Speaker: Jonathan Davidson, Director of Supervision – retail and authorisations
Location: The Sage, Gateshead
Delivered on: 19 May 2016
First published: 19 May 2016
Key points:
- We expect firms to have their customers at the heart of how they do business - building society business models and the ethic of mutuality, resonate well for this objective.
- We welcome a market with diversity; and that includes the building societies.
- The two big themes shaping our interventions in the sector are affordability and promotion of competition and innovation.
- One area where we would like to see more innovation is in addressing the needs of our ageing population and those older borrowers with less certain income sources.
This is the text of the speech as drafted, which may differ from the delivered version.
Thank you for inviting me to speak at your conference today. This is my first opportunity to talk to Building Societies Association (BSA) members since I took up my position as Director of Authorisations and Retail Supervision at the FCA last September.
I am delighted to have this opportunity because I see the homeownership and the mortgage and building society sectors as strategically important to UK Plc and to the general public. I use the word strategy because in the FCA we have a keen interest in strategy – in three ways: first, the strategic factors which shape the landscape in which building societies operate, second the strategies and the business models which result; and third, how the business models create a sector that works well for consumers.
We know that you face many strategic questions such as: can you respond to the digital challenge, are you as threatened by the growth of challenger banks, can you compete with the economies of scale from the large banks?
Obviously it’s not our role to shape your strategies and business models – that is for you to do. But we do know that regulatory interventions are a significant factor in shaping the strategic landscape. So I thought it would be useful to share some of our thoughts about the role of building societies and how we approach the interventions that have an impact on your strategies and business models.
Our overall aim is to make markets work well for consumers and we shape our interventions by viewing the markets through the lenses of three operational objectives. I’m sure you are familiar with these:
Protecting consumers
We expect firms to have their customers at the heart of how they do business – how they develop products and services and how they treat customers. Building society business models and the ethic of mutuality resonate well for this objective.
As we look further into the mortgage market, affordability is a current strategic priority shaping our interventions. Our responsible lending rules aim to prevent a return to the kinds of irresponsible lending that led to many consumers having mortgages which they could not afford to repay. I will come back to this later.
Promoting competition
We welcome a market with diversity; and that includes the building societies. Building societies have recently been publishing their final results for 2015. Overall the picture looks good. Many societies have reported strong results, robust profitability, and strengthened capital positions. Mortgage lending has been strong, with building societies claiming a 26% share of gross mortgage lending in 2015. The sector holds a 21% share of the mortgage market and an 18% share of the retail savings market, and serves a wide range of consumer needs. So all this is good news.
For us promoting competition is not just about preventing market share dominance; it’s about ensuring that building societies and other firms have the opportunities to reach consumers and grow.
For us promoting competition is not just about preventing market share dominance; it’s about ensuring that building societies and other firms have the opportunities to reach consumers and grow, including by innovating to better meet the needs of consumers; and that consumers can find and buy the products that really are most suitable for their needs. I will return to how we are going about this shortly.
Protecting financial markets and ensuring their integrity
Our third aim is to protect and enhance the integrity of the UK financial system. While growth and innovation can be very positive forces, if not managed appropriately they can lead to serious risks that can prove existential to individual firms – and taken to their extreme could potentially affect a whole market.
Affordability and our responsible lending rules, therefore also serve to prevent the return of the irresponsible lending practices in some firms pre-crisis and so protect the integrity of the firms that operate in the strategically important mortgage market.
As you can see the two big themes shaping our interventions in your markets are affordability and promotion of competition and innovation.
Affordability
We aim to ensure that consumers only get mortgages that they can demonstrably afford to repay; and if they do get into financial difficulty, they are treated fairly.
In terms of mortgage affordability, the new mortgage rules have been in place for over 2 years now. At the time of their implementation there were claims that strengthened affordability tests would affect mortgage approvals by anything up to 20 per cent. Looking back it is difficult to square those forecasts with actual market activity. But we still wanted to understand how firms had interpreted and implemented the rules and whether or not this had resulted in unintended consequences, which is why we undertook our Responsible Lending Review.
We published the findings this week and the good news is that based on the firms seen (75% of the market by market share and including some building societies) we think lenders are on the whole currently maintaining responsible lending standards.
But there is always room for improvement and the need to guard against complacency of standards slipping over time. So as you continue to develop your products and processes, you must ensure that each aspect of the affordability assessment remains adequate and appropriate to the circumstances of the customer – whether verifying income, or making assumptions about expenditure. And when considering the effect of expected future interest rate changes, remember that you must have regard for both market expectations and any prevailing FPC recommendations. And you must be able to clearly justify the basis used with reference to both of these factors.
