto consumers. It is likely that lending would be restricted, largely in relation to marginal consumers (i.e.
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customers with a very high risk of default with whom revenue recovery mechanisms are the only way to
make the loans profitable). Firms targeting these consumers and using rollovers and CPAs to make their
businesses profitable would most likely exit the market. Other firms who also serve such marginal
consumers as part of their customer base could be expected to cease to do so as a result of more rigorous
affordability assessments. There might be some change in business models where firms continue to serve
such customers and recoup the revenue from other sources such as default fees and higher charges. We
estimate that between 25 and 30 per cent of firms might exit the market, and an initial reduction in lending
of between £625 and £750 million.
This will impact a significant proportion of consumers –– we estimate between 18 and 30 per cent of
current payday customers would be denied access to credit. For some consumers this restriction is indeed
the policy intent, and likely to be beneficial. However, the alternative options for these consumers may not
be beneficial. We developed scenarios that include doing without, accessing debt management service,
borrowing from friends, illegal lending. In addition, there are likely to be some consumers for whom
payday lending is not unaffordable (or detrimental) who would suffer restricted access. The tighter the
restrictions (in particular of rollovers) the more likely consumers who can afford to borrow will be
constrained from doing so.
In time lending volumes may recover as firms find ways to serve new customers who do not require the
use of multiple rollovers or CPAs to recover cash. However, the population of consumers described
above to whom lending would not be profitable without the use of rollovers of CPAs, would no longer
have access to this form of credit.
These impacts depend on the effectiveness of the policies, and there is evidence to suggest that firms and
customers may seek to game the rollover cap.
Our analysis of the impacts of the policies is limited by a number of factors. Firstly, we do not have access
to data to assess how individual consumers (or types) are made better or worse off by having a payday
loan. It is also not straight-forward to judge the relationship between rollovers and financial difficulty
(particularly where the loan is of very short duration). It is therefore not possible to estimate the extent to
which a restriction in access to payday credit would reduce detriment. Nor is it possible to undertake
welfare analysis of different options, i.e. quantitatively evaluate how different rollover caps would affect
consumers and so comment on the FCA’s calibration of an optimal rollover cap.
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Appendices
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Appendix: Our Approach to Modelling Firm Behaviour
9 Appendix: Our Approach to
Modelling Firm Behaviour
We describe here how we approached the modelling of firm behaviour, and the analytical framework
within which that model was constructed.
9.1 Direct Impact of Compliance Costs for Existing Suppliers
We take profitability to be the baseline criterion that drives business decisions. When faced with multiple
possibilities, firms will choose the option that would lead to the highest profits.
Firms’ decisions typically affect outcomes in multiple time periods. In that case, firms must consider the
present value of the profits of all future periods, discounted by the appropriate factor (i.e. their cost of
capital). In addition, firms have often multiple revenue streams. When firms engage in various activities,
the total revenue is the sum of revenues from each separate product or service.
To conduct this analysis and construct our model for the behavioural analysis, we have made some
simplifying assumptions. Specifically we have assumed that:
If profits remain non-negative the firm would not exit the market (even if could earn greater return on
investment elsewhere).
If profit becomes negative in the long-term and the business cannot be made profitable, the firm will
always exit the market.
We focus here on the impacts of the completed shift to the FSMA regime. However, there will be a
transitional period, between April 2014 when the OFT closes and April 2016 when the FCA will be ready
to introduce its full new consumer credit regime. Firms will be likely to incur different costs during the
transition period and after the transition period.
We recognise that other factors can play a role in determining firm behaviour, such as uncertainty and
concern over regulatory risk, which are not capable of being robustly captured. We describe these at 5.2
(in a section on “downside risk”).
9.1.1 Revenue
Revenue for a specific product is equal to the price times the volume of sales. The price that a firm can
charge depends largely on consumers’ willingness to pay and the prices of competitors and substitutes. In a
perfectly competitive market, firms would have no power to influence the market price. Most real world
markets, however, allow firms some degree of discretion to choose their prices. The second element that
determines revenue is the volume of sales.
Firms can operate in more than one business, resulting in multiple revenue streams. For example, retailers
might not only receive revenue from mark-up on prices, but also from the financial services or
intermediation they offer their customers.
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Appendix: Our Approach to Modelling Firm Behaviour
9.1.2 Costs
For economic decision purposes, costs consist of accounting (or out-of-pocket) costs plus opportunity
costs. The latter are defined as foregone revenue of using resources in alternative activities and include the
cost of capital (even if it is owned by the firm) and the wage of the owners, if the firm is owner-managed.
In the short-run, costs are classified into fixed and variable costs. Variable costs are the ones that depend
directly on the volume of output and can be avoided if the firm decides to cease operations. Fixed costs,
on the other hand, have to be incurred independently of the level of output. Examples of fixed costs
include property taxes and insurance payments. These costs are sometimes referred to as overhead costs.
When a new regime is introduced, firms will typically bear incremental costs. These additional costs can
also be classified into one-off and on-going costs. It is important to understand how these costs map into
fixed and variable costs. While one-off costs are fixed costs, on-going costs can be either fixed or variable,
depending on whether their amount varies with output. For example, renewing a license every period
would be an on-going fixed cost. On the other hand, training new employees in regulatory compliance
could be considered an on-going variable cost, as the number of new employees would depend on the
volume of sales. Such variable costs also have greater scope to be absorbed into “business as usual” costs.
9.1.3 Acquiring new customers
If markets were perfectly competitive and consumers had perfect information, firms could rely exclusively
on the price to influence the total volume of sales of a particular. However, typically both firms and
consumers must incur search costs to complete a transaction. In particular, firms use advertising and
intermediaries to secure new customers. The extent to which firms use such methods depends on factors
such as the profitability of a particular segment and/or the amount and quality of information available to
consumers in the market. When market conditions change, the incentives for acquiring this type of
information could be affected.
