The Woolard Review

The Woolard Review on unsecured credit was launched at the end of Chris Woolard’s tenure as Interim Chief Executive, and it makes 25 recommendations to improve the unsecured credit market in the UK. The headline and most urgently acted recommendation in the review was to bring ‘Buy Now Pay Later’ (BNPL) credit under FCA regulation, a market that has more than trebled in size 2020.

However, the regulation of BNPL is of relatively little consequence to credit unions compared to the rest of the review’s recommendations. The report also raises the issues of:

• Liberalisation of credit union activity
• Lowering costs of mainstream credit serving the sub-prime market
• Wage advances to employees
• Suitability and cost of insolvency solutions
• Forbearance in relation to Covid-19
• Role of the credit information market
• Affordability & repeat lending
• And more

Considering the resource constraints on the FCA, particularly in light of Covid-19, the review suggests that a programme of reform needs to be put in place and it is clear that the FCA will need to prioritise as it has done with Buy Now Pay Later. As credit union lending is almost exclusively unsecured, this review has the potential to be the most significant (it is certainly the most wide-ranging) FCA intervention for credit unions since its formation in 2013. In the briefing below we are going to highlight the areas that have direct relevance for credit unions and outline some of the risks and opportunities these present.

Key areas

Alternatives to high-cost credit

Credit unions

Credit unions are directly referenced as providing an alternative to high-cost credit, and the FCA usefully cite and support the need for reform of the Credit Unions Act 1979 to expand the range of services that credit unions can offer. This is an interesting position for the FCA to take in 2021 as the need for reform, and subsequent ABCUL lobbying activity was borne out of the FCA seeking to block credit unions from undertaking certain activities, starting in 2016. Nevertheless, the FCA’s eventual support to remove these restrictions of their own making is welcome.

However, the FCA muses that a two-tier regulatory system should be created for credit unions. Those credit unions which wish to be ‘primary financial institutions’ (i.e. those who would offer a wider variety of services) could face more stringent regulatory requirements which smaller credit unions or those wishing to offer a simpler range of services would not need to meet.

We have seen two-tier regulation systems before, and you may be familiar with the old Version 1 and Version 2 categories of credit unions which were abolished in 2016. To ascend from Version 1 to Version 2 a credit union needed to complete a lengthy application process to gain access to slightly more complicated business activities. The Prudential Regulation Authority felt that this process only provided a ‘snapshot assessment’ of the credit union’s ability to manage the risks associated with such activity, whilst for the credit union sector, the application process was onerous and presented a disproportionate barrier for credit unions only interested in a subset of the powers granted by Version 2 status.

The ‘additional activities’ regime which replaced two-tier system is more flexible, allowing credit unions to opt-in to new activities at any time, in exchange for meeting new ongoing requirements tailored to the specific new additional activity being carried out. We much prefer this model and will push for this kind of flexibility should a new two-tier system be proposed.

Overall, this is a reasonable starting point considering the FCA could have proposed new requirements for all credit unions in exchange for potential rather than actual widening of credit union services. It is also worth noting that credit unions offering general insurance products will have different risks and challenges compared to those offering conditional sale agreements for car financing and there is no reason for these to be regulated identically.

Mainstream

Credit unions are covered above but are not the only alternatives to high-cost credit cited in the Woolard review. The review suggests that mainstream credit providers should be encouraged to operate at the sub-prime end of the market, and that consumer choice and outcomes are likely to remain limited without mainstream options. Woolard continues, that mainstream economies of scale and expertise is the only way to drive innovation and competition within the market.

Naturally, this measure could have the effect of increasing competition for credit unions and making for a more difficult trading environment with lower margins. On the other side, are the barriers to banks serving the sub-prime market solely regulatory and reputational as the review suggests? It could also be argued that banks are already engaged with the unsecured sub-prime market to the extent that they want to. Banks will generally consider unsecured loans as low as £1,000 at rates where credit unions are often competitive. For smaller amounts, banks have credit cards and arranged overdrafts for those with reasonable credit scores and unarranged overdrafts for those who do not.

