Responsible Lending and Affordability

Do you fully understand your target market? Their needs and wants? What characteristics, circumstances and behavioural biases are driving their decision making? This is a key element of complying with the Product and Services outcome under the Consumer Duty, and also key for effectively assessing affordability.

In the second blog of this series, we will be looking at customer behaviour and vulnerability, and how that impacts the responsible lending framework and affordability assessment.

First blog can be read here.

Retail Lending sales are being driven ever more by consumer demand and firms need to compete on overall customer experience as well as price.

In today’s world most customers want instant access to goods and services, and access to consumer finance is no different. If a customer applies for a loan, they expect to know whether it’s likely to be successful right away. This demand for a quick decision can often be contradictory to the regulatory expectation that firms obtain a detailed understanding of the customer’s financial position – unless instant, data-led, automated solutions can be introduced.

Customers also don’t want a highly intrusive process. They don’t always want firms to have access to their bank account transactions and intricate details of their lives. An affordability assessment should focus on income, committed expenditure (e.g. existing creditor commitments) and essential expenditure (e.g. gas and electric) with customers left to manage their own discretionary income.

There are certain customers who will need a more bespoke service, for instance customers with a vulnerability. By making sure that your responsible lending assessment can accommodate those customers firms can ensure those customers still have access to credit without being at risk of harm. The vast majority of customers, regardless of whether they have a vulnerability, will also want the opportunity to speak to someone if the ‘computer says no’.

The need for flexibility in the process also extends to customers who may not be able to demonstrate affordability through an automated or data-led approach. For example, a customer who is self-employed, gets paid in cash, or relies on non-standard forms of income may require the chance to provide additional information to support their application.

The circumstances in which a customer is applying for finance will have an influence on the way in which they interact with the process. It is crucial for firms to ensure they are not exploiting a customer’s circumstances when designing their sales and responsible lending practices.

Customers usually take out credit to buy an underlying product or service. Their desire for the eventual product can drive their decision making when choosing what credit to take, who from, and at what speed.

We have set out below just three of the potential customer “types” and how their circumstances may impact their behaviour when looking for borrowing:

1. Survival customers – Customers who are in financial difficulty and rely on credit to survive. They are often the most tolerant of the length of a responsible lending assessment. These customers tend to be repeat borrowers and are often subject to the lowest level of scrutiny over time, when arguably they should have the most scrutiny throughout the process. Firms need to be looking to identify ways in which they can help these customers to combat their financial difficulty.
2. Lifestyle borrowers – Customers who use credit to supplement their lifestyle and make one-off purchases. Purchases are typically wholly discretionary and can be susceptible to biases, such as present bias and the urge for immediate gratification, or a ‘fear of missing out’. 
3. Reluctant borrowers – Customers who require credit to fix previous mistakes and may be reacting to an event pushing them towards credit (such as an unexpected bill). These borrowers may be in a vulnerable state, and it may have taken a considerable amount of courage to apply for credit. These customers may suffer from overconfidence (about the likelihood of good events occurring of their own ability) which has led to credit over commitment. These customers may not have explored all of the options available to them.

FCA: Consumer Credit and Customer in Vulnerable Circumstances

Lifestyle events can also distract a customer from giving due consideration to the decision to enter into a credit agreement. Being aware of the potential lifestyle events and biases that could impact your target customer(s), and taking these into consideration when designing your responsible lending framework, will mean firms can ensure customers are able to achieve their financial objectives whilst avoiding foreseeable harm.

The Consumer Duty has re-iterated the requirement for firms to ensure vulnerable customers are receiving comparable outcomes to non-vulnerable customers. With this in mind, firms should be able to demonstrate that their sales and responsible lending process has been designed to cater for the varying types of vulnerable customer that could be in the target market.

There are two key risks to vulnerable customers in responsible lending:

1. They are excluded from access to credit by nature of their circumstances.
2. They are more susceptible to mis-selling or getting a product they don’t understand fully.

There are various implications and considerations that firms must make dependent on the particular vulnerability that a customer may be facing (we have set out some examples in the table below). Firms should consider whether they need to provide additional support for those customers, whether the journey requires additional friction to protect customers, or whether the journey would benefit from the removal of sludge to provide better access to certain customers.

Firms need to strike the right balance and develop a process that doesn’t dissuade customers because it’s overly complex, whilst having enough positive friction to avoid consciously (or otherwise) exploiting their behavioural biases.

KPMG in the UK has specialists with extensive experience with Responsible Lending frameworks and affordability assessments, ranging from supporting firms with design, development and implementation, all the way through to testing whether assessments perform as expected and are delivering good outcomes to customers. If you would like to hear from one of them or require specific support with Responsible Lending and/or BAU activities, please do not hesitate to get in touch.