Compliance in Lending

Many lenders talk about compliance and responsible lending practices, but what do these terms actually mean? While there are slightly different rules and regulations for different types of loans, for the most part, the guidelines are universal. These have been set out by the UK’s financial regulatory body, the Financial Conduct Authority. We’ve explored some of the key compliance regulations within UK lending below:

Who Are the Financial Conduct Authority (FCA)?

The FCA is the regulator for over 50,000 financial institutions and markets across the UK. Their main aim is to ensure that financial markets are fair, honest, and effective. That way, consumers are guaranteed to get a fair deal. In order to carry out certain activities, financial firms must get the approval of the FCA, and be either authorised or regulated by them. Once authorised, firms will have to continue to meet the rules and standards set out by the FCA, or be at risk of having their authorisation revoked.

The Financial Conduct Authority understands that financial services play an important role in our everyday lives. From loans and credit cards to direct debits, you may not realise just how much you rely on the services of the FCA, to keep lending practices fair and compliant.

Why Was the FCA Founded?

The FCA was established relatively recently, in 2013. Previously, financial institutions were regulated by the Financial Services Authority (FSA), but this was split into two bodies in 2013 – the FCA and the Prudential Regulatory Authority (PRA). The latter is still in existence today, mainly focussing on banks, building societies, and credit unions.

The creation of the Financial Conduct Authority was due to the financial crisis in 2008. The government felt that a complete financial regulatory restructure was necessary, in order to prevent further major financial issues.

Prior to the FCA being founded, the financial market was full of mis-sold loans, fraud, and misconduct. This had resulted in billions of pounds of compensation and fines, dramatically affecting the UK economy. The Financial Conduct Authority intended to protect consumers against such malpractice, and hopefully boost the country’s economy too.

Checking Creditworthiness

In order to make sure a credit provider is lending responsibly, the lender has to ensure that they carry out appropriate checks of potential borrowers. One of these checks is assessing creditworthiness. Before entering into an agreement with a borrower, lenders must look at their credit history to get an idea of how they have managed their money in the past.

The simplest way to do this is to look at someone’s credit file. A credit file, or credit report, contains details of any credit an individual has taken out over the last six years, and whether payments were made on time. Regular payments, such as utility bills and a mobile phone contract, are also recorded on your credit file. All of this information can also be used to calculate your credit score which is a number that represents your creditworthiness. Essentially, the higher your credit rating, the higher the likelihood that you’ll be accepted for a loan in the future.

Affordability Assessment

Alongside credit checks, a lender must also look at the affordability of a borrower. They do this by assessing an individual’s income and expenditure. The loan provider will consider how much someone is earning each month, through wages and other means, and then compare that to their outgoings. They need to ensure that the borrower has enough disposable income to make the due repayments and still have some money left over in case of emergencies.

It’s also essential that a lender asks the borrower whether there is likely to be a change in their financial situation throughout the course of the loan. For instance, if the borrower’s hours at work were due to be reduced moving forward, it would be the responsibility of the firm to estimate how much their income would be from that point, and determine whether the loan payments would still be affordable.

It’s furthermore important to note that the lender has to take into account other credit repayments, when looking at a borrower’s affordability. While these payments may be classed as non-discretionary expenditure, they could still include priority debts, such as mortgage repayments.

Treating Customers Fairly

The above checks are in relation to an application for credit. But once a loan has been taken out, there are still guidelines a lender has to follow. These centre around treating customers fairly throughout the entire customer journey. Part of this is about transparency – lenders must make the terms of the loan accessible and straightforward, as well as clearly advertising their interest rates and any relevant charges.

Treating customers fairly is particularly important when a borrower is unable to keep to their original agreement. The FCA handbook states that a firm must treat customers with forbearance in these circumstances. Forbearance could include any of the following:

• Suspending or reducing interest or charges for a short period of time, especially if a customer is able to demonstrate that they are experiencing financial hardship
• Allowing borrowers to defer their payment of arrears, if adding these arrears payments to their instalments would make the payments unsustainable
• Accepting token payments while allowing a customer to recover from unexpected financial changes
• Advising borrowers of free and impartial third parties, and referring them to these debt advisors where appropriate

Overall, in order to be compliant with UK financial regulations, firms must make sure that the loan is affordable for the customer and that they have a good track record of repaying credit. Lenders also have to be transparent about their lending practices and treat borrowers fairly at all times.