FSA Mortgage Market Review Responsible Lending Consultation CP 10/16. Response by the Building Societies Association

Transcription

1 FSA Mortgage Market Review Responsible Lending Consultation CP 10/16 Response by the Building Societies Association 1

2 FSA Mortgage Market Review: Responsible Lending CP 10/16 Response by the Building Societies Association Introduction 1. The Building Societies Association (BSA) represents mutual lenders and deposit takers in the UK including all 49 UK building societies. Mutual lenders and deposit takers have total assets of over 365 billion and, together with their subsidiaries, hold residential mortgages of almost 235 billion, 19% of the total outstanding in the UK. They hold more than 245 billion of retail deposits, accounting for 21% of all such deposits in the UK. Mutual deposit takers account for about 36% of cash ISA balances. They employ approximately 50,000 full and part-time staff and operate through approximately 2,000 branches. 2. We welcome the opportunity to respond to the FSA s consultation on responsible lending (CP 10/16) and the Mortgage Market Review (MMR) more generally. We share the FSA s objectives of a mortgage market that is sustainable for all participants; and a flexible market that works better for consumers. 3. As stated in previous responses, we believe it is crucial that the FSA recognises that in the context of the current financial crisis, problems in the European and UK economies today are primarily a result of liquidity and structural issues arising in global financial markets. They are not a result of a dysfunctional and widely irresponsible residential mortgage market in the UK and the FSA should be mindful that they are not focusing their attention on fixing the wrong problem. 4. Despite the economic slowdown, FSA arrears statistics show that the overwhelming majority of mortgage borrowers in the UK have been able to continue to make their mortgage repayments. Low interest rates have clearly helped, but it does demonstrate that in the UK, the vast majority of building societies and other mainstream lenders have acted responsibly and have been positive and sympathetic to customers in difficulty. 5. We look forward to continuing to work with the FSA on these issues and we are committed to assisting the FSA in arriving at an effective and proportionate regime that will deliver a flexible mortgage market for consumers. Executive summary 6. The BSA supports the FSA's quest for a market based on consistent, responsible lending and borrowing. However, the market failures the MMR is designed to address affects only a small number of lenders in the market. Many of which are no longer active. A measured and well considered response from Government, regulators and lenders is necessary to prevent creating an inefficient and unsustainable mortgage market. 7. It is the BSA view that the proposals detailed in the consultation paper will have far reaching consequences in relation to the wider economy. These wider impacts are not currently considered as part of the FSA impact assessment, in particular what the impact of the proposals will be on Government s stated aims to enable aspirant home buyers to achieve their dreams. We do not believe it is the role of appointed regulatory officials to design the shape of a major part of the UK economy, it is for the Government. 8. We have a fundamental concern that many of the proposals transfer responsibility away from the consumer and onto the lender. Whilst we appreciate the lender's responsibility to verify the application information and to have appropriate controls in place, this must be balanced with the capability of the customer to make sound financial decisions for themselves. The proposals do not achieve this balance and in our view take the very 2

3 patronising stance that customers need protecting from themselves. A view that we believe will be insulting to many mortgage borrowers. 9. The BSA believes that flexibility is key to being able to deliver the best outcome for customers. We have concerns that some of the current flexibility may be eroded by the affordability proposals. Setting prescriptive rules will inevitably lead to some creditworthy customers, with and without complex financial situations, being excluded from the market. This is not an acceptable position to place borrowers in and this will not deliver the outcome that the FSA is aiming to achieve. 10. The FSA should also note that assessment of income and affordability is only one part of the overall underwriting assessment of the customer. The credit score or credit assessment of the customer, is the key element of the underwriting process, providing lenders with relevant information to judge the risk of default by that customer. It is therefore vitally important that the FSA takes account of a lender's overall approach to lending policy and underwriting assessment rather than focussing on one aspect of the process. 11. We believe that further work is required to encourage consumers to make adequate provisions should they suffer an income shock. In our view the current proposals do not drive such behaviour, in fact they will do the reverse. 12. We are extremely concerned with the proposed new rule to require the lender to take account of foreseeable changes to income. Whilst the proposals focus centrally on lending into retirement, the draft rules state that foreseeable changes are not limited solely to retirement. It is our view that the wording of the rule is too broad and will not achieve the intended outcome of ensuring long term affordability. 13. We agree with the principle of ensuring the arrears charges are a fair reflection of the additional administration costs faced by the lender and we are pleased that the FSA recognises this is not an exact science. However, we do have some concerns with the practicalities of the proposals, particularly for smaller firms. 14. We urge the FSA to continue its cost-benefit analysis (CBA) work and believe much of the work already done needs to be developed. Overall, we do not share the main conclusions of the FSA s CBA and are not convinced that the FSA has appreciated the full economic and social costs of its proposals. 15. We believe considerably more customers will be affected by the proposed changes than the FSA expects. We do not believe that tighter controls on affordability assessments will weed out customers on the margins only (those that the FSA believes should not have a mortgage in the first place) but will affect many other borrowers in a variety of ways. We urge the FSA to consider the impact on a wider range of customer in more detail. 3

