FCA Consultation Paper 14/10 – proposals for a price cap on high-cost short-term creditPrint publication
The FCA yesterday published the above Consultation Paper (CP) which sets out its intended approach to the implementation of a price cap for HSTC. Such a cap is due to come into effect from 2 January 2015 and will apply to all loans that satisfy the following definition:
A regulated credit agreement:
- which is a borrower‑lender agreement or a P2P agreement;
- in relation to which the APR is equal to or exceeds 100%;
- in relation to which a financial promotion indicates (by express words or otherwise) that the credit is to be provided for any period up to a maximum of 12 months or otherwise indicates (by express words or otherwise) that the credit is to be provided for a short term; or
- under which the credit is due to be repaid or substantially repaid within a maximum of 12 months of the date on which the credit is advanced;
- which is not secured by a mortgage, charge or pledge; and
- which is not:
- a credit agreement in relation to which the lender is a community finance organisation; or
- a home credit loan agreement, a bill of sale loan agreement or a borrower lender agreement enabling a borrower to overdraw on a current account or arising where the holder of a current account overdraws on the account without a pre-arranged overdraft or exceeds a pre-arranged overdraft limit
The CP has regard to the provisional findings of the Competition and Markets Authority (CMA) in its investigation into the Payday Lending Market. Responses to the CP are requested by 1 September 2014.
Purpose of Note
This paper picks out key points of note from an initial consideration of the CP.
The Price Cap
The price cap which the FCA proposes contains three elements. These are:
- An initial cost cap when loans are taken out or rolled over which means that interest and fees charged must not exceed 0.8% per day of the amount borrowed
- If borrowers default firms may not charge more than £15. Firms can continue to charge interest after default but not at a higher rate than the initial rate
- An overall cap of 100% which means that a borrower can never pay back more than 100% of the amount borrowed in terms of interest and charges.
The CP makes clear that the cap applies to initial loans and to loans that are rolled over with the new loan being treated in exactly the same way as the initial loan. Thus a £100 loan which is topped up by £20 becomes a £120 loan subject to the initial cap, the default fee cap and the overall cap.
In terms of what is included in the cap the following paragraphs of the CP are noteworthy:
Application to brokerage, debt collection charges and other ancillary charges
5.69 The price cap applies to any brokerage charges where the lender receives all or part of the brokerage charge and also where the broker is a member of the lender’s group.
5.70 Debt collection charges made under the terms of the loan agreement are also included in the cap, including where a third party debt collector levies a direct charge on the consumer.
5.71 The price cap also applies to charges for ancillary services, such as services related to processing the application, the transmission of money lent and insurance or insurance like services. This is necessary in order to avoid the risk of gaming the cap through ancillary services.
The FCA also signals its intention to enforce the cap vigorously. It says:
6.4 We consider that there should be an incentive on firms to ensure they comply with the price cap and that firms should have adequate controls in place to ensure they do not charge the borrower more than the price cap.
6.5 We have the power to make agreements unenforceable if they are in breach of the price cap.
6.6 We are proposing that we exercise this power, so that any agreements in breach of the price cap are irredeemably unenforceable against the borrower. This will mean that:
- Firms will not be able to apply to court and seek a court order (or an order from the FCA) that the agreement, or parts of it, is enforceable.
- Generally, the whole of the agreement will be unenforceable, not just the portion of the agreement in breach of the price cap.
- The consumer under an agreement which breaches the rules can elect not to perform the agreement (i.e. not to repay the loan with charges), and if so the lender has to repay all charges but the consumer has to repay the loan.
6.7 One effect of our rule is that the use of repayment obligations (including the use of CPAs and direct debits) imposed in relation to debts arising from agreements in breach of the cap are unenforceable against a debtor.
6.8 We will take breaches of the price cap very seriously. This is reflected in our decision that it should be subject to an unenforceability provision.
Effect on Competition
The FCA accepts that its proposed cap may reduce the number of on-line HCSTC providers to only three and High Street lenders to one. The CP states that:
Our modelling shows that reducing the initial charge element of the cap increases the risk of firm exit, and hence the risk that very few firms remain in the market. The modelling suggests that at 0.8% the three largest online firms will be able to continue to offer high‑cost short‑term credit, and that it is possible that one high‑street firm may be able to operate. Importantly, these impacts do not reflect firm responses to the cap, which would be expected to limit them. Looking at how price caps have affected other countries, it is difficult to predict how firms may respond. The firms that remain in the market will have some flexibility to choose their pricing structure, and we expect that they will continue to compete on non‑price factors, including speed and convenience.
We expect competition will not be lessened in the future because:
- The cap itself will prevent prices rising, if there is upwards pressure due to the oligopolistic nature of the online market in future.
- We expect the degree of non‑price competition will not be lessened, on the basis that we expect consumer demand to continue to focus on the non‑price aspects of product offerings (such as the speed of access to funds) in the future.
- Forthcoming CMA remedies will tackle the currently limited degree of price competition that takes place, resulting in potentially greater price competition in the future.
