At the 2018 Leasing Life Chief Executives’ Lending Forum, executives from across the lending industry spectrum examined what the future holds in terms of risk and regulation – and what is the best way to prepare. Lorenzo Migliorato reports.
As Chancellor of the Exchequer between 2007 and 2010, Alistair Darling experienced the credit crunch from the front seat, both during its lead-up and its clean-up.
“The world has faced the greatest financial crisis that it ever has, and we are still living with the consequences of that,” he tells the audience at the 2018 Chief Executives’ Lending Forum.
Those consequences have not just been of a passive, negative nature. They also involved a massive effort on the regulators’ part – both old and new – to increase the resilience of the financial services system.
Those that lament too much regulation should make peace with the fact it is a one-way process, says Darling: “There is no way that the regulatory system is going to go back to what it was, nor should it.”
On the contrary, regulation still needs refining, to make sure it works in a responsive way. “The idea that we will go back to a loosely characterised ‘light-touch’ regulation … is [something] that I do not think will happen.”
At the same time, regulation does not need to be a one-sided process. Firms have the chance to play a proactive part in shaping it – and before that, take action to reduce the need to regulate activities in the first place. “Most of these things – you know when they are going wrong,” says Darling. “And if you do not stop it, do not be surprised if someone comes along and says, ‘Right, here is a whole bunch of regulations that are going to stop it in the future.’”
The UK market for asset finance grew 25% in three years, far outstripping national GDP growth. For Richard Jones, managing director of Black Horse and chair of the Finance and Leasing Association, this was mostly “good growth”.
“Asset-based lending has taken over other forms of lending for many companies,” he says, “That, I think, is a massive success story.”
Nevertheless, any industry that grows at such speed is bound to get the attention of regulators. In the case of asset finance, that growth happened on what Jones describes as a very benign background of low base rates and low unemployment.
But, he adds, things look pretty uncertain for the future, with Brexit’s shadow looming large and the Bank of England turning increasingly hawkish. It makes sense, then, that the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA) would want to test the system’s resilience under conditions that are less rosy than present ones.
“I think one of the big themes that we will have going forward is: Where is the risk sitting?” he says.
“If you look at major lenders, particularly banks, they have had to run much more off ‘balanced balance sheets’, funding their lending through savings and deposits.”
By contrast, many new entrants to the market in the past few years have relied on private equity or securitisation in order to refinance. Those two elements depend on a stable, liquid financial environment, and might become less viable in an economic downturn.
“Who is carrying the risk? I think a lot more focus is going to come on this,” Jones continues. “Do we really understand the risks that are sitting on our balance sheets? What happens when interest rates go up? When you get an asset shock? I would not want to see competitors’ models collapse because they have not thought about where the risk is.”
That does not mean lenders should sit idly and hope for the best when the PRA knocks on their door. “The worst thing we can do is sit on our hands, or resist,” Jones says.
“You can choose to self-regulate, or you can choose to be regulated. Every market has that choice. But if you do not self-regulate – and what I mean by that is, if you do not operate your market in the long-term interest of your consumers – then you will be regulated.”
Self-regulation is not just about steering rule-making in a favourable direction for lenders. It is also an occasion to rebuild trust in financial services, says Dave Pickering, chief executive of the Lending Standards Board (LSB). To achieve that, one needs standards more than mere rules.
“The key with voluntary standards is to try and anticipate where risks are going to [be],” Pickering says. And if those voluntary standards are to be convincing in the eyes of customers and regulators, they also need to be high enough.
“Anyone can go to a minimum standard,” says Pickering. “But if you really want to signal your intent to the customers and government and statutory regulators, setting a high standard is the way to go – and you may do that in steps.”
The more firms sign up to an organisation like the LSB, the more persuasive the argument for self-regulation is when presented to the FCA. In that regard, SME lending has some catching up to do with consumer lending, says Pickering, who notes that a number of pressure groups out there would prefer to try and push the SME credit segment down the deregulation route.
But once self-regulation gains traction in a sector, the benefits are evident when at the regulators’ table. The FCA has recently devolved the oversight of credit card lending standards to the LSB, after it ascertained that the organisation had sufficient coverage of the market through its members.
The LSB is now aiming to replicate the success in the commercial lending sector, where Pickering sees a gap in terms of redress routes and dispute resolution. He says the LSB intends to look at agreement transparency, treatment of businesses in turnaround, and debt sale through securitisation – all areas that the PRA and the FCA have been looking into recently.