4 Objectives of the MMR 16. The BSA supports the FSA's quest for a market based on consistent, responsible lending and borrowing. The mutual sector has consistently performed considerably better than other lenders, in terms of treating customers fairly and customer satisfaction. Independent research published by the BSA in March demonstrates that building societies provide better service and have customer satisfaction levels superior to banks. 17. Building societies also account for lower arrears, proportionately, than other mortgage lenders reflecting their prudent lending practices and pragmatic forbearance measures. 18. Though there were some instances of poor practice displayed by some lenders during the height of the market, on the whole, the majority of lenders acted responsibly. Again, widespread irresponsible mortgage lending in the UK did not cause the financial crisis. 19. As the FSA itself acknowledges, the mortgage market has worked well for many customers and the vast majority of borrowers will come through this challenging period having maintained their repayments and kept their home The BSA supports the FSA's quest for a market based on consistent, responsible lending and borrowing. However, the market failures the MMR is designed to address affects only a small number of lenders in the market. Many of which are no longer active. A measured and well considered response from Government, regulators and lenders is necessary to prevent creating an inefficient and unsustainable mortgage market. 21. The FSA stated in DP 09/3 that the primary objectives of the MMR are to ensure we have a mortgage market that works better for consumers and is sustainable for all participants. 22. The BSA supports these objectives. However, we are unconvinced that the MMR will achieve them. The BSA has several overarching concerns with the MMR and we outline these below. In addition, many of the proposed measures and rule changes are impractical and result in illogical outcomes. As a result we have suggested a number of changes to the rules, which we believe are more proportionate to the perceived issues. 23. We believe the MMR should be aiming to: Promote responsible borrowing by raising financial capability. Empowering borrowers to take ownership of their personal finances and enabling them to make well informed decisions; Promote best practice to raise standards across the industry and ensure better outcomes for consumers including consumer choice, transparency and TCF goals; Promote competition in the mortgage market, enabling lenders of all business structures, to compete on a level playing field and provide the range of products required to service all appropriate sections of the market; Promote product innovation to meet the demand of a diverse and ever evolving customer base. A wide range of products and providers is necessary to ensure consumers have choice of product and price; and Ensure lenders have flexibility to support their customers when they need to, for example, when they are experiencing financial stress, and ensure sensible outcomes are delivered

5 24. The BSA believes the FSA should work in partnership with the mortgage industry and other relevant industries to deliver these objectives. Furthermore, it must also work with industry to ensure significant concerns over the direction and likely impact of the MMR are addressed. Direction of the MMR 25. The BSA has a number of significant concerns regarding the overall direction, purpose and impact of the MMR. Key amongst these are: The wider impact on the economy and housing market and how the proposals interact with wider Government ambitions and policy A firm shift apparently removing responsibility away from borrowers, and placing disproportionate and unreasonable responsibilities solely on the lender. Distortions in the market, with large banks, in particular benefiting at the expense of smaller and mutual lenders resulting in reduced competition. The adverse impact on social mobility The interaction with existing and planned macro-prudential reforms. Potential conflict with regulatory reform initiated at European level. The urgent need for sensible and practical transitional measures. Wider impact on the economy 26. It is the BSA view that the proposals detailed in the consultation paper will have far reaching consequences in relation to the wider economy. These wider impacts are not currently considered as part of the FSA impact assessment, in particular what the impact of the proposals will be on Government s stated aims to enable aspirant home buyers to achieve their dreams. 27. The Coalition Government's housing policy is yet to be fully defined. Although as mentioned above, recent speeches by Housing Minister Grant Shapps have focussed on the return of the 'age of aspiration'. The Minister has also spoken of the need for a longer period of house price stability, with only marginal price inflation to close the gap between house prices and income growth. 28. The Government needs to provide a clear plan of their objectives for housing policy. It will then be imperative to assess whether regulatory proposals facilitate the desired outcomes for UK consumers or present further obstruction. We do not believe it is the role of appointed regulatory officials to design the shape of a major part of the UK economy, it is for the Government. 29. Furthermore, it is not the role of the regulator to attempt to control consumer demand through prescriptive and restrictive, conduct of business rules, whether intentionally or not. This should be the subject of urgent debate by Government and the industry. 5

