4â Irresponsible lending

4â Irresponsible lending

Creditors and financial institutions must accept some of the blame for the increase in consumer debt, financial exclusion and over-indebtedness due to their lending practices. This has been referred to as irresponsible or predatory lending.72 It has also been called ‘socially harmful lending’, which can include such practices as targeting low-income households at Christmas, targeting people who are facing financial problems and soliciting credit on the doorstep.73 The OFT stated that irresponsible lending is a business practice that it would consider deceitful, oppressive, unfair and improper for the purposes of revoking a consumer credit licence.74 Creditors have been accused of irresponsible lending practices and have been subject to much criticism.75 Inderst stated that ‘in the United Kingdom various reports and taskforces on consumer lending practices have brought up the issue of irresponsible lending’.76

What practices constitute irresponsible lending? Examples include increasing credit card and overdraft limits without the customer’s consent; not requesting proof of income when determining the level of credit to be offered; and providing loans and credit cards to the unemployed and people who are dependent on state benefits.77 Other examples of irresponsible lending practices are the speed and simplicity of credit applications; the prominence given to very high credit limits; the importance given to very low interest rates for cards, incentives to use a particular brand of credit card; unwanted mail shots for credit card cheques;

71 Richards et al., above n. 4. See also National Audit Office, HM Treasury Asset Protection Scheme (London, 2010) 27.

72 For a more detailed discussion of predatory lending in the United States, see A. Penningto-Cross and G. Ho, ‘Predatory lending laws and the cost of credit’ (2008) 36(2) Real Estate Economics 175–211 and M. Spector, ‘Taming the beast: payday loans, regulatory efforts, and unintended consequences’ (2008) 57 (4) Depaul Law Review 961.

73 Kempson and Whyley, above n. 23, at 8.

74 For a more detailed discussion of how irresponsible lending is regulated under the CCA Act 2006, see Part 7, Chapter 2.

75 See, e.g., the predicament of Wendy and Derek Dickerson who were lent £100,000 by Lloyds TSB in spite of having a combined annual income of £5,000. See E. Simon. ‘Banks face crackdown on irresponsible lending’, Daily Telegraph,18 (2005) May 18 2005, available at www. telegraph.co.uk.

76 R. Inderst, ‘Irresponsible lending with a better informed lender’ (2008) 118 (532) Economic Journal 1499, 1500.

77 Insolvency Helpline, ‘Debt from irresponsible lending’, available at www.insolvencyhelpline. co.uk.

5â Regulation of irresponsible lending

As a result of these concerns, a self-regulation system has been proposed by the banks which includes a voluntary Responsible Lending Index that seeks to encourage best practice in credit lending.85 However, Ironfield-Smith et al. noted that:

78 HM Treasury Select Committee, Transparency of Credit Card Charges: First Report of Session 2003–04 (London, 2004) 43.

79 Ibid. 38.

80 uSwitch, ‘Affordability study, Lamsons Digital Media, 6–11 January 2006’, available at www. creditaction.org.uk. As cited in Richards et al., above n. 4.

81 uSwitch, ‘Credit card providers throw £8.8billion of unrequested credit at consumers’, 2 July 2009, available at www.uswitch.com.

82 A. Cattermole, ‘UK banks write off bad debt’, Monetary and Financial Statistics, Bank of England, September 2004, pp. 1–4, available at www.bankofengland.co.uk.

83 Insolvency Helpline, above n. 77, at 1.

84 Richards et al., above n. 4, at 502, citing Ironfield et al., above n. 6, at 134.

85 Ibid. 500. Richards et al. were highly critical of the Responsible Lending Index and the role of the Association for Payment Clearing Services. For an alternative viewpoint see P. Rodford, ‘APACS response to irresponsible lending? A case study of a credit industry reform initiative’ (2009)

86(4) Journal of Business Ethics 535.

