6.  Responsible lending, transparency and fairness for all consumers

6.1 The Government, third sector and mainstream banks all have a role to play in opening up access to affordable credit to low income households, whether they are on benefits or in work. At the same time it is important that existing providers act responsibly, transparently and that there is adequate consumer protection.

6.2 The Department for Work and Pensions provides over three million awards for interest-free credit each year through the Social Fund. These go to some of the poorest households on income-related benefits. It is also supporting the third sector to provide loans at affordable rates of interest to 230,000 people through the Growth Fund. However, recent research suggests that there are at least 1.8 million people on low incomes with no access to affordable credit^[23] and more needs to be done to meet their credit needs with affordable, transparent and fair products.

6.3 In July 2009 the Department for Business, Innovation and Skills published a White Paper entitled “A Better Deal for Consumers: Delivering Real Help Now and Change for the Future”. It set out the real help the Government is providing now to people in financial difficulties, and the measures we are taking to promote responsible lending so as to protect consumers from taking on unsustainable amounts of debt. These include the introduction this year of new requirements on all lenders to explain their products to consumers adequately before they enter a contract, including the consequences of any failure to repay, and to check the creditworthiness of consumers before they lend to them. We are also taking forward legislation to ban unsolicited credit card cheques and consulting on further regulation of credit and store cards and on banning bills of sale.

Review of high-cost credit

6.4 The White Paper noted that the Office of Fair Trading had launched a review of high-cost credit. This review will provide valuable insight into the range of high-cost credit products available in the market.

6.5 This review is looking at a number of high cost credit products, including pay day lending and home credit. Loans such as these are designed to be repaid over relatively short periods of time and it is important that users of these credit services, including those who are on low incomes, understand the nature and cost of these types of loans and the risks of falling into unsustainable debt if they do not repay their loans on time. Pay day loans are designed for consumers who are in employment, but this can include people who are on low incomes. Pay day loan users who repeatedly roll over their loan are at risk of seeing less and less of their wages on a monthly basis. The emergence of new types of short-term high-cost lending such as loans via mobile phones have the potential to make it too easy for consumers to borrow money without thinking through the implications.

6.6 The Office of Fair Trading published its interim research report on 8 December, and the final report is due to be published in spring 2010. The review will provide evidence on the following areas:

• the level of competition, including the effects of the recession on competition and whether suppliers compete vigorously to deliver benefits to consumers
• the business models of lenders
• the nature and prevalence of different high-cost consumer credit products
• the attitudes and behaviours of consumers who use high-cost credit, and
• evidence from international research on credit markets in Australia, Canada, Ireland, Germany and the USA (specifically Pennsylvania, Michigan and Wisconsin).

6.7 The Office of Fair Trading review will also provide insight into the extent of competition in the high-cost credit sector. The Competition Commission looked at the market for home credit in 2006 and concluded that there were competition issues. It introduced a number of remedies, including early settlement rebates paid to customers who pay off their loans early and a price comparison website. The supply of other high-cost credit products, such as payday lending and pawn-broking is more fragmented but there is still a need to establish whether competition is working effectively in these markets.

6.8 Competition is important in ensuring that companies do not make excessive profits at the expense of vulnerable consumers. Combined with clear rules on responsible lending, we see a competitive private sector playing an important and continuing role in the provision of credit to all groups in society. However, we are concerned that some consumers are taking on loans that they cannot afford to repay, leading to worse hardship down the line.

6.9 As with all credit products, a number of users of high-cost credit find themselves in arrears and then miss payments or default on the loan. This can be detrimental to the individuals concerned – it can create additional stress in already stressful lives, put people’s homes and other assets at risk, and may jeopardise their future ability to borrow. It also contributes to the high cost of credit for more responsible borrowers.

New guidance on irresponsible lending

6.10 As part of the reforms introduced in the Consumer Credit Act 2006, we included a new provision concerning the practices in the carrying on of a consumer credit business which may appear to the Office of Fair Trading to involve irresponsible lending. Such practices are among those which may be considered to be deceitful, oppressive or otherwise unlawful or improper for the purposes of considering fitness to hold a consumer credit licence.

6.11 The Office of Fair Trading is currently producing guidance identifying practices that it considers may constitute irresponsible lending practices. The guidance will cover all stages of the lending process from advertising at the pre-contract stage to the handling of arrears and default.

6.12 In essence, the guidance will require lenders:

• not to use misleading or oppressive behaviour when advertising, selling or seeking to enforce a credit agreement;
• to be able to demonstrate that they have made a reasonable assessment of a borrower’s ability to make repayments in a sustainable manner before providing credit;
• to explain the key features of the credit agreement to the borrower so that the borrower can exercise informed choice; and
• to exercise understanding and forbearance with borrowers who experience difficulties during the term of the credit agreement.

The guidance will apply to lending practices to consumers at all levels. The Office of Fair Trading aims to publish the guidance in March 2010.

Proposal to ban bills of sale for consumer loans

6.13 Bills of Sale are a form of subprime lending which can be used by lower income consumers as well as those with a poor credit rating, which is causing concern.

