Speaker: Jonathan Davidson, Director of Supervision – Retail and Authorisations
Location: Nottingham, Consumer Credit Trade Association Conference 2018
Delivered on: 1 November 2018
Note: This is the text of the speech as drafted, which may differ from the delivered version.
- The consumer credit sector has demonstrated a lot of positive change in recent years. Nonetheless, regulatory change will continue as long as we continue to find evidence of considerable harm to consumers.
- Consumer outcomes are driven by the purpose underlying a firm’s business model and culture. A firm with a good purpose will perform a stocktake of all their business activities and product lines and eliminate anything that is not consistent with their purpose, even activities that are profitable.
- Leadership is vital in ensuring a firm’s purpose is the right one and setting the tone for the rest of the organisation. Defining culture is much more than a box-ticking, compliance exercise.
Thank you for inviting me to speak today at the CCTA 2018 Conference on Leadership in a Disruptive World.
Leadership is at the heart of what I’d like to talk about today: culture. Specifically, cultural transformation in financial services and how to move beyond a compliance mindset. The Senior Managers and Certification Regime (SMCR), is coming into effect for all FCA solo-regulated firms next December, and the main objective of the regime is culture change.
The main objective of my remarks today is to provide a sense of what culture change would be good. Good for consumers, good for employees and good for firms.
But first, let’s reflect on the current ‘state of the nation’ in consumer credit and the challenges the sector faces in delivering good consumer outcomes.
State of the nation
Your sector is important to the consumers of this country. You serve nearly 40 million people and you are a part of everyday life for the vast majority of Britain – whether it is through credit cards, car finance, small business credit or short-term loans to tide people over.
How is your sector evolving? We are seeing rapid, extraordinary and positive change. Since I joined the FCA 3 years ago, this sector has made immense progress in offering UK consumers better outcomes. Many of the debt traps that consumers could have easily fallen into a few years ago no longer exist. Many firms have significantly enhanced their approaches to affordability and as a result are making better-informed decisions about whether a loan is affordable. Altogether, I would assert that the sector has become a safer place for borrowers.
Regulatory change will continue in high-cost credit markets as long as we continue to find evidence of considerable harm to consumers which flows systematically from business models.
Progress has been made but there are still challenges. We must consider what the credit landscape will look like in future. And more importantly, we must consider harm that could potentially emerge.
Most consumers that depend on your services can comfortably afford their credit. Nonetheless, at any given time a changing group of your borrowers will fall into the category of vulnerable consumer. The ‘vulnerability landscape’ is forever evolving; vulnerability can strike at different times and for different reasons.
Those employed in the gig economy are often vulnerable due to unpredictable cash inflow. While short-term borrowing can be a short-term fix for them when they need extra cash to make ends meet, we must also remain cognisant of the relative unreliability of gig economy work.
Young people are increasingly vulnerable due to the rise in student borrowing and the climbing cost of getting onto the housing ladder.
Many are vulnerable to interest rate rises and interest rates are starting to rise. For example, we must keep in mind that an unaffordable increase in mortgage payments will have an immediate impact on a consumer’s ability to pay their consumer credit debt. This is something for firms to take into consideration when performing affordability checks.
What these examples of potential harm have in common is that they flow from the interaction of the evolving landscape with the business models of firms. So I will turn next to business models and the leadership challenges they pose for you and the supervisory challenge for me as a regulator.
Business models and the consumer endgame
You are also facing some uncertainty around change and regulation. Indeed, I see that the agenda today includes panels on affordability and creditworthiness and the Financial Ombudsman Service (FOS) and Claims Management Companies (CMCs). I will come back to this topic shortly.
You might ask, as many do, when the regulatory change will come to a halt.
Regulatory change will continue in high-cost credit markets as long as we continue to find evidence of considerable harm to consumers which flows systematically from business models. Monday’s Budget suggested the need for further reforms in the consumer credit sector. I’m certain you will be considering the potential impacts of Philip Hammond’s proposals to extend the ‘breathing space’ period for those experiencing problem debt from 6 weeks to 60 days and his announcement of a feasibility study on a government-backed, zero-interest loan scheme.