The problem the credit industry faces, however, is that it needs debt levels to keep increasing if it is to meet its ongoing profit targets. Consequently, transforming an industry, built on pushing credit, into one that is responsible in its lending will not be an easy task and if this proves to be the case, then this may have to be an area for yet further regulation over and above that which is already scheduled and planned.86

Another example of a voluntary attempt to promote responsible lending is contained in Part 13 of the Banking Code.87 This provides that ‘before we lend you any money or increase your overdraft, we will assess whether we feel you will be able to repay it’.88 Cartwright noted that ‘the Banking Code was created as a result of recommendations made by the Jack Committee which had been established to examine the law relating to the provision of banking services to personal and business customers’.89 However, from 1 November 2009, retail bank deposit taking has fallen under the regulatory umbrella of the FSA and the Banking Code is no longer used.90

The FSA have implemented a number of measures aimed at tackling irresponsible lending. For example, it introduced a mortgage affordability test for lenders, which provides that lenders are responsible for assessing and determining the ability of consumers to meet their monthly repayments; the banning of so-called ‘toxic combination’ loans, i.e., loans worth more than 90 per cent of the value of a house for people with poor credit histories; the banning of charges for borrowers who are behind on payments, but are at least able to maintain an arrangement to repay these debts; and the broadening of the scope of FSA regulation to all mortgage advisers and arrangers.91 In November 2010, the FSA imposed its first financial penalty for irresponsible lending. Bridging Loans Ltd a mortgage lender, was fined £42,000, and its director Joseph Cummings £70,000, for ‘serious failures relating to lending practices and for failing to treat customers in arrears fairly’. The importance of this ground-breaking financial penalty by the FSA cannot be overstated. It is the first reported instance of a firm being fined by a regulatory body for irresponsible lending practices.92 The FSA must be commended for tackling the problems associated with irresponsible lending, an issue that had previously received little regulatory attention.

86See Ironfield Smith et al., above n. 6, at 141.

87For a more detailed commentary on the Banking Code see Part 6 Chapter 1.

88British Bankers Association, The Banking Code (London, 2008) para. 13.1.

89P. Cartwright, ‘Retail depositors, conduct of business and sanctioning’ (2009) 17(3) Journal of Financial Regulation and Compliance 302.

90This process began in 2008 when the FSA published a consultation paper which proposed a new regime for regulating retail banking conduct of business. See FSA, Regulating Retail

Banking Conduct of Business, Consultation Paper No. 89/19 (London, 2008). For a more detailed discussion of this see Part 6 Chapter 1.

91See generally, FSA, Mortgage Market Review: Responsible Lending (London, 2010).

92FSA Press Release, ‘FSA fines mortgage lender and its director for irresponsible lending and unfair treatment of customers in arrears’, 4 November 2010, available at www.fsa.gov.uk/pages/ Library/Communication/PR/2010/159.shtml.

In addition to the measures taken by the FSA, the OFT stated that creditors:

should undertake proper and appropriate checks on the potential borrower’s creditworthiness and ability to repay the loan and to meet the terms of the agreement. The checks should be proportionate, taking account of the type of agreement, the amounts involved, the nature of the lender’s relationship with the consumer, and the degree of risk to the consumer.93

The Consumer Credit Act (CCA) 2006 provides that irresponsible lending is a business practice that the OFT would take into account for the purposes of revoking a consumer credit licence.94

The Consumer Credit Directive 2008/43/EC requires Members States to guarantee that ‘before the conclusion of the credit agreement, the creditor assesses the consumers’ creditworthiness on the basis of sufficient information, where appropriate obtained from the consumer and, where necessary, on the basis of a consultation of the relevant database’.95 This obligation was initially proposed by HM Treasury Select Committee in 2004, stating that ‘it is important that lenders assess a consumer’s ability to repay based on as complete as possible a picture of their current income and credit commitments and not just on their payment history’.96

Q3 What is irresponsible lending?