5.29 In practice we may expect the number of online firms that continue to operate to be greater than implied by our static exit analysis, following changes to business models. For the high street, predicting the number of lenders that will continue to operate is subject to particular uncertainty. If a single high‑street supplier remained, we believe online providers would provide a competitive constraint, and the cap itself would provide a degree of protection for high‑street consumers. However, the extent to which (some) high‑street customers are able to switch online is likely to be limited. Currently, the CMA estimates that 12% of consumers use both online and high‑street lenders. Our own data shows that for those consumers whose first use of HCSTC was through a high‑street lender in Q1 2012, 24% subsequently use an online provider.
5.30 This competition assessment applies to the cap as a package (including a default cap and total cost of credit cap, as well as the initial cost cap shown here).
Effect on Consumers
According to the FCA the effect of the cap will be that 11% of consumers will be denied access to HCSTC. In terms of the impact that this will have on those consumers’ access to credit the FCA view is:
15.15 At a 0.8% initial cost cap, we estimate that a substantial number of consumers will lose access to HCSTC – approximately 11% of consumers who would otherwise be served, around 160,000 individuals. Our assessment of the impact of losing access to HCSTC is therefore critical to the judgement about the level of consumer protection that the 0.8% initial cost cap affords.
5.16 We conclude from the results of our consumer analysis that loss of access will benefit those borrowers who currently only just qualify for HCSTC (i.e. those borrowers with the lowest credit scores). These consumers have a high risk of late or non‑payment (on average, greater than 40%) and an increased risk of other negative outcomes (defaulting on non‑HCSTC and exceeding overdraft limits). For those with higher credit scores, the costs and benefits of using HCSTC becomes increasingly finely balanced to the point where the risk of negative outcomes diminishes to the extent that these borrowers will benefit from continuing to access credit at a lower price.
4.40 Our survey results and CRA data analysis show consumers have limited other options for accessing formal credit. The CRA data analysis finds no substitution to other formal sources of credit for those who are denied loans apart from a small increase in the frequency that consumers go over their overdraft limit in the month of application (which then becomes a decrease of the same magnitude that persists from month three onwards).
The cap on default charges does not mean that £15 becomes the norm. The FCA makes this clear:
5.41 Our rule will still apply that requires firms to limit their charges to reasonable costs. Therefore the cap would be a ceiling and firms may need to make lower charges.
Real Time Data
The FCA reaffirms its support of real time data:
5.77 We also see the benefit of real‑time data sharing to enable firms to carry out more accurate affordability assessments and to prevent consumers from taking on multiple loans which they cannot afford to repay. Currently firms cannot be sure that they have an up-to-date picture of a consumer’s outstanding HCSTC commitments even if they are using a CRA check. There has been progress, but the industry must do more. We expect the vast majority of firms to participate in real‑time data sharing by November and to share data with more than one CRA. By vast majority we mean more than 90% of the current market. If we do not see sufficient progress by November, or CRA coverage does not improve, we will consult on the introduction of data sharing requirements.
Basis for cap idea
When HMG announced the cap would be introduced it referred to “evidence” from Australia. The FCA say that:
we found that the evidence from other countries on the impact of caps on consumers is ambiguous and does not necessarily translate to the UK.
Most of the international regulators we spoke to said that they did not empirically test the impact of the cap on consumers. Those who introduced caps more recently, such as Finland and Australia, are planning to do consumer research within or after two years from the implementation of the cap.
Definition of HCSTC
The FCA does not intend to change the definition but will look at products outside:
5.59 We considered changing the definition of ‘short‑term’ to cover a longer period. We are seeing evidence that firms are developing products with loan durations outside our definition which could be harmful to consumers because of the prolonged period of high charges. However, extending the definition of HCSTC to include loans substantially paid back in periods longer than 12 months starts to undermine the principle that the cap should cover ‘short‑term’ products.
5.60 We have considered whether to include other forms of high‑cost credit which are excluded from the current definition (home‑collected credit, pawn broking, log book loans and overdraft charges) and open‑ended running account credit (most of which e.g. credit cards are excluded because they are open‑ended and not substantially repayable in 12 months). We propose excluding these from the price cap for the time being but will keep this under review.
5.65 There will be a market study of credit cards later this year (open‑ended running accounts).
5.66 The Competition Commission market assessment on home‑collected credit has already imposed remedies on this market to improve competition. We will look at these firms in the near future as part of our supervisory engagement.
The FCA also issues a clear warning against any attempt to “game” the system. It says:
Extending loan duration to fall outside the HCSTC definition
6.13 We are seeing the emergence of products which appear to be designed to avoid our definition of HCSTC by extending their loan durations so that they are not substantially repayable within 12 months. We explain in Chapter 5 that we are not currently proposing to extend the definition with regard to duration. Firms will need to demonstrate that products that charge a high interest rate for periods longer than 12 months are affordable for consumers. The affordability assessment must consider the customer’s ability to make repayments over the whole life of the loan. We will need to be persuaded how such payments are sustainable particularly if interest and charges are high. We will monitor market trends to identify if firms are changing the duration of their products to avoid the price cap. We will take action where we see the emergence of products harming consumers.