Why lenders must act now on affordability

Lenders face a major challenge in 2023. In July, the Consumer Duty comes into effect, requiring firms to avoid “foreseeable harm” and deliver better customer outcomes. Lenders that cannot carry out fast, accurate affordability checks will not only jeopardise the financial health of vulnerable people, they will put the health of their own business at risk.

The Consumer Duty obliges firms to build a more multi-faceted picture of customers than was previously required – or even possible. Traditional approaches to credit scoring and affordability checking simply cannot provide the customer insight needed to comply with the Duty.

The solution lies in Open Banking and Open Finance, which enables a data-driven approach that extends existing approaches to affordability far beyond backwards-looking credit scoring and provides a new lens to view vulnerability, resilience, suitability and eligibility.

It’s no wonder that Open Banking tools that enable fast and accurate affordability checks are set to take off. By drawing on diverse and up-to-date data, lenders can have the best possible conversations with borrowers and avoid foreseeable harm and poor customer outcomes. Firms that embed Open Finance within their affordability assessments will not only achieve compliance but be able to benefit from the many opportunities created by this new paradigm in financial services.

Compliance and the Consumer Duty

The Consumer Duty is much, much more than just a tick box project from the FCA. It is one of the most significant shifts in UK financial services for many years and raises the bar for firms, which must collect enough information to understand customers’ financial context and act to avoid “foreseeable harm”.

When the FCA identifies serious misconduct that breaches the rules, it will use a “full range of powers” to “secure redress for consumers”, including fines and even removing permissions, Sheldon Mills, an FCA Executive Director, said in July 2022. Boards and senior managers will be “held to account for delivering these outcomes,” he added.

The Consumer Duty has teeth. It presents a wide range of challenges and demands, but an even wider range of opportunities. There is huge potential value in truly understanding and responding to customers’ needs. The Duty should be embraced as an opportunity to drive business growth, improve consumer satisfaction and reduce business risk.

It is no longer enough for firms to claim they don’t have the information they need to prevent, reduce, or manage arrears effectively. It has never been easier for a customer to connect a lender easily and securely to their financial world using Open Banking so that a holistic, accurate, timely, forward-looking assessment of income, expenditure and affordability can be achieved. If firms have not yet implemented Open Banking – now is the time to do it. It’s hard to see how they could become compliant without it.

Hard Times

Unfortunately, compliance with the Duty is not the only challenge facing firms. It has been a truly bleak winter for millions of retail banking customers – which means it is also likely to be a busy time for lenders. In the Autumn of 2022, the FCA warned that 7.8 million people in Britain were “finding it a heavy burden to keep up with their bills”, an increase of around 2.5 million people since 2020. In January 2023, the ONS report revealed a 17% increase in the price of food, one of the highest levels in 40 years prompting many to switch to supermarkets that focus on value, including Aldi and Lidl. According to Moneyhub, Aldi and Lidl have seen an increase in the number of shoppers by 19% and 17% in January 2023 vs January 2022. While supermarkets such as Morrisons and Waitrose have seen decreases of 10% and 17% respectively. Citizens Advice warned that half of its debt assessment clients are left in the red after paying for essentials.

The rising cost of living is also eroding the savings capacity for UK adults. In March 2022 someone with a net income of £31K a year would’ve been able to save £232 or 9% of their income, however, someone on the same wage in January is likely to only have the capacity to save £51, or just 2% of their income.

And the data shows that savings are even smaller for those on a lower income of £24K who would now have almost no capacity to save. Instead, they like many consumers will have turned to credit to get through the winter. Those struggling to make payments will be looking to lenders for support. Too many firms are ill-equipped to address this challenge because they lack the ability to carry out accurate affordability checks which reveal a customer’s true financial context.

Two reports issued by the FCA in November indicated that the industry was simply not prepared for a surge in demand. The MS19/1: Credit Information Market Study Interim Report and Discussion Paper focused on the data lenders draw from credit reference agencies. It found “significant differences in the credit information held on individuals across the three large CRAs” and warned that “market failures and inherent difficulties in matching new credit information can lead to poor outcomes, including the oversupply of credit to individuals whose credit risk is understated, and limiting access to credit for individuals whose credit risk is overstated”. Between 5 million and 7 million UK Britons are now at risk of financial exclusion due to limitations in the information that is used to make decisions about them.

A second FCA report called Borrowers in Financial Difficulty following the Coronavirus pandemic – Key Findings said that “firms need to do much better”. It assessed 65 lenders and asked 32 to make “material and significant changes to their processes” and pay more than £12 million pounds in remediation to roughly 60,000 customers. Firms face the difficult but unavoidable job of complying with the Duty at the same time as serving customers in a challenging business environment.

A Consumer Duty Case Study

To get a sense of what can go wrong if firms do not switch to Open Banking, think of a consumer credit firm that has designed a lending product, with late payment fees for a target market that includes consumers with low levels of financial resilience. If the firm finds that a large proportion of its customers are not making payments on time and are paying substantial late payment fees, it may be forced to withdraw the product in order to review customer outcomes. The product is simply not meeting the needs of its target market, who are paying far higher fees than anticipated and facing unaffordable borrowing rates.

If this firm had used an Open Banking platform with connected accounts, they would have been able to see which customers were likely to struggle to make payments based on their cash flow records. Using Open Banking data, firms can model customer outcomes before they are financially harmed by the design and distribution of inappropriate products. Without this data, the firm can only spot the problems a product will cause post-launch, by then the damage is already done.

Open affordability

To comply with the Duty, firms must understand and demonstrate affordability throughout a product’s lifecycle – not just at the point of sale. Open Banking and Open Finance data can be combined with businesses’ existing customer data to provide a holistic picture needed to ensure compliance.

Real-time transactional data points relating to banking, pensions, loans, investments, mortgages and savings products can now be gathered, analysed and modelled throughout the lifetime of a customer relationship. This not only conveniently and cost-effectively addresses affordability, but can help firms solve problems around vulnerability, capability, and suitability.

When firms enable their customers to grant explicit permission to Open Banking-powered affordability checking, they gain access to a holistic view of financial well-being. They can see applicants’ capacity to afford loans, a mortgage, or other credit agreements.

Moneyhub’s Open Banking-powered Affordability Dashboard delivers the benefits unlocked by access to real-time data. It can be up and running in contact centres within weeks, giving firms the ability to demonstrate improved customer outcomes and be ready to comply with Consumer Duty in July.

The Consumer Duty will fundamentally change the lending landscape. Firms that embrace Open Finance will be well-placed to deliver better outcomes for their customers and business. We expect the new rules to be a milestone in the development of Open Finance and expect to see genuine benefits to financial health and wellness of consumers across the nation.

By Dan Scholey, Chief Operating Officer (COO) – Moneyhub