UK: Consultation On The Regulation Of Credit And Store Cards

Last Updated: 6 November 2009
Article by Jean Price and Kate Duke

The Department for Business Innovation & Skills has launched a consultation on changes to current practices in the consumer credit industry. The objective of the review is to address five key areas where the Government currently considers firms do not act in the best interests of their customers, namely the allocation of payments, minimum payments, unsolicited credit in relation to credit cards and store cards limit increases, interest rate rises and an over-arching theme of greater transparency.

The proposals are wide-ranging and, if adopted, will have a significant impact on the financial models of both credit card and store card issuers. Given that around 69% of consumers clear their credit card balances every month and approximately 60% of store cardholders do the same, it is important that a sense of proportion is maintained and that changes do not skew the sector so that the majority of cardholders, who pay on time, bear increased costs incurred as a result of the minority who do not acquaint themselves with their card terms and conditions, and/or represent a greater credit risk to the card provider.

Allocation of payments

General industry practice allows lenders to allocate payments to the cheaper/lower interest debts first and while allocation of payment is disclosed in credit agreements, the Government has concluded that some consumers remain unaware of the way in which payments are applied to the balance outstanding on the card account. This is notwithstanding that issuers currently provide this information in credit card summary boxes, in any pre-contract information document they are required to issue and in the credit agreement itself. In addition, on implementation of the Consumer Credit Directive next June, all card issuers will have to provide a Standard European Consumer Credit Information sheet which also includes details on allocation of payments. This consultation recognises that that some consumers may not be able to understand payment allocation even if increased information is provided and therefore considers whether there should be a prescribed allocation of payments that works in the consumer's favour. The consultation sets out five proposals to tackle the issue:

  • Do nothing beyond current legislative and regulatory activity;
  • Improve information transparency;
  • Allocate payments proportionally to debts attracting different rates of interest;
  • Allocate payments to the most expensive rate first; or
  • Allow consumers to pay off cash advances first.

It is unlikely that the Government will adopt either option 1 or 2, having already concluded that something needs to be done and that providing additional information will not solve the issue for the class of borrowers it is seeking to protect through these measures. Adoption of any of the remaining three options will involve significant systems changes and may see a drop in the number of 0% deals available and the withdrawal of many cash advance facilities.

Minimum payments

Minimum payments are designed to ensure that a borrower repays more than the month's interest charges. The issue is that an increasing percentage of cardholders are only making minimum payments, extending the period of time they take to pay off their debt and, consequentially, paying more interest on it. Warnings on the impact of only making the minimum payment appear on the credit agreement and statements but it appears that certain borrowers are still unaware of the effect of making minimum payments.

It is clear that the "do nothing" and "improve information transparency" options proposed are not serious contenders, the third and fourth options representing better the direction the Government wishes to pursue. The third option is to set a recommended minimum payment that is higher than the current average contractual minimum. This could be set voluntarily by the industry or as a regulatory requirement. However, it is anticipated that it should be based on repayment over a reasonable period of time, 36 months being cited as the likely term. This would, inevitably, see a fairly significant increase in the minimum payment that could cause those households whose finances are already under pressure even greater anxiety. While it is envisaged that the recommended minimum payment could be phased in, it may be a considerable time before such borrowers are able to adjust their finances to meet the increased amount.

The final option is a proposal to increase the minimum payment. The minimum payment could be set with reference to a prescribed repayment period with a consumer opt-in or opt-out. Again, the difficulty with this proposal is that the increase in monthly payment is likely to be problematic for exactly the class of borrower the Government seeks to protect and could make implementation a particularly sensitive issue.

Unsolicited limit increases

Previously, it was common practice for a borrower's credit limit to increase without his active consent however, anecdotally, we understand that, certainly among the banks, this practice is now less widespread than in earlier years. The paper acknowledges that there is no evidence of a direct link between individual limit increases and an increased likelihood of loss, but concludes that the practice of increasing limits has contributed to the growth in card-related debt. It is unfortunate that there is not a greater focus on responsible borrowing, but this appears to be treated as something of a lost cause. The industry has already put forward new best practice standards on unsolicited limit increases but the Government's view is that these do not go far enough.

It appears that the Government's preferred option is to place a ban on all unsolicited limit increases so that increases can only be given in response to a specific customer request. Such proposal will, if adopted, have a significant impact on profitability, especially for those operating a "low and grow" business model.

The final option is for consumers to be allowed to opt-in to receiving unsolicited credit increases. There are two ways in which this could operate. The first is for the lender to offer an unsolicited increase that the customer could then positively accept. The second is for a customer to agree, at the time he enters into the credit agreement, that unsolicited increases may be made. Neither option is ideal but the second would be less costly to implement and more attractive to lenders, while the Government is less keen since it asks borrowers to opt-in to increases at a time when they are unable to predict how their personal circumstances may change.

Increases in interest rates

The Statement of Fair Principles, which have applied to the sector since 1 January 2009, already set a sensible framework for implementation of rate rises but the Government now considers that this is not operating to protect "some customers" from "unjustifiable rate rises on existing debt". It is asking lenders to evidence that customer detriment has been reduced and is considering placing the Statement of Principles on a statutory footing to ensure that breach of a principle could be dealt with by enforcement action. Again, the "better information" option is in evidence but this time it is anticipated that increased information would enable a customer to exert pressure on a lender to lower his interest rate where he is able to demonstrate improved credit behaviour. This is somewhat at odds with the stated "information overload" concerns.

The third option – defining the factors that would be fair for lenders to take into account when changing an individual's price on grounds of risk again - sees another proposal to move towards greater transparency but would not tackle the key issue of what is, or is not, unfair-re-pricing so is unlikely to be adopted. Limiting the size and frequency of existing debt-re-pricing is also put forward as an option. While this would make interest rate rises more predictable for consumers (and is already covered to some extent by the Statement of Fair Principles and now appears in the Lending Code) it would restrict lenders' abilities to respond to changing economic conditions or any change in a borrower's risk profile. This may lead to higher rates being charged at the outset and reduce the availability of credit to those who most require it.

The final option would be a complete prohibition on the re-pricing of existing debt or a specific prohibition on risk-based re-pricing. Aside from the systems changes such a measure would entail, it is difficult to see how this option would ultimately benefit customers since it could result in complex arrangements with different tranches of debt being subject to different interest rates, an increase in initial borrowing charges and a significant reduction in lower rate introductory offers. As the consultation acknowledges, the availability of credit to high-risk consumers is likely to see a material reduction that could force some to seek less beneficial forms of credit.

Simplicity and transparency

The consultation also contains proposals to improve the simplicity and transparency of credit and store cards, that is, to make the costs of using a card simpler to understand and making it easier for consumers to compare alternatives. To address this, the Government supports the idea of sending consumers annual electronic statements setting out the cost of running the card for the previous year, with information on fees and charges incurred. Given that the paper readily acknowledges that the consumers it is seeking to protect do not read the information they are provided with and suffer from information overload at times, it is difficult to see any real rationale for the addition of a further statement.

Simpler card lending products are also suggested as a possibility for those new to credit or who have had difficulty in managing credit in the past but, as lenders have already pointed out, it is difficult to see how the inherent flexibility of the card product could be retained in such a product.

What next?

The consultation moots the option of not changing the mechanics of credit and store cards mentioned above. However, the increasing impetus of the government to tackle the level of debt in the UK and the desire to protect consumers makes this extremely unlikely. The consultation closes on 19 January 2010 and a response will be published by 20 April 2010. A further consultation will take place prior to any legislative change.

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.

The original publication date for this article was 05/11/2009.

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