Affordability: A Big Cog in the "Problem Debt Support" Machine

June’s Dear CEO letter “The rising cost of living – acting now to support consumers’ highlighted the FCA concerns about affordability and their expectations of problem debt support provision

This article:

• Considers the central themes of the letter, the FCA's expectations and the implications for arrears management and problem debt support
• Reflects on the emerging affordability threat, and the capacity v capability challenge
• Explains why Affordability is not just about numbers
• Shares a three-step approach to affordability designed to meet FCA expectations, demonstrate duty of care, support fair value, and optimise the potential for good customer outcomes
• Offers ten top tips for meeting the FCA’s expectations and managing the evolving affordability challenge

Unsurprisingly consumer protection and support for the financially vulnerable is right at the forefront of the FCA’s focus.

Three recent “Dear CEO” letters have focused on the affordability threat faced by increasing numbers of consumers and emphasised the FCA’s expectations of Lender support.

With activity across arrears book looking inevitable to rise the letter is a timely reminder of “what good looks like” from the regulator’s perspective, and of the need to ensure this is reflected in policy, practice, and outcomes.

Core messages include:

• a prediction of rising numbers of customers experiencing affordability issues
• an expectation of proactive action to support customers at risk of, or already experiencing, affordability issues
• the importance of a comprehensive toolkit of support options
• the need for flexibility to tailor support options to meet the circumstance-driven needs of customers
• the need for active management of problem debt support plans, ensuring they remain aligned to the customer’s circumstances, and on track to deliver a good customer outcome - supported by the flexibility to modify plans where necessary to protect outcomes
• recognition of the additional challenges linked to supporting a large population of customers facing an affordability threat and financial difficulty for the first time

Understanding the Affordability Threat … Ripples and Waves … Capability and Capacity

For the majority of lenders it’s a long time since arrears policy and practice have been closely scrutinised, or indeed put to the test. However, the growing Affordability Threat means that looks set to change

• Recent ONS figures indicate inflation is at 9.4%. The IFS have highlighted that this understates the inflationary impact experienced by lower-income families are disproportionately affected by increases in energy costs, and basic food prices. For these families, the true cost of inflation is significantly higher
• Lloyds Bank have reported a 30% increase in demand for debt services in the first half of this year
• StepChange have reported a 12% month-on-month increase in new clients seeking debt advice - up to 14,000 in May – with the cost of living becoming the second most commonly cited reason. They estimate that 27% of the population are considered to have low financial resilience
• National Energy Action has warned that they expect one in three in the UK, are expected to be in fuel poverty following October’s price cap increase
• Foodbanks are increasingly reporting that they are unable to meet escalating demands

Whilst felt by all, the immediacy and severity of impacts are not homogenous. Households will vary in their financial resilience and financial reserves - and therefore in the tipping point into financial hardship.

Consequently:

• some lenders are yet to experience a significant upward trend in arrears, or requests for problem debt support
• neither the industry as a whole nor the majority of mainstream lenders are likely to face the huge wave of need for support akin to that linked to Covid Payment Holidays.

What’s more likely is a ripple effect, as differing levels of financial resilience and financial reserves are eroded and exhausted.

Whilst much of the media focus is on the impact on lower-income households, from a lender’s perspective it would be unwise to assume that higher-income borrowers, with good credit histories and responsible borrowing behaviours (indicated by high Delphi Scores), are exempt from risk.

Indebtedness Indexes will prove increasingly useful in identifying those at greater risk from inflation and interest rate rises – regardless of income level, previous borrowing behaviours, and payment history.

A high-income borrower with a high indebtedness score may be at greater risk of problem debt than a low-income borrower with a low indebtedness score.

How and when individual lenders experience a significant upturn will be determined by the borrower profiles of their books, but few will ultimately remain unaffected.

Whilst it may take time for the ripples to build into waves, and some may find a degree of comfort in their success in managing Covid Payment Holiday volumes, for the industry as a whole, and most lenders, the real challenge has shifted from capacity to capability.

The disruption to the relative financial stability of recent years means that established ways of thinking, analysing and operating may no longer be fit for purpose.

The FCA’s endorsement of customer-led support, significantly reducing (although not entirely erasing) lenders’ duty of care (and the skill needed to provide support) ended when the Covid Payment Holiday window closed.

The ability to manage complex affordability issues to the standards expected by the FCA, and necessary to deliver good commercial and customer outcomes has not been tested, or closely scrutinised for an extended period of time.

Historically thematic reviews and enforcement actions have demonstrated the FCA’s capability concerns. Added to widespread recognition of skill erosion over time, lenders should be prepared for detailed scrutiny ahead.

Similarly, new ways of thinking about risk, and an agile approach in responding to evolving economic factors will be needed in order to meet the FCA’s clearly expressed expectations of a proactive approach.

Customer behaviour adds another layer of challenge. The FCA’s letter reminds that many customers will be facing significant financial difficulty for the first time. Experience shapes behaviour, understanding and expectations, and many needing support will be unprepared for the debt support process.

Supporting customers to understand and make informed decisions at all points of their problem debt journey will be key to demonstrating a duty of care, and to achieving positive outcomes.

Affordability – A big cog in the “problem debt support machine”

Systems Theory reminds us that “the whole is greater than the sum of its parts”. Like cogs in a machine, each part has the potential to impact positively or negatively on others, and on the overall outcome.