At the FCA, we continue to work on tailored solutions to address the issues we detected in our high-cost credit review, including problems in overdrafts, rent-to-own and other sectors. We will announce more on these solutions before the end of the year.
We see far greater value in detecting and preventing harm proactively than in fire-fighting after harm has occurred and administering redress for customers and punitive outcomes for firms. We’ve tailored our approach into identifying the features inherent to a firm’s business model and culture which may drive harm. I think that the role of leaders in this industry is to do the same – to think about the consequences and risks of your firm’s strategy and business model.
What might that reflection reveal? A couple of examples.
Let’s take the topical example of repeat borrowing. A recent Daily Mail article was titled ‘I borrowed £100 for a night out and ended up owing £19,000’. The article described how high-cost lenders approved ever-increasing loans despite the ‘overwhelming’ debt the customer faced. Though perhaps an extreme example, it is illustrative of the fact that affordability checks weren’t working.
But what about the hypothetical case of a customer who I will call Becky. Becky has taken more than 100 payday loans of £100 each over the last few years. Becky has been exemplary in paying back every loan in full plus £24 in interest before re-borrowing. However, the reality for Becky is that Becky is now into a cycle where only a few days can elapse between her paying off a loan and needing to take a new loan. Although this lending might be highly profitable for the lender, and Becky has paid down each loan as it came due, what kind of consumer endgame is being facilitated by the business model here?
If we reflect on this arrangement, I’m less interested in whether each of these loans is technically compliant with the various rules and regimes. Although the rules are important, I’m interested in whether this arrangement is sound from a common sense, consumer outcome perspective. It seems to me as though Becky is falling deeper and deeper into a situation in which she cannot afford to live a few days without taking another loan. I don’t think the person on the street would agree that this is a case of a payday loan fulfilling its purpose, to get consumers out of the rare tough spot.
This autumn, the Financial Ombudsman ruled on a couple of cases similar to Becky’s. The Ombudsman upheld the borrowers’ complaints, which argued that the loans were unaffordable and the lender should not have issued them. The Ombudsman ruled that the lender should have recognised the emerging pattern of unsustainable debt and the various ways this would result in detriment to the borrower.
What would your employees say they feel is the driving purpose of your firm?
We don’t know how prevalent this business model might be. So, following these Ombudsman rulings, we wrote a letter to approximately 150 CEOs of high-cost short-term credit firms, in which we asked firms to consider whether there are recurring or systemic problems in their provision of a financial service. If so, we asked firms to consider what customer detriment this may have caused and whether proactively undertaking a redress exercise would be the right thing to do.
Another thought-provoking finding on business models and the consumer impact came out of our high-cost credit review on overdrafts. We found that the distribution of overdraft charges is such that a tiny minority of consumers, 1.5% to be exact, pay the majority of overdraft fees. Many of these are likely to be vulnerable customers. Do we consider this business model to lead to a satisfactory endgame for consumers?
We know there is always the risk that poor consumer outcomes can happen on a one-off basis due to unforeseeable circumstances, despite a firm having taken all reasonable steps. However, when this is happening systematically we must ask the question as to whether this is an acceptable business model for consumers, and whether the business model is being promoted by an unhealthy culture.
How do you think about your firms’ business models and consumer outcomes? What is the endgame of your firm? What is the endgame for your customers? What would your employees say they feel is the driving purpose of your firm?
Culture – a healthy culture or a compliance culture?
This brings me on to culture. I’ve said before that culture in a firm is, in simple terms, ‘the way things get done around here’.
There was a time when a good culture was a luxury in comparison to a competitive strategy. In this respect, the financial services industry is changing. I’ve seen a tangible mindset shift in industry leaders – many of them are telling me that, in their view, defining and managing a firm’s culture has become as important as strategising. Leaders are taking ownership of their firms’ cultures. Leaders are reflecting on the purpose and business models of their firms. Leaders are making culture a competitive advantage.