Another point to note is that while most lenders we reviewed are applying the permitted flexibility to their existing mortgage customers (who want to make changes to their loan), we are encouraging some firms to improve the experience for these customers, by making their processes more customer friendly. I know that as building societies this is something that you will care about and is a big focus for us this year too, with treatment of existing customers being one of our 2016/17 priorities.
I have heard it said that the Mortgage Market Review has indirectly created a number of ‘niche’ or specialist sectors, because some lenders have chosen not to compete in certain market segments such as lending to the self-employed, or contractors who have only been trading for less than 3 years, or lending to older borrowers. In the Responsible Lending Review, we found that lenders were still lending to these types of borrowers and I know that was always the case for the majority of the building society sector. This is greatly encouraging to see. Some lenders will undoubtedly see these specialisms as a growth opportunity in what is currently a highly competitive and crowded market. So it is important that, when considering how to increase lending and target new areas, firms have the appropriate product governance structures in place to identify and mitigate any additional risks.
The important thing to ensure when targeting customers, who some in the industry now refer to as ‘under-served’, is that underwriting standards remain robust for what are often more complex cases.
The important thing to ensure when targeting customers, who some in the industry now refer to as ‘under-served’, is that underwriting standards remain robust for what are often more complex cases.
We will continue to monitor lending standards across the sector to ensure that standards hold firm because no one wants to see a return to some of the poor practices seen in the past.
Fair treatment of borrowers in financial difficulties
I am not going to labour the point about the need to treat borrowers in financial difficulties fairly because we have undertaken several thematic reviews (us and the FSA) and have been clear about our expectations of firms.
The most obvious concern is what will happen to borrowers in the event of a rate rise. Over a million borrowers have never seen an interest rate rise. We want building societies that ensure future affordability for that generation of borrowers. Whilst it is noteworthy that the repossession of homes is at its lowest ever level (with only 13% of serious arrears cases now being repossessed) we can miss the point if we focus fair treatment of customers solely around how many homes are repossessed.
When I spoke at the Council of Mortgage Lenders' conference in November I raised this issue because it is important that lenders start to plan for this now. I know that prudent lenders are already undertaking this kind of analysis to proactively identify borrowers most at risk. Once the size of the problem is understood, lenders can then begin to develop strategies to assist these customers and ensure they are treated fairly.
We have seen good pre-arrears practices from a number of lenders. Now is the time to review your approach for dealing with customers who could experience payment difficulties, and now is the time to consider the different options you may be able to offer to them to ease the burden.
One group of customers that could experience payment difficulties are customers with interest-only mortgages.
Maturity of interest-only mortgages
The action taken by lenders to develop contact strategies and solutions to help borrowers to repay their interest only mortgages at maturity is a good example of a model that demonstrates good conduct outcomes and putting customers first.
Progress has been encouraging. But, and there is always a but, while the stock of interest only mortgages continues to decline year on year, the maturity profile of interest only loans worsens, with peaks in 2017 to 2018 and the mid-2020s because borrowers who took out mortgages in the early 2000s may not have sufficient arrangements to repay their mortgage.
It goes without saying that it remains very important that lenders continue to engage with borrowers as soon as possible to discuss their repayment strategies so any remedial action can be made.
So moving on to my other theme, which is:
Promoting competition and innovation
Our engagement with the market through the Call for Inputs (CFI) has brought a number of areas to our attention where we think we may be able to take steps to improve competition in the mortgage sector and that we are planning to explore in further detail in a market study to launch in Q4 2016. Many of these issues resonate with the ambition and interests of building societies.
The engagement we’ve had with building societies throughout the CFI process has shown that this is a sector that wants to provide consumers with products that address their particular needs and preferences which are changing over time.
Building societies have been designing products to address the real challenges facing families today, such as mortgages for younger family members needing help to get on to the housing ladder. Building societies have also been innovative on the technology front, recognising that many consumers today want to transact via their computers or tablets from the comfort of their home or on the move over their smart phones. We are seeing good examples of genuine product and service innovation designed to meet consumers’ needs.
Integral to competition is therefore ensuring that innovation can take place - I am aware that regulation (both conduct and prudential) has been blamed for a lack of innovation in the mortgage sector.
We are also aware that some are concerned that we at the FCA want to see a market where everyone behaves in the same way.