9.1.4 Risk
In the presence of uncertainty, firms must rely on their assessment of their expected profits. Firms
consider various possible scenarios and estimate their profits in each of them. The expected profit
incorporates these estimations together with the probability of each scenario.
The extent to which firms are willing to trade off profits for reduced levels of risk will depend on their risk
aversion. A firm that is risk averse will prefer not to have large variability across scenarios. Consequently,
firms might be willing to reduce their expected return in exchange for lower risk.
In corporate finance theory all agents are framed as risk averse. However, the risk appetite of an
organisation can vary depending on its ownership and debt structure. A 100 per cent debt financed firm
will have a lower risk appetite than a firm with 100 per cent equity finance.
This is because a 100 per cent debt-funded organisation will be disciplined only by its lenders (as opposed
to shareholders). Lenders want to be repaid. So the lender’s concern is to minimize downside risk – there
is no upside risk for a lender. By contrast, an organisation with equity will have shareholders that
experience upside as well as downside risk. Such shareholders will want to maximise enterprise value,
which includes upside risk. The consequence is that the organisation will have a higher risk appetite if it has
shareholders.93
93
This is purely from the capital structure risk management side, ignoring the cost management side for now.
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Appendix: Our Approach to Modelling Firm Behaviour
9.1.5 Scenario 1: Costs have increased, but can be passed on to consumers
In the event that the change in the regulatory regime would imply increase compliance costs the first
question to ask would be whether or not such costs could be passed on to consumers. This will determine
the impact on the firm’s profitability.
In a competitive market firms can only charge the customer the marginal cost of providing the service. To
the extent that the additional compliance costs represent fixed cost (e.g. authorisation fee) these would not
be passed on to consumers but borne by the supplier. Where the compliance cost represents a variable
cost (e.g. reporting of individual agreements) we would assume that this would be passed on to consumers.
In competitive markets, the pass-through rate is determined by the relative price sensitivity of consumers
and firms. If consumers are very price sensitive (relative to firms), it would not be possible to increase
prices without a significant drop in demand. Therefore, in the short term at least, firms are likely to passthrough a lower proportion of any increase in the cost, rather they would reduce the supply of credit. In
the opposite case, when the firm’s supply is more sensitive to changes in price than consumer demand is to
changes in price, the firm would be less able to continue supplying the market if they absorb a large fraction
of costs and therefore, the pass-through would be greater and the reduction in supply smaller.94
The charts below offer a simple illustration of these dynamics. In the left hand diagram demand is less
sensitive to changes in price than supply; consequently the reduction in supply (Q to Q new) is comparatively
less than the increase in price (P to Pnew). Conversely in the right hand diagram consumer demand is
relatively more sensitive to changes in price than the supply of credit, as such the reduction in supply (Q to
Qnew) is larger than the price increase (P to Pnew).
Table 9.1: Extent of Pass-Through with Different Degrees of Price Sensitivity
Source: Europe Economics
The rate of pass through would also be affected by the persistence of any cost increase. The less persistent
the increase in marginal cost is expected to be the lower the pass-through rate will be to consumers.95
94
95
To note we have assumed here that markets are competitive, and as such inelastic demand matched with perfectly
elastic supply would result in 100 per cent pass through. In contrast, a monopoly would only pass through 50 per
cent of the cost increase. See for example Donghun Kim and Ronald W. Cotterill (2008), “Cost Pass-Through in
Differentiated Product Markets: The Case of U.S. Processed Cheese”, The Journal of Industrial Economics, Vol. 56,
No. 1, pp. 32-48, March 2008.
See for example John Taylor (2000), “Low inflation, pass-through, and the pricing power of firms”, European
Economic Review, 44 (2000), 1389-1408
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Appendix: Our Approach to Modelling Firm Behaviour
Where the firm is able to pass cost increases on to consumers this would represent a change in its
strategy. Where the cost increases are temporary and consumer demand is thought to be relatively
sensitive to price changes compared to supply, we would not expect the firms’ pricing strategy to change
dramatically.
In contrast, if the cost increases are more permanent in nature and consumer demand is thought to be
relatively insensitive to changes in the price of credit, we would expect the pricing strategy of the firm to
change. Specifically we would expect prices charged by the firms operating in the market to increase. This
would have implications for consumers. Where cost increases cannot be passed on to consumers, we
would need to consider whether bearing these additional costs would undermine the firm’s profitability.
9.1.6 Scenario 2: Profits have decreased, but are still positive
In the event that any increases in the costs of compliance created by the changes to the regulatory regime
cannot be passed on to consumers but do not undermine the firm’s profitability, we assume that firms
would not, as a direct consequence of this, alter their business strategy.
In order to determine the impact on profitability both the incremental one-off and on-going costs of
compliance must be considered. Depending on the nature of the one-off costs these would need to be
spread over an appropriate period of time. Current guidance from the UK Government requires that
certain types of expenditure are spread over a specified number of years. According to the guidance, staff
costs, such as recruitment, training, or external advice, would all be written off immediately. In contrast,
for software and capital expenditure (such as new computers and/or premises) the cost is spread over a
number of years (between two and five years depending on the nature of the expenditure and the expected
life of the capital stock). For simplicity we have applied an amortisation rate of 25 per cent to one-off costs
incurred when comparing them with profitability.
9.1.7 Scenario 3: Short run losses as a consequence of one-off costs, but the on-going
business is still profitable
When the long run profitability is not threatened, firms might choose to continue operating despite losses
in the short run. For example, a one-off investment to set up required compliance systems may cause the
firm to incur a loss in the short-term, while relatively small increases in on-going costs do not undermine
the continued profitability of the business. This decision is inter-temporal in nature: it would depend how
current losses compare to the present value of future benefits. This calculation would be affected primarily
by the ability of firms to access capital in the short-run and the cost of doing so.