6 Responsible borrowing 30. We have a fundamental concern that many of the proposals transfer responsibility away from the consumer and onto the lender. Whilst we appreciate the lender's responsibility to verify the application information and to have appropriate controls in place, this must be balanced with the capability of the customer to make sound financial decisions for themselves. The proposals do not achieve this balance and in our view take the very patronising stance that customers need protecting from themselves. A view that we believe will be insulting to many mortgage borrowers. 31. We recognise that irresponsible lending can be a driver of irresponsible borrowing and that some consumers will take higher risks if they are not fully informed or aware of the commitment that they are entering into. However, we strongly believe this to be the case in only a minority of instances and believe that many of the proposals are a step too far. 32. The economist John Maynard Keynes 3 explored the drivers of consumer behaviour and identified six motives for borrowing money; enjoyment, extravagance, short sightedness, miscalculation, ostentation and generosity. There is also the social motives to consider, resulting in the desire to possess what others have. 33. Purchasing a property, be it for the first or subsequent time, or remortgaging to withdraw equity, is often driven by many of the factors stated above. It is important to recognise that this does not automatically result in unaffordable or irresponsible borrowing. The desire or need for a larger house is frequently fulfilled by obtaining an affordable mortgage. The FSA has recognised this, stating clearly in DP 09/3 that the 'market has worked well for the majority of consumers.' 34. Consumer behaviour varies greatly between individuals and is influenced by a wide range of factors. We do not believe it is possible, nor do we believe that it is right, to attempt to control, or manage consumer behaviour by a detailed set of rules imposed via lenders. Lending is a business based on risk, this is fine if recognised and managed by both lender and borrower, and as long as adequate safeguards are in place to protect vulnerable borrowers. 35. Ultimately consumers need to take responsibility for the choices they make. We do recognise that consumers with poor knowledge of financial products are more likely to buy financial products that do not match their needs and budgets. However, such action is not going to be curtailed by the changes outlined in this consultation. This is far better achieved through increased levels of financial capability. 36. We do not agree that simply requiring the customer to provide verification of income will focus their minds on the actual risks involved in taking on a mortgage. It will become another part of the administrative process. The same can be said for affordability assessments. Whilst ensuring the customer can repay the loan is central to the lender's decision, consumer behaviour will not necessarily be curtailed by the lender granting a lower amount than that requested by the customer. Instead, the customer is likely to be driven to other types of credit, often more expensive, but not subject to the same stringent assessment criteria as the mortgage. 37. Overall we do not believe the proposals will result in changes to consumer behaviour in the majority of cases. Those that already enter their financial obligations in a responsible way, will continue to do so. Those in the minority which do not are likely to move further away from taking responsibility for the loan and instead view the mortgage as affordable and suitable purely because the lender is willing to lend the money. 38. In our view the way to encourage responsible borrowing is to ensure and promote the availability of suitable advice and information. Whilst we await the consultation on 3 6