6.14 Bills of sale are legal instruments that are being used to support lending where, typically, people’s cars are used as security – a practice known as ‘log book lending’. There have been high levels of complaints to consumer groups and the Office of Fair Trading about the very high rates of interest that consumers are charged, about the very few protections available to consumers if they fall into arrears and about unfair collections practices by the lenders. Bills are written in complex language that consumers may not understand and some people are having their cars repossessed without a court order. The Government is concerned that increasing numbers of vulnerable consumers who resort to bills of sale loans are ending up in a worse position and slipping further into unsustainable debt as a result.

6.15 The Government believes that a ban on using bills of sale for consumer lending is likely to be necessary and published a consultation document on 21 December. The consultation closes on 15 March 2010. You can find more information about it at: www.berr.gov.uk/consultations/page54078.html.

Banning unsolicited credit card cheques

6.16 Credit card cheques are provided by credit card companies to holders of their credit cards. They are very similar in appearance to ordinary bank current account cheques and can be used in any situation where a current account cheque can be used. These credit card cheques attract a higher rate on interest than normal card purchases and attract a handling fee. In 2008 around 292 million credit card cheques were sent out to consumers.

6.17 The Government is concerned that in many cases credit card cheques are being sent to and used by the most vulnerable in society, leading to an increase in their level of debt and in many cases making their situation worse as they do not realise the high costs associated with using credit card cheques.

6.18 Legislation currently before Parliament seeks to limit the sending out of these cheques and ensure that consumers are fully informed and are aware of the costs associated with using them.

Tightening up on credit cards

6.19 General industry practice is that when a consumer makes a payment against their credit or store card, debt it is allocated to the cheapest debt first. The Government is concerned that many consumers do not understand that this is common practice, and may therefore not realise that balances accruing interest at a high rate will be paid off last, with consumers paying a lot more interest over a longer period as a result.

6.20 This is a particular problem in relation to consumers who regularly withdraw cash on their card; typically charged at 25 per cent or more. These consumers are often those most likely to be vulnerable to financial difficulties. Through this system of allocation of payments, most card lenders are profiting from the lack of understanding and limited choices of vulnerable consumers.

6.21 The Government wants this to change and is consulting on proposals on whether payments should be reversed so that the most expensive debts are paid off more quickly, or are paid off first, ensuring that vulnerable consumers who use their cards to withdraw cash are not doubly penalised.

Minimum payments

6.22 The Government is also concerned that recent evidence suggests that around 14 per cent of cardholders only make the minimum payment on active credit card accounts. Minimum payments are set at a level which just covers that month’s interest charges, but does not make significant inroads into the capital borrowed (and may not cover fees and charges). This means that some consumers will be repaying their debts over decades and paying significant interest over the life of the debt.

6.23 The Government is consulting on proposals to introduce a mandatory higher minimum payment to be paid by consumers that would reduce their exposure to the burden of high-cost lending. The Government is aware, however, that there is the possibility that this could expose consumers to greater risk of default at difficult times and could limit consumers’ flexibility to adjust their repayments to help manage short term pressures.

6.24 Government is seeking views on alternative approaches such as the introduction of a recommended minimum payment that is higher than the contractual minimum. This amount would be set to pay off the card over a much shorter period of time (for example three years) and could be the default level of payment for those who choose to pay the minimum by Direct Debit.

New requirements on lenders

6.25 The requirement to provide a consumer with an adequate explanation of their credit product is one of the major provisions of the EU Consumer Credit Directive being implemented this year. We want to see consumer credit providers face up to their responsibility to explain products properly even if it means a change in the way some lending takes place. Lenders will be required to explain their products to consumers adequately before they enter into a contract, including the consequences of any failure to repay. In the case of secured credit, the lender will need to make clear the potential threat to a consumer’s home or other assets. This is in addition to information about fees, charges and repayment schedules that the lender will need to provide. The introduction of Standard European Consumer Credit Information means that lenders must provide certain information in a standardised form, providing key information ‘at a glance’.

6.26 Consumer credit providers will also be required to check the creditworthiness of consumers before lending to them. Many lenders generally perform basic income and expenditure checks already, such as completing a personal budget planner and taking copies of bank statements to prove salary deposits. Lenders may, however, have to take further steps to meet the obligation to lend responsibly. This could include using the credit reference agencies and performing more detailed checks on the consumer’s ability to repay, amongst other measures.

Improving access to affordable credit for low-income households

6.27 The Government and the third sector are acting to ensure that responsible, transparent and fair lending is available to low-income consumers who can afford to borrow, and the Office of Fair Trading is reviewing high-cost credit and looking at measures to ensure responsible lending. But the Government and third sector cannot possibly meet all the needs of lower income consumers who find themselves excluded from fair and affordable credit.

6.28 Therefore, looking at how all sources of affordable credit might be more accessible becomes increasingly important if lower income consumers are to be able to access affordable credit, thus avoiding reliance on high-cost credit.

6.29 Whilst there remains a need to extend access to mainstream credit or other sources of affordable credit, the range of activity across Government in this area has taken forward this agenda significantly. However, we are determined to take steps to ensure that affordable credit is available to lower income groups in society who want to borrow responsibly and are serious about repaying any debts that they incur.

6.30 We will continue work to build up the capacity of third sector lending institutions to provide affordable credit to low-income households, by following the model pioneered by the Growth Fund, and by making enabling changes to legislation for the sector.