So what kind of culture are these leaders coming up with?
We don’t plan to tell you what kind of culture you should have. These leaders emphatically do not see culture as just a compliance exercise. For them it is fundamental and there is a growing consensus that a purposeful culture in which everyone is encouraged to contribute is healthier for long-term endgames.
In these healthy cultures, leaders are fostering an environment in which employees feel comfortable speaking up; diversity is valuable and valued; curiosity, reflection and experimentation is encouraged; people feel ‘listened to’. In these healthy cultures, there is a lot less fear and blind obedience, and, importantly, questioning the status quo doesn’t result in retribution.
In these healthy cultures, firms are not promoting themselves through misleading adverts and employees are not forced to face the moral dilemma of selling a product that they know is riskier than advertised.
And in these healthy cultures, sexual harassment or assault is not swept under the rug, leaving perpetrators to believe that they can get away with it again and leaving victims feeling unsafe.
Leaders emphatically do not see culture as just a compliance exercise, it is fundamental and there is a growing consensus that a purposeful culture in which everyone is encourages to contribute is healthier for long-term endgames.
I think there is an underlying theme to all of this, and that is purpose. We tend to overlook the gravity of a firm’s purpose. It’s not often that we question the core purpose of a bank, an insurance company, an asset manager, a loan company. But a firm’s purpose is its driving force.
I’ve seen firms where the purpose is ‘we want to serve our customers with integrity’ and I’ve seen organisations where the tone from the top is ‘take no prisoners, we’re here to make money’. And I have seen a lot of firms whose purpose seems to be ‘let’s pursue our strategy but make sure that we are compliant with the rules’.
For example, we are currently performing a thematic review of the debt management sector. What we are finding is that it is a bit of ‘A Tale of Three Cultures’.
Some firms exhibited a desire to help customers and we could see a clear link to positive customer outcomes. These are the firms that are getting it right. These tend to be the firms who take it upon themselves to understand the unique needs of each customer. These firms routinely review their customers’ debt management plans and tailor solutions for vulnerable customers.
A very small number of firms appeared either to be trying to make easy money from a vulnerable population or consciously overcharging customers. You can imagine the consumer outcomes there. In a couple of cases, firms demonstrated a flagrant disregard for systems and controls; they have been referred for investigation. These firms aren’t getting it right, but they also aren’t trying to get it right. Thankfully they are few and far between, but they fundamentally seem to believe they can get away with making money off of misconduct.
And then there are the firms that are hell bent on simply being compliant with the rules. These firms focus a lot of time on box-ticking, but are still slipping up on a conduct front from time to time, because the common purpose to do the right thing is lacking. My concern with this kind of culture is that it leads to a lot of mistakes, because staff don’t appreciate what’s trying to be achieved through the rules. Despite the presence of large, fear-driven compliance departments, these firms may still be missing the mark.
The firms with a clear sense of purpose had a much better record of ‘getting it right’.
A firm with a good purpose, one that strives for positive consumer outcomes, will perform a stocktake of all their business activities and product lines and eliminate anything that is not consistent with their purpose, even activities that are profitable.
Examples of good purpose can increasingly be found in the credit sector. There are a number of types of organisations which successfully combine social and community purposes with commercial viability. This can be by providing loans to the financially excluded, as Community Development Finance Institutions do. There is nothing to say that a good purpose can’t be good business.
Accountability and the role of leadership
Purpose and leadership are the chicken and egg of culture. Did the leaders set the purpose or did the purpose drive the selection of the leadership? Whichever way you look at it, leadership is vital in ensuring a firm’s purpose is the right one and setting the tone for the rest of the organisation and putting in place systems, controls, governance and training, and incentives to drive them through.