Aside from tighter affordability assessments, there are no additional regulatory requirements for serving the sub-prime market and the reputational question is not fully within the FCA’s control. The likely barriers are risk, cost, margin, and quality of assets related. However, we will monitor this area, and we would want to thoroughly assess the impact and fairness of any significant changes to regulation to encourage mainstream lenders into the sub-prime market.

CDFIs

Alongside credit unions CDFIs are also mentioned and one of the review’s recommendations to to explore the ways to increase the lending capacity of CDFIs through, for example, subsidies or the development of investment incentives. However, the review also states that the “effectiveness of CDFIs to address the gaps in demand is limited”, and that they need to balance sustainability, with their high operational costs while ensuring their interest rates remain below that of high-cost credit providers. As you may be aware, several CDFI’s provide credit at interests above what is considered by the FCA as ‘High-Cost Short-Term Credit’ but are exempt from requirements aimed at high-cost lenders due to their community lender status.

New entrants

The review believes that there are several barriers to entry for commercial providers of alternative credit. These are:

• Securing the necessary funding as investors are nervous about regulatory uncertainty and the penalties for accidental non-compliance
• Reputational risk of offering anything other than low-cost mainstream products due to the negative impact on the wider brand
• Lack of economies of scale and the higher costs of lending to sub-prime consumers, especially where small sums are being lent, it is not profitable to encourage entry from commercial firms without interest rates comparable with high-cost credit.

The review states that the first two are based on perceptions and regulatory uncertainty. A key issue is the Financial Ombudsman Service’s judgements on affordability and the huge amount of FCA activity in this area against bad actors. Again, the review sees more merit in mainstream banks extending their services into this area rather than encouraging new companies or growth of existing alternative credit due to the better economies of scale available to mainstream providers.

Insolvency

The review discusses the impact of Covid-19 and the large increases in demand for debt advice and insolvency in the short to medium term, the FCA estimates that a further 1-1.5 million demand for debt advice sessions. The FCA believes that its action on forbearance and an additional £37.8 million for debt advice in England and £5.9 million for the devolved authorities means that the debt advice sector should be able to cope with this demand, but it will be tight.

The review also touches on the unfairness around how free debt advice is funded, with only the financial services sector compelled to fund advice, whilst utility companies and local government which are responsible for much of the increased demand on debt advice are not required to contribute anything. Unfortunately, the review stops short of recommending further sectors to be compelled to contribute to the debt advice levies which fund the free advice sector.

More positively, the review highlights ABCUL’s, and other stakeholders’ view that there are real failings within the debt instruments which are not regulated by the FCA, i.e. IVAs and Protected Trust Deeds (PTDs). The FCA has understood that the message is that the IVA market is broken, the high level of upfront fees and commission along with the increased failure rates of IVAs has led to poor outcomes for both consumers and for creditors. The FCA states that free and more holistic debt advice providers are now being crowded out by unregulated lead generators making it harder for consumers to find the best debt advice for their needs.

The review makes three recommendations in this area. Firstly, that the FCA should coordinate with the UK government, devolved administrations, and insolvency regulators to ensure that debt solutions best serve those in financial difficulties.

Secondly, to work with the multiple regulators covering different aspects of debt advice to remedy the issues that can be observed in the IVA and PTDs. Whilst this falls short of the FCA taking IVA’s into regulation themselves, we hope their direct involvements leads to a greater understanding and knowledge of the bad practices of some IVA firms which if not improved upon can only further add weight to the argument for direct FCA regulation in this area.

The third insolvency recommendation is to help the poorest debtors overcome the £90 cost of a DRO. The review proposes that the government provides an emergency fund on a means-tested basis to cover these costs or look to amend, reduce, or waive the fee. In principle, these measures should not be objectionable, those people who are unable to find this relatively small sum would be unlikely to make significant payments to creditors. Particularly in the wake of the crisis, it might be preferable to provide an individual 12 months to see if their situation improves under a DRO rather than be locked into an IVA where payments to creditors are severely diminished by the high fees charged for the arrangement.