Firms might decide to stay in a particular market at the expense of short term negative profits for different
reasons. In particular, if a firm decides to exit the market, it would incur a loss equivalent to its fixed
costs.96 If the loss in profitability that a firm incurs as a result of the regime change is smaller than its fixed
costs, it is still more profitable not to exit.
96
These represent sunk costs — once incurred, sunk costs cannot be recovered. Money invested in sunk costs is
effectively lost on exiting the market. As indicated by D Friedman (2010): “While the same costs are often both
fixed and sunk, they need not always be. Fixed costs are costs you must pay in order to produce anything. One
could imagine a case where such costs were fixed but not sunk, either because the necessary equipment could be
resold at its purchase price or because the equipment was rented and the rental could be terminated any time the
firm decided to stop producing.” Here we assume that all fixed costs are sunk costs.
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Appendix: Our Approach to Modelling Firm Behaviour
9.1.8 Scenario 4: Profits become consistently negative
Where the impacts of an increase in cost are permanent and result in negative profits in the long-term, the
firm has various options.
Where such losses are not tenable, we consider four possibilities:
the firms change their strategy
the firms expand the business, either through growth or merger
the firms exit the market
the firms over to grey market
In assessing these scenarios the first point to establish is whether or not the profitability of all product
lines/consumer groups served would be affected, or whether only certain revenue streams would become
unprofitable.
9.1.9 Change Strategy
If only certain revenue streams are affecting the overall profitability of the business, if the firm can
distinguish between these streams, the firm could address any fall in profitability via a change in their
business strategy. In particular, firms can offset cost increases by altering their pricing and marketing
strategies. For example, if firms are able to price discriminate (i.e. charge different prices depending on the
characteristics of the customers), they might be able to adjust prices charged to certain groups to restore
the profitability in each of them.
Such strategies would not be feasible if the firms cannot differentiate between the different revenue
streams, the losses would run across all revenue streams, and/or the firm cannot distinguish between
different consumers (and so would not be able to adopt separate strategies for the unprofitable groups).
Pricing strategies
There are various forms of price discrimination, each of which requires different information to achieve.
These are generally referred to as follows:
First degree price discrimination — charging each consumer their willingness to pay;
Second degree price discrimination — offering discounts for different quantities demanded; and
Third degree price discrimination — charging different prices to different types of consumers.
The more common forms of price discrimination relate to quantity discounts (i.e. reduced prices for bulk
purchasing) and charging different prices for different types of consumers (e.g. elderly, businesses, etc.). In
order to price discriminate in this way it is important that the firm can distinguish between the relative
price sensitivity of different groups. For example, to be able to price discriminate effectively a firm needs
to have sufficient information on its customers or be able to structure their products in such a way that
consumers are self-selecting, that is they select themselves the products most suited to their own
willingness to pay.
In the consumer credit market access to customers’ credit ratings and income can facilitate this type of
pricing strategy, similarly setting credit agreements of different lengths and with different penalty structures
can allow self-selection by consumers. It is likely that pricing strategies would be easier in certain segments
than others, for example credit rating information may allow price discrimination in the credit card or
store-card segment, while the scope for such pricing strategies might be less feasible elsewhere.
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Appendix: Our Approach to Modelling Firm Behaviour
If price discrimination is not possible the firms marketing strategy may become more relevant. For
example, firms may choose to focus their business efforts into attracting the customer base that is most
valuable while neglecting other market segments.
Marketing strategies
Firms could also alter their marketing strategies. Where the additional costs render the business
unprofitable, firms may decide to change the way in which they target consumers, and/or the types of
consumers that they target.
Assuming that these firms are profit maximisers, it is not unreasonable to assume that they currently
employ the most efficient (or optimal) method of acquiring customers. As such, in the absence in any
change in the cost of acquiring consumers via the various methods, we would not expect their behaviour in
this respect to change in this context.
However, if the cost of serving certain types of consumers increases more than for others firms may have
an incentive to change the types of customers they serve (and thus target). For example, if certain types of
customers become disproportionately less profitable, firms may choose to either stop serving them
completely, or reduce the supply of credit to those groups in order to free up credit for more profitable
customers. Ultimately firms will aim to maximise their expected return. This may have a knock-on effect
for the way in which they acquire customers, if different types of customers are targeted in different ways.
9.1.10 Expand or Merge
Where such strategies are not feasible firms may attempt to make the business profitable by expanding
their operations, including the possibility of merging with other firms. There are typically incentives for
expansion/consolidation when economies of scale are present (i.e. when the cost per customer decreases
as the volume of sales increases). An increase in fixed costs due to regulatory compliance would be such
an example. For instance, if the cost of renewing licenses is independent of the volume of sales, small firms
will suffer as they must divide this cost among fewer customers.
9.1.11 Exit
Firms may be willing to bear continued losses if:
they operate in several markets and are able to cross-subsidise across revenue streams and providing
the loss-making service offers some benefit (e.g. allows the company to offer a package of products/act
as a one-stop shop); and/or
the losses are offset by benefits obtained in a complementary activity.
In the absence of such benefits to their business as a whole, and without the scope to change their business
strategy or take advantage of any economies of scale, the firm would ultimately exit the market.
Market exit could take a variety of forms. A firm could:
sell the business on in its entirety;
sell part of the business; or
close down the business.
Whichever approach is adopted, the impact on market concentration would be the same unless new firms
enter the market.