Regulation, of course, whether self-set or externally imposed, comes at a financial cost. The financial services industry is always looking for a way to not let compliance costs eat into margins. The great challenge is how to do that without relaxing credit quality in order to increase volumes.
“We have lived through many economic downturns,” says Graham Toy, chief executive of the National Association of Commercial Finance Brokers.
“The consequence of this is that lenders are continually refining and perfecting their lending policies – which can, if not done carefully, place them in the crosshair that they are not supporting UK [firms].”
The pivotal question for the coming years, says Toy, will be how to keep lending quality among increased competition and rising cost, in a way that does not put a responsible lender – or broker – at a disadvantage against the “plethora of pretty poor proposition” ready to snatch business opportunities.
With growth in an industry comes more competition, which in turn puts pressure on margins. That is exactly what has happened in the leasing industry over the last decade, says Nathan Mollett, director of asset finance at Metro Bank, one of the very challengers that drove growth in the sector next to traditional high street players.
“I think there is enough competition in the commercial lending space. In fact, in certain sectors I think there is too much competition,” Mollett says. “For me, it is also about the quality of the lenders rather than the number of them.”
Despite the pressure from ever-expanding competition, Mollett believes margins for the industry are still sustainable. “Profitability still looks good for lenders,” he says.
“That does not mean challengers should be complacent. The cost of risk is something that will need to be monitored closely in the future, especially since, unlike for more established banks, only a fraction of the new entrants’ lending is secured against real estate assets.”
In fact, the asset finance industry has seen a relaxation in credit and asset quality assessment, Mollett points out, which might spell trouble in an economic downturn. Instead of relaxing their lending criteria, banks, especially challengers, should look at ways of reducing overheads, even if that comes with sunk costs, or delayed results.
“To maintain a low cost to serve, if you are a challenger bank, you have to continue investing in technology, to make sure it remains legacy-free and as simple as possible,” Mollett explains. This is true not only for customer service, but also for regulation: the FCA is even giving the industry a say in the matter with a consultation on so-called “regtech”.
If technology is the way forward, it is easy to imagine the peer-to-peer sector as having an edge over the rest of the industry, especially now that some of the more mature players, like MarketInvoice and RateSetter, are specifically dipping toes in the asset finance market.
Yet even a lean, completely digital challenger will not escape regulatory oversight. As the FLA’s Jones puts it: “When you get big enough to be systemically important, you will be more heavily regulated – and you just have to accept that.”
There are two sides to this. If regulation is inevitable, some new players’ might prefer not to grow to the point where they will have to go through its hurdles – meaning, says Mollett, that regulation also acts as a kind of protection for the more established players.
The P2P sector has already understood what Jones or Pickering suggests: the best way to handle regulation is to engage with the regulator, before they come to the office with their own proposals. Revealingly, Pickering says the LSB is in discussion not just with asset and invoice finance providers, but also with P2P lenders.
“We have been in discussions with the larger P2Ps, and there is a keenness to look at the voluntary [regulation] route,” Pickering explains. “We are not that far away from bringing a P2P platform on board. I will be very disappointed – and surprised – if we did not have our first P2P [member] by the end of this year.”
Like the rest of the commercial finance sector, asset finance has long enjoyed a relaxed regulatory environment. Most speakers agree that this is set to change; so how do industry players prepare?
As Toy puts it, embracing the regulator is the only way forward. History will prove whether post-2008 regulation is irreversible – but current regulators and policymakers certainly see it so. As things stand, the best option for the industry is not to pressure for less regulation, but to take ownership of it.
“We have to very proactively work with regulators,” adds Jones, “You have to open your arms, talk to them about the business model that you run, and how it works.”
As FCA chair, Andrew Bailey put a lot of focus on understanding business models: the leasing industry should cherish this culture of openness to the industry, notes Jones.
“The regulator is very open to solutions that come from within the industry,” and the industry in turn has a duty to go and explain its inner workings to the likes of the FCA. “We need to do more of that,” says Jones, adding that the industry needs to “explain how it works and then explain how we think it could work better – not let the FCA come and figure out how it thinks it could.”
For asset finance to take ownership of its own regulation, and standards, is key to keeping its proposition attractive.
Costly, externally imposed rules need not be the only solution; regulation can also start from within.
As Toy points out to the attendees: “As long as we can demonstrate that our code of practice is applied, regulators are happy for us to do their job.”