This is why leadership is one of 3 key components of the SMCR. The SMCR requires firms to define exactly what each of its senior managers is accountable for. But even more important than clarity of accountability, we expect senior managers to take reasonable steps to ensure that decisions made by the people that they lead are appropriate.
Reasonable steps is a legalistic phrase so I’ll translate it for all of our benefit. You are not just accountable for your own actions but – to a reasonable extent – for those who work for you. In my mind, this defines the role of a leader. Be clear on what is acceptable behaviour in your area, and satisfy yourself that you have sufficient governance, controls and transparency to ensure the right behaviours and outcomes.
We often talk about having an effective risk management framework; what does this mean for leaders? Strong leaders reflect on all of the ways things might go wrong, make sure that there is some way of knowing if it is going wrong and put mechanisms in place to stop it going wrong.
Of course, we’ve spoken a lot about what we expect of our leaders. But the Senior Managers and Certification Regime’s second key component goes to the culture of all individuals working in financial services. How? By setting 5 Conduct Rules which are minimum standards for behaviour. I think of the Conduct Rules as a Hippocratic Oath for financial services, so consumers can expect a level of professionalism from their financial services providers.
These rules are:
- you must act with integrity
- you must act with due care, skill and diligence
- you must be open and cooperative with the FCA and other regulators
- you must pay due regard to the interests of customers and treat them fairly
- you must observe proper standards of market conduct
Purpose and leadership are the chicken and egg of culture. Did the leaders set the purpose or did the purpose drive the selection of the leadership? Whichever way you look at it, leadership is vital in ensuring a firm’s purpose is the right one.
The final major component of SMCR is the Certification regime, which puts the onus on firms’ leaders, including many of you here today, to really think whether people in key positions are up to their jobs.
Again, this is not a tick-box requirement. This is thinking deeply and regularly about their capabilities. Are they trained and fit for purpose? Are they keeping up with the changing needs for capabilities? For example, are they keeping up with the ever-growing challenge of cyber risks and data protection requirements?
I have talked about the importance of purpose, leadership, accountability and capabilities in driving a healthy culture. Finally, I want to address the role of incentives. They are important – as we found in last summer’s thematic review of staff incentives in consumer credit. And again it was a story of 3 cultures. Some firms purposefully incentivise staff to act in a customer’s best interests. Some firms look at the risks of customer detriment and apply systems and controls to manage the risks.
However, a high proportion of firms operated high-risk incentive schemes with little awareness of the risks driven by these schemes and inadequate controls to address them. We also published some guidance, with examples of good and bad practice. Many of these examples are very compelling. For instance, we describe a firm in which a lender paid staff a flat commission on any loans they sold, but only if the loan value was above a set amount. If customers requested a loan for less than this amount, staff might attempt to qualify for commission by using high-pressure selling to increase the loan value.
I would rather that firms reflected on their purpose and ensured that everything in their firm including incentives embodied that purpose. Failing a purposeful approach I would like firms to think for themselves about the risks and put in place appropriate controls. And finally, failing even a risk-based approach, I think we have to put in place rules and guidance. So, in the case of incentives, we have since updated CONC, our Consumer Credit Sourcebook, to require that firms establish, implement and maintain adequate policies and procedures designed to detect risk arising from remuneration arrangements.
In the current environment, I ask you, leaders in consumer credit, to pause for a moment of self reflection on the business models and the cultures of your firms. We are not going to demand that you adopt any particular strategy or culture. But I think there is a lot to be said for a purposeful culture which is about the outcomes for consumers not just about compliance with rules and box-ticking.
After all, as we’ve seen, the FOS does not have a box-ticking mindset. The FOS adjudicates on the basis of whether firm actions are fair and reasonable, which is not to say that this is inconsistent with our rules, it’s just about much more than the strict interpretation of the rules.
You are leaders and we expect you to exercise leadership over your business model and your culture.
Consumer credit has played, and will continue to play a crucial role in the economy of this country – let’s work together to ensure that this sector keeps Britain’s consumers front and centre.