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Appendix: Our Approach to Modelling Firm Behaviour
9.2 Model for Assessing Impact
Based on the above dynamics and the factors underpinning business decisions we have developed a model
to determine how a firm may react to an increase in the cost of compliance. The model encodes the
decision tree described above with the individual decisions at the forks within this model driven by data
from the compliance cost model, from the survey work conducted by Policis and insights gleaned from
economic theory.
In particular the model considered the likelihood of:
No change in the business;
A change in the business strategy — including the potential for a firm to increase prices and/or reduce
supply, to specific customers or across the board, and to change the range of products/services it
offers;
Expansion of the business;
Consolidation (i.e. merger); and
Market exit.
This behavioural model was constructed around the decision tree set out below. The raw data to
parameterise the model was drawn from a mixture of the quantitative survey and also the economic
literature and other sources external to this study.
Table 9.2: Decision-tree underpinning the Behavioural Model
To construct this model we have made some simplifying assumptions. Specifically we have assumed that:
If profits remain non-negative (after accounting for the cost of capital) the firm would not exit the
market (even if it could earn greater return on investment elsewhere).
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Appendix: Our Approach to Modelling Firm Behaviour
If profit becomes negative in the long-term and the business cannot be made profitable, the firm will
always exit the market.
Non-SMEs will be able to cover any short-term costs.
That incremental compliance costs represent increases to on-going fixed costs.
If fixed costs increase by more than 10 per cent post regulatory change there will be economies of
scale.
If firms can pass through the costs to consumers they will just change their prices, if not they will
change the consumers they target but not their prices to those consumers.
The outputs of the model allow us to assess the impact on:
Competition in market.
Prices.
Consumers served.
9.2.1 Competition in the market
The extent of competition will be determined largely by any change in the concentration of firms operating
in the market. In particular the extent of any market exit, and expansion and merger activity will have
important implications for the competitive environment. Any reduction in the number of firms and
increase in the concentration of the market would potentially reduce the competitive pressure between
the firms operating in the market.
Aside from such changes in firm behaviour, any impact on the scope for firms to enter the market and
changes in demand side behaviour for different credit products will also be important in determining the
competitive dynamics in individual markets.
9.2.2 Prices
Prices may be affected via two mechanisms:
a change in the business strategy of the firm; and/or
a change in the competitive pressure in the industry — a reduction in competitive pressure may be
accompanied by a rise in prices.
The extent to which a change in the competitive environment would result in a change in prices would
depend not just on the scale of any change in the competitive dynamics, but also any changes in the quality
of the service offered.
9.2.3 Consumers served
Any changes in the numbers or types of consumers being served will be driven primarily by any changes in
the business strategies of individual firms as well as the extent of any market exit. If firms decide to alter
supply to certain consumer groups, and/or the types of firms exiting the market tend to serve particular
groups then there may be a shift in the types of consumers served by lenders. An important part of any
analysis of the impacts on consumers would be to consider the extent and supply of alternatives available to
affected consumers.
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Appendix: Our Approach to Modelling Firm Distributions
10 Appendix: Our Approach to
Modelling Firm Distributions
10.1 Introduction
Analyses of firm size using historical data have strongly indicated that the distribution of firms can be
described by a form of lognormal distribution.97 Similarly, research carried out on the distribution of U.S.
firm size indicated a particular form of power law distribution, a Zipf distribution.98 Technically this means
that the probability of a firm being larger than a given size, S, is inversely proportional to S. In the other
words, firm sizes are highly skewed such that there are a large number of small firms and a small number of
large firms. Heuristics like the 80:20 “rule” draw upon this research.
Table 10.1: Illustrative Set of Firms Distributed by a Power Law
Source: Europe Economics
Our analysis of Critical Research’s data indicated that the segments within the consumer credit industry in
the UK conform to such a distribution — however there were not enough data in this research to model
the distribution in the ways that we needed to feed into our models. The chart below, for example,
captures the consumer credit turnover for the 26 home credit lenders disclosing such data as part of
Critical Research’s work.99
97
98
99
R.Perex, et al. (2005), ‘Company size distribution for developing countries’, see
http://esfm.ipn.mx/~richp/papers/developingcountries_PhysA_359_2006.pdf
R. Axtell, et al. (2001), ‘Zipf distribution of U.S. Firm Sizes’, http://www.swarmagents.cn/thesis/doc/jake_204.pdf
Here we refer to those firms that self-described within Critical Research’s work as having home credit as their
primary business activity. These data points are actually drawn from the first survey conducted by Critical
Research (i.e. from 2012): this timing difference is not important to the point being made here.
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Appendix: Our Approach to Modelling Firm Distributions
Table 10.2: Distribution of Home Credit Participants within Home Credit
Source: Europe Economics analysis of Critical Research 2012 dataset
10.2 Our Approach
For a discrete pareto-distributed random variable, X, the distribution of firm size (by turnover) is drawn
from the following cumulative distribution function (CDF):
where k is the minimum firm size and α defines the curve, and which, in effect, captures the degree of
market concentration.
Through desk-based research, analysis of the Critical Research data and the Policis survey, and additional
stakeholder engagement, we gathered information on the number of firms100 and the aggregate revenue in
each segment. Analysis of Critical Research’s data gave an upper boundary for the minimum firm size. We
also gathered data on market concentration, where available, so that we could benchmark α in these
segments. Where such data on market share of the larger firms were absent we imposed a condition of α
equal to one (i.e. equivalent to that in a Zipf distribution).
We were then able to analyse the distributions generated to assess those proportions of firm numbers
(and their share of total revenue) applicable to different sizes of firm. A boundary set at £250,000
supported the modelling work on small firms; boundaries set at other levels aided the modelling of, for
example, authorisation fees.