6â Irresponsible borrowing

Despite such practices of lenders outlined above, it is necessary to consider whether debtors are also culpable for irresponsible borrowing.97 This was a point raised by the DTI who stated:

creditors should be expected to undertake enquiries that are proportionate, having regard to the type of agreement, their relationship with the customer, and the costs and risks involved. The obligation on the lender must also be balanced with an obligation on borrowers to provide true and accurate information about their financial circumstances.98

93OFT, Irresponsible Lending: A Scoping Paper (London, 2008) para, 2.14.

94The OFT had published guidance notes on irresponsible lending, which provided that creditors should employ appropriate business practices and procedure; there should be transparency

in dealings between creditors and borrowers; there should be proportionality in dealings between creditors and borrowers; and creditors should not treat borrowers unfairly. See OFT,

Irresponsible Lending: OFT Guidance for Creditors (London, 2010).

95Directive on credit agreements for consumers 2008/43/EC, Art.8 [2008] OJ L133/66. These obligations were introduced by the Consumer Credit (EU Directive) Regulations 2010, SI. 2010/1010.

96HM Treasury Select Committee, above n. 78, at 40.

97For a more detailed discussion of the problems directly associated with irresponsible borrowing see Kempson, above n. 16, at 44–9.

98DTI White Paper, above n. 19, at 57.

This was a point raised by HM Treasury Select Committee, who pointed out that ‘despite all the sophisticated scoring techniques used, it must be recognised that the borrowers themselves have an important contribution to make in the decision’.99 Ironfield-Smith et al. took the view that:

Improving consumer financial capability and awareness will rely in large part on the availability of better and more accessible information and a number of changes to legislation and voluntary codes of conduct have been made or are in the pipeline to facilitate this, including a number of reforms to the Consumer Credit Act.100

Is there a need to increase the level of financial education or even debtor education?101 The FSA has been charged with improving the public’s awareness and understanding of the financial system.102 This includes promoting the awareness of the benefits and risks associated with different kinds of investment or other financial dealings,103 and the provision of appropriate information and advice.104 This is an extremely innovative objective and never before has a financial regulator been explicitly charged with the significant role of educating consumers. Taylor states that assigning this role to the FSA ‘represents an innovation in the sense that this type of regulation serves a social purpose as well as contributing to the efficient working of financial markets’.105

In order to achieve the statutory objective two aims need to be fulfilled: to improve general financial literacy and to improve the quality of the information and advice that is available to consumers. The rationale behind the statutory objective is that evidence suggests that consumers do not understand how the financial services system works. Theoretically, the objective should be a major step forward for consumers now that a regulator has been charged with the role of increasing public awareness of the increasingly complex financial system. However, to what extent will the FSA actually be able to fulfil its role? A core problem that needs to be addressed regarding consumers is the psychological barriers that appear to exist, with many people appearing to believe that they do not need financial education.106 A major task facing the FSA is getting consumers actually to realise that they have financial information and education needs. How successful they can be in achieving this will only be seen with time,

99HM Treasury Select Committee, above n. 78, at 38.

100See Ironfield Smith et al., above n. 6 at 139.

101For a more detailed commentary on these issues see J. Tribe, ‘Personal insolvency law: debtor education, debtor advice and the credit environment: Part 1’ (2007) 27(2) Insolvency IntelligenceÂ23.

102FSMA 2000, s.4. For a general discussion of this issue see N. Ryder, ‘Two plus two equals financial education: the Financial Services Authority and consumer education’ (2001) 35(2)

Law Teacher 216.

103FSMA 2000, s.4(2)(a).

104Ibid., s.4(2)(b).

105M. Blair, M. Minghella, L, Taylor, M. Threipland, and G. Walker, Blackstone’s Guide to the Financial Services and Markets Act 2000 (London, 2001) 33.

106See generally FSA, Better Informed Consumers (London, 2000).