ZF Non-Prime Lending Market Manual and Service Guide PDF

Contents Foreword 1 Executive summary 2 Section one: The role of non-prime lending in a well-functioning economy 3 Section two: Evidence of market failure 5 Section three: Reasons for market failure 11 Section four: Building a non-prime lending market that delivers for consumers 21 Call to action 25

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Foreword Andy Sleigh Chief Operating Officer, Christopher Woolard CBE Partner, ClearScore Ernst & Young LLP Since ClearScore’s launch in 2015, we have grown to Three years ago, I had the privilege to undertake a review into the support over 14 million UK customers with their financial unsecured credit market on behalf of the FCA Board. Since then well-being, giving us a comprehensive perspective on the evolution of the credit market over the last nine years. there have been several developments.

The Financial Conduct Authority (FCA) has completed an investigation into the credit We have seen a significant reduction in the options for information market and set out targeted interventions to improve non-prime borrowers during this time. the information used by lenders to make lending decisions. The government committed to introducing new rules for providers of buy- The deterioration of the non-prime credit market over this period is not the result of a single factor. Instead, a now-pay-later (BNPL) products, although as of today, BNPL remains confluence of diverse elements has led to the withdrawal unregulated despite the market doubling in size.

Developments in technology have opened the prospect of a more sophisticated of investment capital and reduced innovation — leading to sub-optimal outcomes for UK consumers. The understanding of affordability and better customer support. non-prime market has contracted by more than 30% since At the same time, the economic environment has become increasingly 2019 — and this contraction has, in turn, pushed more people towards unregulated and illegal lending. challenging for households and businesses with cost-of-living pressures and interest rates higher than we have been accustomed In response to these multi-faceted issues, ClearScore to in the last decade.

This situation has further emphasised the has used its convening power to bring together our lending partners to develop a series of actionable importance of access to affordable, regulated credit. Credit isn’t the right answer for everyone, but it does play a vital role in enabling recommendations to build a more robust and equitable people to participate in the modern economy — particularly in non-prime lending market. challenging economic times. This report, co-authored with Ernst & Young LLP (EY UK), proposes practical and comprehensive solutions Unfortunately, the lenders we spoke to when researching this report to address the array of factors affecting the market.

say that the UK consumer credit market is becoming increasingly difficult to operate in, reducing choices for consumers, especially By doing so, we aim to work with government and regulators to support the creation of fair, accessible and those considered to be higher risk. The reasons are set out in this sustainable non-prime lending. This is especially critical in report — many of which will be familiar to those who have operated in the market for a long time and are consistent with the themes in my the short term, given the current economic climate and the ongoing cost of living pressures, but also in the long 2021 review.

term, given the knock-on economic impact that a well- The objective of this report is to offer a view of how the market functioning credit market can have on broader economic activity. could evolve, building on the work that government and regulators are already doing to remedy some of these issues, like rebalancing In closing, I express my gratitude to EY UK for co- incentives for claims management companies (CMCs) taking cases to developing this report and to our lending partners for their significant contributions, advice and support. I hope the Financial Ombudsman Service.

However, a more strategic reset is required if we want to build a market that delivers for UK consumers the ideas and recommendations contained herein will by attracting investors and incentivising lenders to compete. A vibrant ultimately improve the financial well-being of the broader UK public by advocating for a reformed non-prime credit market with a variety of firms will lead to more choice and fairer prices for consumers. Much of this can be achieved through existing tools market. without needing to pass new primary legislation. I’d like to thank ClearScore and its partners for commissioning Ernst & Young LLP to undertake this report.

I hope this research supports policymakers and the market in their efforts to create a better-functioning market that serves customers well. 1 Financial Conduct Authority, ‘The Woolard Review — a review of change and innovation in the unsecured credit market’ (February 2021). 1

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Executive summary The UK needs a long-term strategy for the non-prime lending market market — leading to reduced access and higher lending rates for non- to rebuild confidence and broaden access to regulated credit for a prime customers with low or average credit scores. Exclusion is leading wider group of customers. The government has already recognised the need to make changes — including by paving the way to change more customers to seek alternative solutions including unregulated BNPL products, relying on family and friends, and simply going the Financial Ombudsman Service’s (the Ombudsman’s) case fees, without essentials.

There has also been a concerning growth in illegal committing to introducing new rules to regulate buy-now-pay-later (BNPL) and announcing a review of the Consumer Credit Act 1974. moneylending reported by organisations such as the Illegal Money Lending Team, Fair4All Finance, and the Centre for Social Justice. Local We encourage policymakers to build on this foundation — providing a Trading Standards have been releasing warnings about loan sharks stable and supportive regulatory environment for private-sector firms offering affordable credit. in their area.

2 This is happening at the same time as many people are struggling with higher day-to-day costs and declining real incomes in a Policymakers should support industry efforts to improve how the much more challenging economic climate. cost of credit is communicated plainly and clearly, including by exploring new ways of illustrating the cost to consumers for loans The reasons for a decline in access are varied and complex. This report attempts to unpack them and offer practical solutions. The industry with terms of less than a year.

This will go some way to address the is committed to working collaboratively with the government and negative and binary perceptions of lenders offering loans with higher annual percentage rates (APRs), which currently undermines the regulators to build a well-functioning non-prime market that delivers better outcomes for all consumers. attractiveness of lending to higher-risk consumers where the likelihood of default is higher due to greater uncertainty of income and a lower saving buffer. Innovations like open banking and, more broadly, open finance have the potential to revolutionise how firms make decisions about who to lend to.

It is a particularly promising innovation for firms lending to non-prime customers with thin credit files or irregular incomes. Some firms are experiencing significant improvements in the accuracy of their lending decisions. In contrast, others need more certainty about how the regulator and the Ombudsman will treat them if something goes wrong. The regulator’s efforts to improve the quality of credit rating agency (CRA) data will further improve lending decisions — but a joined-up approach to open finance between the FCA and the Ombudsman would support quicker and more widespread adoption.

The lender perspectives and analysis of ClearScore data presented in this report point to a withdrawal of firms and product types from the 2 Illegal Money Lending Team, ‘Report reveals more than one million in debt to loan sharks in England’ (2022); Fair4All Finance, ‘As one door closes’ (June 2023); Centre for Social Justice, ‘Swimming with sharks’ (March 2022); Devon County Council, ‘Trading Standards warn of loan sharks as households borrow to meet rising costs’ (November 2022). 2

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SECTION ONE The role of non-prime lending in a well-functioning economy Used responsibly, access to affordable, unsecured credit provides histories meaning their needs were going unaddressed. Today, this the flexibility people often require to meet their everyday needs. Regulation plays an important role in the consumer credit market figure has risen to 16 to 17 million people — with an estimated shortage of credit supply of around Ј2 billion. 3 — ensuring that lending is done responsibly and providing valuable Many of these customers are referred to as ‘non-prime’ and are, on protection for those who may seek to utilise credit.

A well-functioning economy is one that offers a range of credit average, seen as higher risk — with thin or poor credit files resulting in lower credit scores. This may be because a customer has not used options — serving prime and non-prime customers. Yet the number of much credit before or struggled to repay debt in the past. Their credit underserved customers in the UK is growing. In 2018, it was estimated that around 12 to 13 million customers had non-standard credit score alone may not reflect their ability or willingness to repay, leaving millions of people with a real need for credit struggling to access the flexibility they need. 3 L.E.K.

‘Improving Access to Lending for the Financially Vulnerable’ (November 2023). 3

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