Covid-19

During the review, the FCA considers their actions in ‘masking’ short term difficulties on consumers credit files as a response to the pandemic. FCA admits that whilst minimising the impact of a situation out of consumers’ control was generally positive, the method used was necessarily blunt due to the need to act quickly.

The review acknowledges that this intervention has created problems as firms are less willing to lend as they no longer have the full picture of the consumer. A recommendation in the review is to assess the FCA’s approach here and whether a more nuanced approach could be taken towards reporting forbearance and longer term Covid-19 related difficulties.

Role of the credit information market

The review highlights issues with the availability and quality of credit information, noting that under the current system, lenders may need to access more than one Credit Reference Agency (CRA) to see all the given information for a borrower. Respondents to the review called for greater consistency and transparency of the credit information market.

The review also cites the fact that lenders reporting into a CRA is entirely optional and questions whether making this mandatory would improve consumer outcomes. The reviews suggests that such a change may lead provide lenders more data whilst encouraging CRA’s to compete on the quality of data analysis.

The accessibility to Open Banking to community lenders is also discussed noting that many will not have the in-house expertise to analyse the data available from Open Banking and therefore will require effective and affordable tools. They also note that consent is needed and consumers’ hesitancy to provide this consent may be barrier to fulfilling Open Banking’s full potential.

Briefly covered in the review is another potential alternative source of data i.e. data from government sources such as HMRC data, DWP benefits data, council tax or student loan repayment history. However, the review states that there is no plan or provision to allow lenders access to these datasets and does not make a recommendation in this area. The recommendations instead focus on possible mandatory reporting to CRAs and addressing barriers to Open Banking data use.

Credit Builder Products

The review briefly touches on credit builder products common in the credit card market but mentions that this is also applicable to loans. The review states that these are advertised as supporting consumers to improve credit scores and transition to cheaper forms of credit however some respondents to the review doubted the effectiveness of these products i.e., whether these improved credit scores and if access to lower cost credit was being enabled.

The FCA balances some consumer group opinions that these products are a ‘gateway to debt’ and its own Credit Card Market Study which did not identify any specific harms unique to these products. The FCA however states that as many people are specifically choosing these products as credit builders that it is vital that they are effective. The review makes a couple of recommendations:

• The FCA should conduct work to identify whether ‘credit builder’ products currently in the market are effective in supporting consumers to access a wider and cheaper range of credit products. If these products are not found to be effective, they should take steps to limit the use of terms like ‘credit building’.
• Include a theme on a future cycle of the FCA’s ‘Regulatory Sandbox’ (a regulatory test environment for new or innovative products) on products which support consumers to transition from high to low-cost credit and increase their financial resilience.

Consumer Awareness

The review makes two recommendations in this area. First, to increase the awareness of alternative products, by working with Fair 4 All Finance to identify and address barriers preventing consumers from having a better awareness of alternative products.

Second, the review recognises the changes and innovation in illegal money lending, including through online platforms and recommends that the FCA works with the English, Scottish and Welsh Illegal Money Lending Units.

Innovations in the unsecured credit market

This section of the review focuses on Buy Now Pay Later (BNPL) lending which the FCA proposes to bring into regulation, but we will focus on the potential intervention into Employer Salary Advance Schemes (ESAS) which has much more relevance for credit unions, particularly those which offer payroll deduction services.

According to the review, ESAS is still in its relative infancy and is currently being provided by a small number of firms to large employers in the hospitality, retail and healthcare sectors. ESAS allows employees to access some of the pay they have already earned before their regular payday, usually charging a fixed fee for the service around £2 per withdrawal. The amount of the salary which can be withdrawn is usually capped at 50% and the sum is deducted from employee’s salary that pay cycle.

ESAS operate entirely outside of credit regulation as the early payment of the wages does not involve the provision of credit. Neither ESAS providers or employers are required to conduct affordability assessments and employees are unable to refer complaints to the Financial Ombudsman Service (FOS).

