The cornerstone of responsible lending
In the consumer finance sector, responsible lending is an important buzzword.
It is now widely accepted that some of the practices once commonplace in the sector were irresponsible, and did not have customers’ best interests at heart.
A quick Google search will throw up countless media stories from a few years ago of unscrupulous payday lenders that were more than happy to lend to individuals despite knowing that they probably shouldn’t, and with little concern for their ability to repay.
Since coming under Financial Conduct Authority (FCA) regulation in 2014, the sector has professionalised and seen many changes. This includes the introduction of an interest rate cap, the reform of collections practices, and an authorisation process that removed the licence of those businesses that did not trade responsibly. At Dollar UK, we were proud to go over and above these regulatory changes by, for example, removing penalty fees altogether.
But as I see it, the most important element of responsible lending is getting affordability assessment right.
In simplest terms, any sort of responsible lending should follow certain basic principles. It should always be about providing consumers with access to the credit they need, but in a manner which is sustainable, and treats them fairly. In order to do this, the terms of the loan must absolutely reflect the realities the consumer faces, and repayments should not present undue difficulty – namely, the customer should be able to make repayments on time, and without recourse to other sources of credit.
From the lender’s perspective, the only way to guarantee your terms are fair, responsive to realities, and won’t present undue difficulty, is by employing robust affordability assessments.
So how does a firm get this right? There are several different processes that must be employed in conjunction, and with genuine sincerity on the part of the lender. Firstly, it’s important to assess affordability based on a calculation of the customer’s income and expenditure, as well as taking into account any circumstances that may indicate a customer’s cash flow will be subject to unexpected change. Of course, predicting unexpected change is difficult, but it is possible to take a view based on employment type or family circumstances.
Secondly, it’s vital to assess intent and likelihood of paying the loan back. For example, a customer may have plenty of disposable income, and easily pass a simple affordability test, but may also have a long history of failing to repay loans on time. They would nonetheless present too great a credit risk, and this should be factored into the decision to lend.
By contrast, a customer who tends to overstate their expenditure or understate their income (for example by excluding income from a second job or overtime), but has always repaid loans on time, could fail a simple affordability assessment but present an acceptable credit risk.
For a lender to get affordability assessment right, in all its complexity, it’s important to assess the circumstantial information as well as the verifiable information provided by the customer, and act in good faith.
This is the cornerstone of responsible lending, because it ensures the provision of credit is sustainable in the long term. It nurtures customers who are not only able to repay, but also have a good track record of repayment – and saves those who would be unable to repay from falling into a cycle of unmanageable debt.
From a corporate perspective, the business benefits from lending responsibly and effectively managing affordability assessment for every loan – because operationally, the business as a whole becomes more focused on loans, rather than debt collection.
We appreciate the value of being able to focus on loans rather than debt collection, as it is a strong indication you’re getting affordability assessment right.
This level of responsible lending is only possible if you are confident your affordability assessments are robust, and non-repayment is just a rare anomaly due to unfortunate circumstances.