Interest rate rises and conduct risk3rd October 2014
Rate rises will create conduct risk challenges but there are steps which can be taken to minimise lenders’ exposure, says Peter Jordan, head of lender services at law firm Hamlins LLP
The one thing we all know is that interest rates are going up. What no-one is completely clear on is when that will be or the real size of the problem. Various ‘time bomb’ figures have been quoted over the last few years. The most recent one from The Resolution Foundation think tank states a rate rise to 3 per cent in 2018 would make 800,000 borrowers mortgage prisoners and place 1.1 million in ‘debt peril’ (i.e. spending over half their income on debt).
It is clear that firms’ approaches to this problem may lead to conduct risk issues. How is the Financial Conduct Authority going to look at what steps firms should take when dealing with those borrowers who are likely to get into difficulty when rates rise? What should firms be considering at different stages of the rate rise problem? In this article I have set out some approaches and views I have seen when advising on conduct risk.
In its recent Arrears Thematic, the FCA wanted firms to be proactive and take steps to engage with customers who may be susceptible to interest rate rises. It made the clear statement that ‘proactively and effectively engaging borrowers at an early stage is likely to result in better outcomes’.
It seems clear the FCA will expect firms to be contacting customers. The FCA’s approach to interest-only mortgage (IOM) term expiries gives a practical example of what can be done. The proactive approach of firms and their contact strategies has been welcomed by the FCA. Firms may have found out things they didn’t want to know but from a customer’s point of view early contact and a clear understanding of problems can only lead to a better customer outcome.
It seems inevitable that a similar approach to interest rate rises is what the FCA will want. From what I have seen, most firms have conducted an analysis of the impact of a rate rise from a portfolio basis but not yet moved to an individual basis.
Should firms be engaging with their customers and if they do what should their approach be? The answer appears to fall into three distinct areas: before, during and after.
What can you do before? One option is to fact-find. Rate rises may be six, nine or 12 months away and there may be significant changes (good and bad) for customers in that time, making the data of limited value. It will, however, allow you to segment the most ‘at-risk’ customers.
The difference with IOM, where there was a specific date looming (end of term), is that you may wish to use the contact to send a ‘warning’ letter as to likely impacts of a rate rise and advice as to what steps to take should a customer believe a rise may present payment difficulties. Perhaps less focused on affordability, but providing guidance on potential impacts and offering support. Equally, an affordability approach may suit certain firms due to the nature of their book.
Policy and risk
At the time of the rate rise, policy and risk appetite are likely to be the key drivers. There will inevitably be a different approach taken by the FCA and the Prudential Regulatory Authority as the problem emerges. Does over-forbearance create prudential risks of forbearance, provisioning and capital levels and does over-forbearance present a conduct risk of delaying the inevitable?
The most likely answer to a good customer outcome and therefore lower conduct risk issues is affordability. Can the customer afford it? When there was a standard variable rate rise last year most lenders allowed for a short-term breathing space providing borrowers with time to adjust. Something similar would seem logical for base rate rises. If a borrower cannot afford the mortgage it must be the right customer outcome for firms to say that.
When rates go up it is likely that mortgage payments will outstrip wage rises and inflation, regardless of whatever forbearance and repayment solutions firms offer. As such, it is inevitable arrears will increase. Most firms’ arrears departments have put in place good conduct risk policies but these will be tested and need to be flexible.
You will need to be in a position to understand affordability and provide the right solution with appropriately skilled staff. That may mean a review of your existing conduct risk policies and procedures. Complaints will inevitably increase so you will need to consider how you manage and report those.
Firms that use outsourced providers should review their controls. The evolving controls, quality assurance, management information and processes you and your outsourced provider should already have in place now to manage conduct risk will play an ever increasing part in minimising any conduct risk issues when dealing with customers who may be susceptible to rate rises.
This article was written by Peter Jordan, Head of Lender Servcies and first appeared in Mortgage Finance Gazette on 2 October 2014.