100
By and large, these were drawn from the proportions of the total sample within Critical Research’s population
data. In a few cases, this generated results at variance to knowledge gained elsewhere. In these few cases we
substituted our own estimates (on banks and mainstream lenders) for those from Critical Research. These
adjustments were not significant overall.
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Appendix: Our Approach to Modelling Firm Distributions
10.3 Our Results
The table below summarises the proportion of firms above and below the £250,000 consumer credit
revenue boundary, and the proportion of revenues within that segment that our model ascribed to them.
Table 10.3: Population Characteristics by Segment
Participants
Proportion attributable to firms with
consumer credit revenue:
Banks
Turnover
≤ £250k
0%
> £250k
100%
≤ £250k
0%
> £250k
100%
Card monolines
0%
100%
0%
100%
Online payday
0%
100%
0%
100%
Traditional bricks & mortar
50% - 53%
47% - 50%
6%
94%
Home credit
79% - 80%
20% - 21%
3%
97%
Other non-bank lenders/consumer hire
65% - 67%
33% - 35%
12% - 13%
87% - 88%
Credit union
Credit brokers and other credit
intermediaries
Secondary credit brokers (motor)
89% - 90%
10% - 11%
34%
66%
98%
2%
37% - 38%
62% - 63%
96%
4%
33%
67%
Secondary credit brokers (other retail)
99%
1%
44%
56%
Aggregator & lead generator
82%
18%
24% - 25%
75% - 76%
61% - 64%
36% - 39%
12% - 13%
87% - 88%
Debt collectors & administrators
76%
24%
14%
86%
Credit reference agencies
0%
100%
0%
100%
Debt management and related
Source: Europe Economics
10.4 Comparison to Critical Research’s Findings
Critical Research’s work was one (important) source alongside our own desk-top research used in
developing our population models. It is therefore unsurprising then that our results do not match in all
regards those generated by Critical Research. First, Critical Research’s (original) fieldwork indicated about
25 per cent of active participants to be sole traders. Certain segments — such as banks — will not have
any sole traders: excluding these, we applied a higher percentage (about 30 per cent) to the remaining
segments (e.g. credit brokers and secondary credit brokers). The overall result is that we have assumed a
comparable number of sole traders when the whole population is considered. We recognise that, given we
believe that there are proportionately more small firms in the population than identified by Critical, there is
an argument to increase this proportion — since small firms are more likely to be sole traders. We have
not done so, but note that this would tend to reduce the overall cost impact since some policy concessions
are available to sole traders.
Second, the proportion of already directly FCA-authorised firms within the population: in this case we
estimated this population segment by segment. Overall, our approach is well-aligned to the results from
Critical Research.
Third some minor categories of firm were not included in the Critical research. In particular, we added a
pre-transfer sub-population of 600 field cash collectors which operate in the debt collection arena.
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Appendix: Detriment in Consumer Credit Markets
11 Appendix: Detriment in Consumer
Credit Markets
This appendix presents an in-depth discussion of the types of consumer detriment evident in consumer
credit market.
Unaffordable borrowing/lending, debt traps or spirals
Consumers can have incentives to take out credit they cannot afford. This includes borrowers who believe
they can and will repay the loan when in reality they cannot. Distressed borrowing is more likely for
borrowers who are already struggling financially and who may overextend themselves when borrowing.
Credit products that can easily be rolled over can be a concern for consumers who are prone to
procrastination or who focus more on the immediate need for the loan than on their ability to repay it
long-term. These loans can accumulate charges and interest and increase the risk that the borrower will be
unable to repay.
Lenders may provide unaffordable lending if it is profitable to do so, for example if the lender can extract
sufficient revenue from the borrower even if they eventually default, or if the costs of distinguishing
between borrowers of different credit worthiness are greater than providing the same credit product to all
of these borrowers.
Unaffordable borrowing and lending is linked to firm and consumer behaviour, such as:
Consumers may lack important information on the credit product, or not understand product
characteristics, such as consequences of late payment.
Consumers’ focus on their immediate credit need rather than whether they can repay the loan (present
bias).
Consumers’ overconfidence in their ability to repay the loan, and lack of awareness of consequences of
late repayment.
Consumer preferences driven by regret. For example not sorting out debt problems as thinking about
the problem is stressful. This could lead to debt spirals, or make consumers over-willing to accept loan
rollovers to avoid ‘dealing’ with the debt.
Consumers under stress and in urgent need of credit can be more prone to biases.
Firms may downplay long-term costs of loans, or have low up-front charges to entice consumers and
exploit present bias.
Firms can provide loans that are easily rolled over, which make debt traps and debt spirals more likely.
Firms can levy significant upfront charges to recover revenue even if borrower defaults.
Firms can design their products to secure repayments even if a borrower is struggling (e.g. through
continuous payment authority).
Firms may not carry out proper affordability checks and therefore lend to borrowers who are unable
to replay loans.
There are also wider market failures which can drive or exacerbate firm behaviour which leads to
unaffordable lending.
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Appendix: Detriment in Consumer Credit Markets
Information asymmetry between lenders and borrowers increases the cost to lenders of distinguishing
between borrowers of different credit worthiness and may lead to credit being extended to all
borrowers regardless of their ability to repay loan (adverse selection). It may also lead to lenders
mistakenly believing borrowers can repay loan.
Lack of information sharing between lenders exacerbates difficulties in affordability checks.
Credit intermediaries’ incentives may not depend on whether the credit they arrange is affordable or
not.
Poor value credit or services
Consumers can suffer detriment where the price of a credit product or service is persistently more than
the marginal cost of providing it. This indicates that the provider exercises some market power. As
highlighted in the FCA market failure analysis, it is difficult to conclusively determine whether some
products are poor value. However, an OFT review did conclude that some credit suppliers in high-cost
credit markets (pawn-broking, payday lending, home credit) appear to be charging higher prices than
expected.