This is absolutely not the case. However what we don’t want to see is a repeat of the past where much of the innovation in the mortgage market related to a relaxation of lending standards and credit risk often to target consumers who would not have been able to afford a mortgage otherwise.
We recognise the need for good innovation across the financial services sector. Indeed, we recently launched the regulatory sandbox to firms in order to encourage and foster innovation in the sector. The sandbox is a ‘safe space’ in which businesses can test innovative products, services, business models and delivery mechanisms while ensuring that consumers are appropriately protected.
One area where we would like to see more innovation is in addressing the needs of our ageing population and those older borrowers with less certain income sources.
Ageing population
There is an ever-increasing proportion of consumers aged 55+, and over 85s represent the fastest growing segment of the population.
For this reason, we have launched a project that looks specifically at the way in which financial services meet the needs of older consumers, with a view to publishing a series of recommendations for future action in 2017.
We are pleased to see the building society community pioneering positive action in this area through your commitment to review maximum age limits for mortgage borrowers. Furthermore, we are already beginning to see real progress, with a number of firms having taken steps to facilitate lending in this space.
We also have a part to play. We found that our rules could have unintentionally contributed to restricted development and take-up of some lifetime mortgage ‘hybrid’ products. These products can help consumers transition from repayment to interest only which could be the right answer for some. We have published a ‘modification by consent’ on our website which allows firms to apply for a dispensation from the rules that require an affordability check to be carried out for these lifetime mortgages, which we hope will lead to more firms offering this product.
We thank the BSA for their contribution to our thinking and the engagement that we have had on the ageing population.
We are keen to bring to light more opportunities for markets to adapt and better meet consumer needs in the future - and we will be including a consideration of mortgages in our work programme. We recognise that we need to work together to find solutions- so we are keen to engage with you and help facilitate a helpful, forward looking debate.
As mentioned, the output of this project is a Regulatory Strategy for older consumers. Throughout the course of the year we will be developing recommendations to feed in to our Regulatory Strategy and we welcome further engagement with interested members, to help enhance our understanding of both challenges and opportunities to help better serve our ageing population. In particular, we are seeking dialogue with those who are innovating or seeking to innovate in this space. The Discussion Paper includes details of how to contact the FCA on this important issue.
Market Study
We are pleased that many building societies have expressed their interest in entering or expanding into new segments of the sector. I said that our CFI had identified some ways that we might be helpful to you in this endeavour.
We are therefore launching a market study to look, amongst other things, at the extent to which current panel and other commercial arrangements in the sector represent a barrier to entry or expansion. Is there a problem of misaligned incentives or conflicts of interests in the commercial arrangements between lenders, brokers and other players in the mortgage supply chain holding building societies back?
Our market study will also look at consumers’ ability to make effective choices and to access the products that meet their particular needs, such as the innovative products building societies are making available.
Our market study will also focus on whether the tools available today for helping consumers make choices, such as price comparison websites, best buy tables or interactions with advisers, do in fact effectively help them source the products that meet their needs. Is there adequate provision for those with less common needs and circumstances, for example, or those with lesser advice needs? Are there opportunities for better technological solutions?
So, overall, I would argue that the market study can provide building societies with an opportunity to pursue their vision.
We are alive to the reactions of some, mainly intermediaries, to our decision to undertake a market study.
We will be looking into a fairly narrow set of issues – much narrower than the wide set of issues set out in the call for inputs.
I think it is also important to stress that we have no preconceived views on any of the issues raised – these are issues that you and other market members have raised with us as areas that are worthy of closer examination.
There are other competition issues that have been raised by you with us, that although are not within the direct remit of the FCA, still have an impact on the ability of your sector to compete. We have been alerted to the fact that the capital requirements regime may place certain firms at a competitive disadvantage to their more established rivals – and that this is particularly the case for building societies. We will continue to liaise with the Prudential Regulation Authority (PRA) and government departments to inform their approach to capital requirements and the consideration of their potential impact on competition in the mortgage sector.
We have also received and taken on board feedback about the potential limitations that the Sourcebook may place on building societies, which may put them at a disadvantage vis-à-vis, other lenders. We will share all relevant feedback we have received with the PRA to inform their consultation on the new Supervisory Statement.
Conclusion
In conclusion, there is a lot going on in the mortgage market today. The challenges facing markets require a multi-faceted response from industry, the BSA, the Government and regulatory bodies.
I think that you are well placed to tackle the challenges head on. And we look forward to continuing our productive engagement with the sector in our competition work, both via the BSA and individual building societies.
Thank you.