The review suggests that the FCA closely monitors the use of such schemes and encourage ESAS providers and major employees to draw up a code of best practice which could then be formally recognised by the FCA. Of course, this fall short of FCA regulation which we feel may be necessitated in future. As the FCA rightly points out, where some of these providers are also offering credit, there are conflicts of interest at play and as none of the activity is reported to CRAs, even if someone is consistently drawing down half of their wages before each payday cycle.

Further, we hold that aligning each repayment with the payday cycle was a major part of the problem that payday lenders posed. As extortionate as interest rates were, a key part of their problem was that if someone was unable to find both their living expenses and a particular sum from one pay cycle, they were also unlikely to be able to find it from the next pay cycle (assuming that they are paid the same and their expenses are the same) after charges. This created a perpetual cycle of debt, that people were unable to recover from.

We believe that ESAS have the potential to cause harm, and the relationship between ESAS and regulated credit providers (potentially offering their services once an employee’s attempts to manage their finances through a ESAS fails) should be closely monitored by the FCA.

Affordability

Whilst credit unions are not subject to the affordability under the Consumer Credit Act for the vast majority of lending, affordability is nonetheless an issue of growing concern and relevance for credit unions. The review states that affordability assessments will always be of critical importance, however, affordability needs to be considered over the life of the customer journey and not just the beginning.

The review throughout stresses that an outcomes-based approach should be taken towards regulation and therefore rejects the calls for more prescriptive minimum requirements for affordability checks which should be carried out. On the other hand, some respondents have stated that uncertainties around how affordability assessments should be carried out and potential future FOS complaints have acted as a barrier towards firms lending to or investing in non-prime lending.

The review feels that the FCA and the FOS already coordinate to ensure that their activities are aligned and cite a joint public meeting held last November where the FCA and FOS aimed to provide greater clarity to firms as well as ‘myth-busting’ around how complaints are handed. The review’s recommendation here is to reduce the ‘perception’ of disjointedness between the FCA and the FOS and regulatory uncertainty around affordability.

Repeat lending

The review highlights how recent FCA rules on credit cards and overdrafts tackle persistent debt. Whilst the consumers may have been able to afford the minimum interest repayments in the case of a credit card the FCA felt that consumers were stuck with expensive debt with no clear route of paying it down.

Several respondents to the review raised that there are significant numbers of consumers repeatedly taking fixed term loans in a manner comparable to using a revolving product. In August 2020 the FCA published a supervisory investigation into relending the high-cost sector which found similar issues to those in overdraft and credit card markets.

The review recommends a review of relending and consider the outcomes of repeat lending and persistent debt across all products. It should look at whether additional protections or guidance are needed around relending of fixed-term loans to achieve these outcomes in light of the FCA’s previous work on relending in high-cost credit.

This could have ramifications for credit union top-up loans and other products, should the FCA produce new regulations or guidance affecting credit unions directly, or indirectly as we have seen with affordability requirements through the FOS and general expectations. This is a move beyond affordability, considering cases where the debt is affordable considering but there does not appear to be a plausible path out of debt for each repeat borrower.

Conclusion

The Woolard Review is extremely broad and far reaching and it will take time to work through the entire list of 26 recommendations – some of which will require further review and consultation before any regulatory intervention is tabled. Whilst the headline of Buy Now Pay Later regulations is clearly the FCA’s top priority it is the medium to long term interventions that pose the most risks to credit unions and the products they currently offer.

As ever, ABCUL is continually monitoring all regulatory developments related to credit unions. If anything, this review provides a probable roadmap for FCA activity for at least the next 5 years in the market which credit unions carry out most of their lending activities. ABCUL is already across many of these areas such as affordability where we are working with our membership and external expertise to identify where best practices might be employed by the sector and areas of greater risk for credit unions.

If you have any comments or questions about the Woolard Review please contact us at policy@abcul.org