The OFT found that the home credit market is dominated by one large player and together with its market
structure (networks of agents and personal relationships between agents and the customers) there is a lack
of price competition and barriers to entry.101 The Competition Commission also found that profits in the
home credit market had been “persistently and substantially in excess of the cost of capital for firms that
represented a substantial part of the market.”102
The OFT has previously taken action in relation to unarranged overdrafts, where it highlighted that
problems such as high charges and the complexity of charges were indicative of ineffective competition in
the personal account market. Changes in the market have taken place, such as providers giving consumers
greater choice on whether to have an unarranged overdraft.
As another example, retailers tends to advertise their credit offering facilities such as “interest-free” which
could be misleading and do not take into account of the premium price incorporated in their bundled price
of the product as compared to market price. This may induce the consumer to make a suboptimal choice
if they only rely on the APR figure for the cost of borrowing.103
The underlying market failures of this type of detriment are:
Insufficient competition (particularly at the point of a loan rollover) and market power of firms
Information asymmetry can make it difficult for consumers to gather correct information on products
and services and thus to choose the most appropriate product or service.
Firm behaviour and consumer actions can arise out of, and exacerbate, these market failures:
Complex charging structures by firms make it difficult for consumers to compare products and services
and chose the best value, and can act as a barrier to entry.
Consumer actions can grant market power, for example where they find it difficult to shop around, are
unduly swayed by brand names, or face barriers to switching.
Lack of understanding of consumers of available options — consumers may lack the financial literacy to
compare products with different characteristics, such as loan lengths and structure of fees and may not
understand the potential saving they could made from alternative options.
101
102
103
OFT (2010), Review of high-cost credit, Final report
Competition Commission (2009): ‘Home credit market investigation’, page 7
OFT (2010), Review of high-cost credit, Final report
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Appendix: Detriment in Consumer Credit Markets
Detriment arising from conflicts of interest
Consumers can face detriment if they lack information to adequately judge whether a product is provided
or a service is carried out appropriately and in their best interests. Conflicts of interest exist whereby
credit product and service providers act in a way that benefits them at the expense of the consumer. This
could have detrimental outcomes such as:
unsuitable advice or products being given to consumers; or
the loss of client money and assets.
An example of the former is found in previous work done by the OFT in the credit broker market. There
was evidence that some brokers were charging upfront fees to search for credit for high-risk borrowers,
but either not finding any credit solutions or offering unsuitable credit. Given the upfront fee payment, the
brokers had no further incentive to provide a good service. Similarly, the OFT, in its review of the debt
management market, found several instances of high upfront fees and of unsuitable advice.
An example of the latter also relates to the debt management market, as client money held by debt
management companies could be used inappropriately (i.e. not for the benefit of the client) or be lost if the
company becomes insolvent.
Lack of access to credit
Consumers can experience detriment when they are unable to access credit, access sufficient credit, or
access a sufficient variety of credit products, where they would be in a position to manage the credit.
Consumers who are unable to access credit may suffer from having to do without, or may be incentivised
toward unregulated sources of credit, including illegal sources.
Lack of access to credit is a market failure in itself. This could arise from the market power of some
lenders (who could price some borrowers out of the market) and barriers to entry to new entrants who
would be willing to meet the credit demand.
Information asymmetries could also prevent consumers from being aware of all possible credit options.
For examples, users of home credit may be unaware of the possible credit options from cheaper sources,
such as credit unions. Customers may perceive that there are low degree of substitutability between
credits products and hence, reluctant to explore alternative sources.
Lenders can lack information about borrowers’ ability and willingness to repay loans and as such may
attract less credit worthy borrowers (adverse selection) which in turn may lead them to be overly
restrictive on lending criteria and to reduce access to credit.
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Appendix: Estimating Quantitative Benefits
12 Appendix: Estimating Quantitative
Benefits
12.1 Estimating Unaddressed Consumer Detriment
The NAO report provides a good starting place for estimating unaddressed detriment.
methodology:
The NAO’s
Uses an average ‘assumed consumer detriment’ (ACD) figure per complaint received about an OFTregulated firm. This is £180-£220 per complaint, and is linked to the average payment amount of
transactions involved in complaints, multiplied by a formula linking payment amount to detriment, taken
from the OFT Trading Standards report.
Estimates a total number of ‘incidents’ by taking complaints recorded in the Consumer Direct database
and uplifting these to reflect the fact that not all incidents would have been complained about. This
multiplier is 59.3, based on the OFT Trading Standards report.
This total number of incidents is disaggregated across sectors based on the distribution of complaints
across sectors.
The number of incidents was then multiplied by the average detriment per incident to arrive at the
total unaddressed detriment of £450 million, broken down by individual sector.
The figure estimated by the NAO provides a valuable starting point for estimating the level of unaddressed
consumer detriment in the consumer credit market, and subsequently the level of benefit that might be
achieved through the transfer to the FCA regime. However, there are two main limitations of the NAO
figure for our purposes:
It is unclear how directly the evidence underpinning the NAO figure relates to the detriment identified
in the consumer credit market, or to the areas where the new regime is most likely to be beneficial.
There are possible shortcomings with the assumptions and methodological approach taken by the
NAO, which we describe below.
The detriment captured by the NAO figure
To compile the consumer detriment, NAO used complaints data from the OFT’s Consumer Direct
database. These complaints do not cover all the expected types of detriment identified in the consumer
credit market — such as inability to repay loans; debt spirals; stress and anxiety; loans to consumers who
cannot afford to pay back, etc. It is not always likely that sufferers of such detriment would recognise they
are being poorly treated, especially if the driver is one of market failure/structural detriment (they would
not be aware of anything better). This unobservable detriment could be particularly relevant to consumer
detriment in consumer credit markets.
