Before coronavirus hit, family and household budgets were pretty tight. In 2019, economic growth fell in the UK in quarter 2, and in quarter 4 was flat. Unemployment, under-employment and 0 hours contracts all increased in 2019 and wages had started to fall. There were clear signs of actual and potential strains on family budgets in 2019 prior to the virus.
Now that COVID has disrupted so many lives, hardship is even more widespread than before. The Money&Pensions service estimates that just over 5 million people in the UK need debt advice, and the people who are calling services at national debtline are reporting significant distress in the form of lost jobs, furlough and housing difficulties. Trussel Trust predicts that 1 in 6 households will need a food parcel at some point during the winter period. I’ve explained in more detail the effect that COVID has had on our finances in this article.
The credit industry has assisted people in the short term, largely due to the FCA schemes such as payment holidays. But after the financial crash, it was three months down the line that the problems really hit. When we hopefully return to some normality, payment holidays will stop. At this point, many people will find that their finances have been affected in the long-term, and they will also have extra interest added to their loans due to the payment breaks. It is at this point that financial vulnerability will become severe and widespread amongst households in the UK; the existing credit industry is not equipped to support people through such financial hardship.
A (long overdue) redesign of the credit industry is therefore necessary in order to counteract the havoc wrought by the pandemic. And not just the credit industry needs to step up, but also the government. In this article, we shall discuss how financial vulnerability is ultimately universal, and how lenders, credit bureaus and government policy all therefore need to play a part in the restructuring of the financial services industry to incorporate this understanding.
The Universal Nature of Financial Vulnerability
If there’s one thing we need to have learnt from this pandemic, it’s how financial vulnerability is far more widespread than we may believe.
Many people are only a pay-cheque away from falling into financial difficulty. Job loss, bereavement and relationship breakdowns (which have skyrocketed during the COVID pandemic), are often the trigger for this slippage.
Furthermore, COVID-19 has proven that financial hardship can happen to anyone; it isn’t a circumstance reserved for low-income households or people with poor credit history. This time last year, an aeroplane pilot would have perceived herself as having an excellent, high-income, stable job. Now she finds herself unemployed and with very few transferable skills to gain entry into the job market. Negative life events are capable of derailing any household’s financial stability.
So, the focus on vulnerability by lenders needs to shift; there needs to be an understanding that absolutely anybody can be vulnerable. The credit-industry-myth that everybody fits into a specific customer category from which nobody should default is far from the truth at the best of times, and even more so in times of crisis such as the one we find ourselves in today. Categorising people into financially stable vs financially vulnerable is out-dated. It is vital that financial products and services are designed with this in mind.
- The credit industry needs to design products with vulnerability embedded
- The credit industry needs to tailor products better to ensure affordability
- The credit industry needs to be thorough in its checking of customer affordability
The Credit Industry Redesign
The way in which creditors regroup over the next five years will be crucial to the financial well-being of households across the UK. FCA regulation has ensured generosity from these institutions in the short-term, but what about the aftermath?
An ethos of responsibility among mainstream financial institutions has been fostered by the FCA regulatory approach during the pandemic. This presents an opportunity for a more permanent re-adjustment of the credit market.
Since the 1960s and the arrival of the credit card, there hasn’t been any real innovation in credit product design. All other products have been riffing on the same credit-card theme. It’s time the credit industry saw real innovation, in the form of products that have built in flexibility.
As we’ve seen, every credit consumer in every consumer-category has the potential to experience financial vulnerability. Issues then arise when the credit products they’ve been sold no longer fit their circumstances. In reality, the credit industry needs to foresee those circumstances and build flexibility into the product in the first place.
Affordability and Resilience
In addition, greater attention will need to be paid to assessing customer affordability. Any innovation that the industry has seen over the last five or ten years has been that of speed of decision making. That’s been at the cost of sophisticated and thorough assessments of people’s underlying circumstances and checking their financial resilience. Lenders will have to think about a new way, complimentary to the traditional credit-assessment and basic affordability tests, to include a third test that assesses how resilient a customer is and what is the right product for them.
A test for resilience would acknowledge that everybody is at risk of becoming financially vulnerable, but that there is a scale to that risk factor.