An underperforming cog leads to an underperforming machine at best, total breakdown at worst. However individual cogs do not all make the same contribution, some are more powerful and impactful than others.

Affordability is the big cog in the “problem debt support machine”, It’s not just the problem that switches on the machine into life, it’s also integral to decision making, providing fair value support plans and achieving good outcomes.

Busting the Affordability Myth - affordability is not just a number – an Affordable Plan is not always a “good plan”

Offering problem debt support that could have been reasonably foreseen as unaffordable is an obvious failure of duty of care.

Equally, demonstrating the support offered to be affordable would not on its own be sufficient to demonstrate the regulator’s expectations have been met.

An affordable debt support plan is not always a good plan. A good plan must deliver fair value, not result in avoidable detriment, and have a reasonable expectation of achieving a good outcome for the customer.

To achieve these standards the qualitative aspects of affordability must be understood and embedded.

Effectively integrating affordability into problem debt support requires three steps.

Affordability Snapshots, Profiles, and Journeys

1. The Affordability Snapshot – this is a point in time measure that determines if a customer is in or at risk of financial difficulty. Driven from income and expenditure information it’s the trigger for the debt support process. However, basing debt support decisions and plans exclusively on an Affordability Snapshot creates a high risk of detriment. It will at best result in temporary sticking plaster, and may exacerbate the customer’s difficulties, and at worst result in a missed opportunity to bring the borrowing back on track.
2. The Affordability Profile – creating an Affordability Profile is the foundation for providing tailored debt support that is outcome orientated and offers fair value. It incorporates qualitative information - what is known, or reasonably expected, about changes to the customer’s circumstances - to determine how the affordability of the customer’s debt is expected to evolve over time.
3. The Affordability Journey – a problem debt support plan based on a well-produced Affordability profile, and utilising tailored tools from a comprehensive toolkit, is a good start, but a duty of care continues to apply for the duration of the support plan. As the saying goes “life is what happens as we’re busy making other plans.”

In some cases, the events will not happen as expected or assumed in creating the initial Affordability Profile.

Effective problem debt support monitors each customer's progression through their debt support journey, re-assessing alignment to the customer’s circumstances and needs, and re-evaluating the plans being on track to deliver outcomes

A poorly aligned support plan doesn’t deliver fair value, reduces the likelihood of a positive outcome, and increases the risk of detriment.

Ten Top Tips for Meeting The Affordability Challenge

1. Consider “what good looks like” through a lens that balances regulatory requirements and expectations, with customer needs and outcomes, and business drivers.
2. Be mindful of the potential and risks of Group Think when assessing your "as is"
3. Keep up to date with signposting from the FCA The June 16 Dear CEO Letter is the most up-to-date insight into what the FCA expect and where scrutiny will be directed – how does your problem debt support provision match up?
4. The finalised Consumer Duty Guidance is another useful signpost. It applies throughout the product journey and for increasing numbers of customers problem debt will be part of that journey. Consider how Outcomes & Cross-cutting Rules apply.
5. Recognise the pivotal role of Affordability in meeting your duty of care, satisfying the existing Rules and Principles, and meeting the expectations of Consumer Duty
6. Ensure the three-step affordability model is embedded throughout your problem debt support framework. Policy, processes, problem debt support strategies, systems, customer communications, staff development
7. Focus on the capability challenge. Be wary of the untested comfort of a “groupthink” assumption that everything is ok. Recognise the skill erosion of recent years. Invest in upskilling to become match-fit for the challenges ahead. Remember this is a longstanding area of regulatory concern.
8. Don’t overlook behavioural issues and biases that will impact your teams and your customers, and the implications for problem debt support
9. Consider how to meet the FCA’s expectations of a proactive approach. Not just for customers already in difficulty but for your overall lending book. Horizon scan for affordability at-risk hotspots and initiate pro-active outreach
10. Build an outcome-orientated quality framework that triggers action and resolution where issues are identified

Be prepared to provide evidence of how your debt support provision enables and delivers tailored, fair value and outcome-orientated problem debt support. Expect scrutiny not only of customer outcomes but also exploration of how the overall debt support framework and agent capability combine to deliver for your business and your customer and to satisfy regulatory expectations

About the Author

I am an experienced, independent transformation consultant, catalyst, and “critical friend”, and offer extensive end-to-end experience of delivering complex regulatory change into an operational environment.

I am a veteran of the previous financial crisis, when, in an Irish Department of Finance approved role, I supported the Irish Bank Resolution Corporation’s implementation of the Central Bank Of Ireland’s industry-wide Mortgage Arrears Resolution Strategy as a lead consultant.

My experience includes supporting customers to define and improve policy, develop greenfield operations, interpret and respond to regulatory change, address the outcome of regulatory intervention, define and implement strategy, and to achieve improvements in operational efficiency and effectiveness through process design, knowledge transfer and upskilling.

Recent work has included an Arrears Management Modernisation project for a UK Lender, and a vehicle finance affordability project.

I have specialist subject matter expertise in areas such as mortgages, consumer credit, product/service design, vulnerable customers, arrears management/problem debt support, affordability, operational improvements, process design, outcome-orientated customer communication strategy, and training support.

My academic background includes lecturing in Organisational Behaviour, and my earlier financial services career has included product management, programme management, business analysis, systems development and operations.

Tessa Jenkins

[If you're interested in working with Tessa and find out how she can help your organisation, contact Selena Tye on 0121 643 2100 or e-mail [email protected]]