Even if consumers are aware that they are suffering detriment at the hands of poor business practice it is
not always likely that they would complain to the OFT. Therefore the NAO figure is likely to
underestimate the true level of detriment in the market as identified for the purposes of our work.
Methodological shortcomings
There are also methodological shortcomings underpinning the NAO figure:
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Appendix: Estimating Quantitative Benefits
The value of the multiplier used by the NAO may over-estimate the true number of ‘incidents’. The
proportion of unreported incidents may be lower in 2010-11 (the years from which the complaints
were taken) than in 2008 (the year in which the multiplier was developed) given increasing awareness
of consumer credit issues since the financial crisis and the possibility that consumers are now more
likely to complain. The extent to which the propensity of harmed consumers to complain would have
increased between 2008 and 2010-11 is not clear.104
Also, the multiplier does not take into account complaints to the Financial Ombudsman Service (FOS)
and therefore the number of real incidents is likely to the greater than those captured by the CD
database (i.e. by not including complaints to the FOS the CD database already underestimates the total
number of complaints).
In relation to the previous bullet, the NAO methodology also assumes that the unreported complaints
give rise to the same detriment as reported complaints. However, the multiplier developed by the
OFT explicitly covers ‘consumers who experience a problem with a trader’ and do not report it and
therefore some detriment would be experienced, although we cannot say whether it would be at the
same level as that experienced by people who do complain. It is possible that unreported complaints
involve a lower level of detriment.
Complaints may not always be upheld or reflect true detriment. A customer may suffer detriment
from a loan due to a life event that is neither the fault of the consumer or the seller. In this case it
would not be appropriate to include these complaints in the estimation.
12.1.1 Our methodology for estimating unaddressed detriment
Our methodology is broken down into three stages:
We combined complaints data from both the CD and Financial Ombudsman Service (FOS) sources
We estimated the average consumer detriment (ACD) per complaint
We then calculated the total consumer detriment with a range of multipliers to reflect the number of
unreported complaints.
Our first step was to allocate the OFT and FOS complaints data to the market sectors defined in this study.
In some cases this meant making judgements about the appropriate allocation. For example, one OFT
classification is simply described as “loans and credit agreements” which we disaggregated across all lender
categories. This emphasises the biggest segments in terms of revenue, which are not necessarily where the
greatest detriment lies.
The two sets of complaints data were then compared and the larger number of complaints of the two in
any given sector was selected to reduce any influence of double-counting (as a consumer may complain to
both OFT and FOS at the same time with respect to the same problem). The breakdown of complaints by
sectors is shown in the table below. We note that for the purposes of the benefits section we combine
online and bricks and mortar payday lenders into one category.
104
One might consider a “life cycle” here: few complaints → picked up by press → more complaints → market starts
harvesting complaints → many more complaints. This would fit PPI at least, but otherwise no immediate examples
in other sectors.
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Appendix: Estimating Quantitative Benefits
Table 12.1: Complaints from the OFT Consumer Direct and the Financial Ombudsman Service
Sectors
No. of Complaints (2011/2012)
Lenders
OFT
FOS
Combined
Banks & Building societies
7,631
20,982
20,982
Credit card monolines
361
4,789
4,789
Payday lending
368
296
368
Mainstream & Bricks and Mortar
351
0
351
Home credit
377
41
377
1,948
5,353
5,353
34
0
34
Secondary Non Motor Retail
0
0
0
Secondary Motor
0
0
0
2,541
627
2,541
0
0
0
Non-Bank Lenders and Consumer Hire
Credit union
Credit intermediaries
Traditional Credit Brokers
Aggregators & Lead Generators
Others
Credit reference agencies
532
69
532
Debt Managers and Related
3,160
586
3,160
Debt Collectors and Related
7,131
576
7,131
24,435
33,319
45,619
Total
Note: For the purposes of this quantification exercise we have grouped online and retail payday lending together, and this was how complaints were
recorded by the OFT.
Source: Financial Ombudsman Service and OFT complaints data
The total number of complaints reported to the FOS is somewhat larger than to the OFT. This could be
because consumers’ willingness to complain to or awareness of the FOS could be higher compared to the
OFT. However, the relative complaint behaviour varies from sector to sector.
We assume that the average consumer detriment (ACD) remains constant for both reported and
unreported complaints.
Given that the classification used by NAO is again different to the one we used in our analysis, we
calculated a weighted average ACD using the number of complaints reported to transform the NAO
classification into one that fits our purpose. The average ACD is estimated to be £251 per complaints and
the weighted average ACD per sector is shown in the table below:
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Appendix: Estimating Quantitative Benefits
Table 12.2: Average ACD by Sector
Lenders
Weighted average ACD (£)
228
Banks & Building Societies
Card Monolines
78
Payday lending
500
Mainstream & Bricks and Mortar
253
Home credit
500
Non-Bank Lenders and Consumer Hire
293
Credit Unions
500
Credit intermediaries
Secondary Non Motor Retail
Nil
Secondary Motor
Nil
Traditional Credit Brokers
80
Aggregators & Lead Generators
Nil
Others
Credit reference agencies
43
Debt Managers and Related
131
Debt Collectors and Related
152
Source: NAO report, OFT complaints data
This is a significantly smaller number than the ACD estimated in the Consumer Focus survey 2012 which
used a different approach to quantify detriment experienced by consumers specifically with respect to
credit. Their measurement included the cost of resolving the problem and the cost of personal time spent
on resolving the problem. The average payment-related detriment per complaint was calculated to be
£660 for the whole industry.