In order for creditors to accurately assess the credit-worthiness, affordability, and resilience of a customer, there needs to be accurate credit reporting.
There is a lot of uncertainty in the world at the moment, including in the credit ecosystem, which is far from ideal. Lenders need accurate information on which to make important judgements on credit risk and affordability. However, the regulations instigated by the FCA have posed problems to the accuracy and reliability of the credit-reporting data available.
Credit Reports aren’t designed for mass-payment-breaks
At the start of the pandemic, the FCA ensured that the payment holidays wouldn’t affect people’s credit scores. There was therefore a large and rapid shift in the lending industry to implement new emergency credit reporting guidelines, which banks and lenders have successfully followed. This should help protect people’s future access to affordable credit and help not deter people from getting help, because so many people these days are aware of their credit scores and understand the role they play in lending. However, it has posed a problem to the credit-reporting industry.
During these payment holidays lenders have uniformly allowed people to miss payments and generally interest has frozen. But the whole system for credit reporting is based around telling credit bureaus what someone’s payment performance record is, and the credit reporting industry is not set up for a giant payment holiday.
Next year, lenders will have to make their decisions based on data from credit reporting from this year. So the question facing the credit-reporting industry is: How do we analyse what’s happened to consumers this year, when we’re making lending decisions next year.
To illustrate the extent of the problem, we only need to look at the variety of credit-consumers who took payment holidays this year. They fall into three very different, but ultimately indistinguishable categories.
- People whose income has evaporated due to the pandemic and they’ve therefore not been able to make their payments.
- People who are taking advantage of the fact that there’s a payment holiday but could still actually pay
- People who would struggle to make payments at the best of times.
Furthermore, there’s a blurring of these three, and consumers took payment breaks on some loan repayments, but not on others. A lot of customers whom the credit industry expected to take breaks actually started paying a lot more towards their loans at the start of the first lockdown. This is because these people were taking mortgage payment holidays to free up extra cash and using it to pay off their unsecured debts. With the payment break not recorded on the credit report, there’s no way to trace this kind of behaviour and to analyse the financial situation of the consumer.
Return to normal
Credit bureaus are obviously keen to return credit reporting to normal when it’s sensible to do so, to give lenders confidence on the credit reporting data. The past 9 months can therefore be seen simply as a temporary realignment of the way people were assessed by creditors to help them through.
Credit as a Lifeline and the Government’s Role
Credit is clearly a lifeline for people in this crisis, when they can’t afford essentials, they have unexpected bills or their income has dropped. There are generally 3 or 4 million people in the UK who are excluded from the credit market on the basis of affordability; they can’t get access to a mainstream option, they can’t get access to a credit card, they can’t get access to a loan. We can reasonably presume that figure has climbed up to around 8 million people now, due to COVID-19.
These people are often then pushed into more nefarious forms of predatory credit, or even illegal lending, which we can expect to rise during the impact of the pandemic. All creditors need to play a role to ensure that people don’t get pushed into those dangerous options that will impact their financial well-being, as well as their general well-being. There need to be innovative solutions to uphold the lifeline that credit usually provides.
The solutions include affordable credit, no-interest loans, and consolidation loans that repackage some of the debt that people have had to take on credit cards and other loans during this time at a more affordable repayment rate.
Clearly, the government has an important role to play here. This is not least because debt owed to the government – council tax, HMRC payment – is one of the major outgoings for the financially vulnerable, and one of the major causes of stress. The introduction of the debt management bill, which aims to implement serious and systematic improvements to Government debt collection, would alleviate this.
The government also needs to move forward with the loan-scheme they were looking at prior to the pandemic, which is similar to the Australian good-shepherd scheme. It constitutes a no-interest loan for people who need credit but really cannot afford any amount of interest at all. Looking forward to the financial difficulties many people will be facing towards the end of next year, this is the most important and urgent addition to the credit ecosystem. The government must make this a priority.
2020 has been an incredibly difficult year for many households. Unfortunately, 2021 is set to bring more challenges and complications: financial hardship will rise, and FCA enforced support will end. The unprecedented financial era in which we find ourselves calls for an unprecedented overhaul of the credit ecosystem, within which product flexibility, resilience-checking and interest-free government support need to be made a priority.