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March 15, 2018

FCA warns around incentives in otherwise calm review update

By Jonathan Minter

The Financial Conduct Authority (FCA) has warned that certain types of commission arrangements may provide incentives for brokers to use higher interest rates in an update to its Motor Finance Exploratory Review.

Specifically, the FCA warned that interest rate upward adjustment (increasing DiC) and interest rate downward Adjustment (Reducing DiC) were a risk, due to the link between commissions and interest rates.

The FCA warned: “For some arrangements, the interest-linked element of the dealer’s commission is significant and a large share of potential earnings. Also, differences between commission levels at the lowest and highest interest rates can be significant. Without appropriate systems and controls, Increasing DiC and Reducing DiC structures could provide incentives for dealers to arrange finance at higher interest rates.”

It added that the next phase of its analysis would include tests on the effectiveness of lenders’ systems and controls, and an analysis of data on motor finance contracts to assess whether commission arrangements have led to higher finance costs as a result of incentives.

One other point of slight worry was around the level of information provided to potential customers by firms. In general, the FCA said it found contracts to be generally transparent, with terminology and language clear and consistent.

However the regulator also noted it had seen cases where relevant information was spread across multiple documents, which it said may make it difficult for consumer to absorb key information. It said it had also seen cases where information was not sufficiently prominent, and may not meet the FCA’s requirements.

Calming

Beyond this, the FCA’s update was more benign. It noted that the largest FCA solo-regulated lenders have been adequately managing the risk of a severe fall in used car prices, such that it would not materially affect their overall financial soundness. This follows a note from the Prudential Regulation Authority (PRA), which came to a similar conclusion earlier this year.

Looking at the growth of motor finance over recent years, the FCA repeated past statements that this growth had not been driven by the lowest credit score range. In fact it noted lending to consumers in the highest credit score range had grown more than lending to consumers in the lowest credit score range.

While the FCA said it had so far found that in general missed payments, arrears, severe arrears and defaults were generally low compared to other finance products.

It added there had been ‘moderate’ increases in these measures between 2014 and 2016, and warned that those in the lowest credit score range – who account for 3% of the market of outstanding motor finance lending – had a relatively high rates of missed payments and arrears compared to those with higher credit scores.

While this may perhaps be expected, it added that these have also increased more in percentage terms over the two year period. This rise has taken place in the context of benign credit and macro-economic conditions, so the FCA said: “This means that consumer circumstances and their ability to meet repayments could change as a result of changing conditions.”

Next steps

The FCA said it expects to complete its review of the market by the end of September 2018. At that point, it will publish its findings in full, setting out any areas of concern it identifies, and how it intends to tackle them.

In the intervening period, its work will include an exploration of whether lenders are adequately assessing consumers’ ability to repay motor finance – for example seeking information from a sample of lenders on how they assess affordability in motor finance and what information or data they take into account. The FCA said this would be focussed on assessments for higher risk credit risk consumers.

It will also conduct a mystery shopping exercise to establish if consumers have access to clear, timely and transparent information at the point of taking out motor finance.

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