With the inclusion of financial ombudsman data into our model, the number of complaints is now
considerably higher (86 per cent higher) than the original OFT complaints data. The multiplier used in the
NAO approach (59) represents the ratio of reported to unreported complaints and it is likely that the
multiplier would be smaller with the incorporation of the FOS as an additional channel for complaints. To
reflect on the potential uncertainty, we adjusted the multiplier down with ranges. This is also to address
the arguments for the final number of incidents based on CD data being over-estimates. We have used a
multiplier in the range 21 to 39 with the central estimate being 30.
These assumptions allowed us to compute the following ranges for detriment as shown in the table below.
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Appendix: Estimating Quantitative Benefits
Table 12.3: Aggregate Observed Detriment by Sector
Sector
Total ACD (£m)
Low multiplier
104.3
Central multiplier
146.9
High multiplier
189.5
Card Monolines
8.1
11.4
14.7
Payday lending
4.0
5.6
7.3
Mainstream & Bricks and Mortar
1.9
2.7
3.5
Home credit
4.1
5.8
7.5
Non-Bank Lenders and Consumer Hire
34.1
48.1
62.0
Credit Unions
0.4
0.5
0.7
Secondary Non Motor Retail
0.0
0.0
0.0
Secondary Motor
0.0
0.0
0.0
Traditional Credit Brokers
4.4
6.2
8.0
Aggregators & Lead Generators
0.0
0.0
0.0
Credit reference agencies
0.5
0.7
0.9
Debt Managers and Related
9.0
12.6
16.3
Debt Collectors and Related
23.6
33.2
42.9
194.3
273.8
353.2
Banks & Building Societies
Total
Source: Europe Economics calculation
12.1.2 Attributing benefits to these estimates of detriment
There are two steps in the translation of possible detriment into scaled benefits. First we need to consider
the extent to which the identified detriment falls within the FCA’s regulatory ambit. HM Treasury and BIS
attempted a similar exercise as part of their Impact assessment and we show their views alongside our own
(more bullish) estimates below.
Table 12.4: Scope of the FCA to Address Detriment
% of all
complaints
HMT/BIS view on scope
for FCA to address
EE view on scope for
FCA to address
Defective goods
4.1%
0%
0%
Substandard services
33.1%
0%
100%
Credit
1.6%
100%
100%
Prices
3.0%
100%
100%
Delivery/Collection/Repair
0.7%
0%
0%
Cancellation
3.3%
100%
100%
Selling practices
8.7%
100%
100%
Misleading Claims/Omissions
16.8%
100%
100%
Offers of inadequate redress
2.0%
100%
100%
Unknown
0.0%
NA
0%
Terms and conditions
1.3%
100%
100%
Problems pursuing a claim
1.6%
100%
100%
Business practices
23.5%
100%
100%
Source: HM Treasury and BIS – “A new approach to financial regulation: transferring consumer credit regulation to the Financial Conduct
Authority”, Annex C
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Appendix: Estimating Quantitative Benefits
We have re-classified the OFT complaints categories that we consider the FCA can address to align them
with the areas of detriment arising from market failures that we identified in the preceding section. This is
shown in the table below.
Table 12.5: Re-classification of OFT complaints to areas of detriment
OFT complaints categories
Substandard services
Unaffordable
lending
Credit


Prices

Cancellation
Poor sales of
products and
services
Unsuitable
advice/products












Misleading Claims/Omissions



Unknown
Terms and conditions
Problems pursuing a claim
Business practices









Selling practices
Offers of inadequate redress
Loss of client
money and
assets

















Second, we assessed the effectiveness of each policy on reducing the number of complaints (and hence
detriment) in each category described in the table above. These assessment matrixes align with the
summary of qualitative benefits presented earlier in the chapter, i.e. Table 7.2, Table 7.3and Table 7.4.
We evaluated each policy against three level of effectiveness: strong, good and negligible in three scenarios
of low to high efficacy. Where the effect is expected to be “strong”, we have attributed a reduction in
detriment of 5–10 per cent of the total; a “good” effect reduced detriment by 2.5–5 per cent. These
figures are clearly judgments, and the results need to be considered carefully in that light.
We have assumed that each policy has an equal effect in addressing the consumer detriment behind each
type of complaint in all sectors, except for the policies specific to debt management. The table below
shows the effectiveness of policies by types of complaints.
Applying these percentages of reduction in detriment to the total detriment in each sector suggests a range
of estimates for consumer benefits as shown in the table below.
- 169 -
Appendix: Estimating Quantitative Benefits
Table 12.6: Summary Table
Reduction
in Detriment
Low
High
Benefit (£m)
Low
Central
High
Banks & Building Societies
16%
to
32%
16.9
35.7
61.4
Card Monolines
16%
to
32%
1.3
2.8
4.8
Payday lending
27%
to
55%
1.1
2.3
4.0
Mainstream & Bricks and Mortar
19%
to
37%
0.4
0.8
1.3
Home credit
19%
to
37%
0.8
1.6
2.8
Non-Bank Lenders & Consumer Hire
18%
to
36%
6.1
12.9
22.1
Credit Unions
16%
to
32%
0.1
0.1
0.2
Secondary Non Motor Retail
18%
to
36%
-
-
-
Secondary Motor
18%
to
36%
-
-
-
Traditional Credit Brokers
16%
to
33%
0.7
1.5
2.6
Aggregators & Lead Generators
13%
to
26%
-
-
-
Credit reference agencies
13%
to
26%
0.1
0.1
0.2
Debt Managers and Related
21%
to
41%
1.8
3.9
6.7
Debt Collectors and Related
14%
to
28%
3.3
6.9
11.9
32.4
68.6
118.0
Total
- 170 -