7 distribution, we believe it is important that mortgage advice is expanded from being solely product focussed to a more holistic approach to advice and financial planning, including the need for a form of income protection or 'safety net', and to ensure the mortgage meets the needs of the borrower in the short to medium term. Competition and a fair playing field 39. There are a number of stakeholders rightly concerned about the degree of competition in UK financial services. The Office of Fair Trading (OFT) and the Treasury Select Committee (TSC) are currently carrying out independent inquiries into the level of competition in the market, including the extent to which to barriers to entry exist. This is also being looked at by the Independent Commission on Banking (led by Sir John Vickers). We believe that regulatory overshoot could present a significant and increasing barrier to competition. 40. It is apparent that both recently introduced regulations and also the proposals in CP10/16 tend to favour large, proprietary organisations. It appears that little account has been taken of organisational structure in terms of reacting to the recent crisis. The redefinition of core tier one capital is an example of an area where mutuals have been treated only as an afterthought and even then authorities have attempted to shoehorn the sector into a proprietary model. A model which has hardly proven itself to be the gold standard in recent years. 41. The Building Societies Specialist Sourcebook has also increased the potential to stifle competition by imposing limits on lending, particularly in niche areas. Although we acknowledge that the sourcebook is guidance and not rules, we are yet to be fully convinced that it will not have an adverse impact on the ability of building societies to compete fairly with the banks. 42. A further situation arises with this consultation on responsible lending. The paper draws attention to the benefit to current account providers of having the ability to automatically cross-check affordability. This does not apply to many building societies as many do not offer current accounts. In fact this benefit applies disproportionately to the large banks. 43. In March 2010 the five largest banks held 85% of the personal current account market 4. In view of the fact that 82% of gross mortgage lending was provided by the five largest lenders in 2009, this is a market that is currently far from competitive. Lloyds Banking Group alone has a market share of approximately 30% in the current account market and outstanding mortgages. 44. The FSA also needs to consider whether the proposals will foster diversity within the market. Diversity of business models promotes stability and assists in providing greater choice and quality to consumers. Mutual lenders in particular, often serve markets that banks have less interest in. They also provide access to financial services on a localised basis, providing a valuable service in the communities in which they operate. It is therefore fundamentally important that the proposals in this CP do not hinder diversity. 45. Competition and diversity is of vital importance to ensuring a sustainable and vibrant market, which offers appropriate choice for consumers. We do not believe that the current environment, where six lenders dominate the market is desirable in the long term, nor does it meet the FSA objectives of ensuring a sustainable market for all participants and a flexible market that works better for consumers. 46. We would urge the FSA to avoid falling into the trap of treating mutual lenders in the same way as large international banks. Mutual lenders have a good track record over many years in responsible lending and the FSA should give due attention and recognition to their business models

8 Social Mobility 47. In our view a large number of existing borrowers, the majority of who are successfully meeting their mortgage repayments, will find it difficult under the proposed rules, to remortgage in the future, or in some instances get a new mortgage at all. This could have considerable negative effects in terms of social mobility, particularly as the coming years will remain particularly challenging in the labour markets. 48. Restricting the ability of consumers to move home in order to take up new or improved employment, will have serious adverse consequences for the economy as a whole. This could drive higher arrears and possessions resulting in an increase in state support. 49. We do not believe that these impacts have been fully considered and further analysis must be undertaken, looking at the wider economic and social impacts. Macro-prudential reform 50. In our view the FSA should not consider implementing any changes to conduct of business rules until a full assessment of the impact on changes already made to prudential requirements and enhancements to the supervisory regime has been carried out. Once this has been undertaken, if there are still concerns, targeted action through rule changes can then be undertaken. European reform 51. As the FSA acknowledges in the consultation, there is a European Directive expected in Q focussing on Responsible Lending and Borrowing. This directive may well have an impact on the changes proposed in this consultation. 52. The FSA states that the uncertainty around timing and the form of the proposals is not a reason for delaying the proposals in this consultation. We disagree, this is very much a valid reason, particularly if the EU directive, as is expected, requires changes to the UK regulatory regime. In our view it is far more sensible to await the EU proposals and for the FSA to consult on changes to the UK market with these taken in to account. 53. Our concern is that pressing ahead with the proposals in this consultation, will lead to further changes and consultation once the EU directive is published. This creates further instability and uncertainty for firms, therefore we strongly recommend that this consultation is kept on hold and revisited once the EU position is clear. Transitional arrangements 54. The BSA has stated consistently since the publication of the MMR Discussion Paper (DP 09/13) in October 2009 that we are concerned about the impact the proposals will have on many existing borrowers. As stated previously, many existing borrowers, already successfully meeting their mortgage payments, will find it difficult under the proposed rules, to remortgage in the future, or in some instances get a new mortgage at all. This remains a real area of concern for the BSA and for many consumers. 55. The FSA needs to be aware that the outcome for these mortgage prisoners will not be to exit homeownership, but instead they may need to maintain their mortgage on a more expensive rate. Particularly this is the case in a market of higher and/or rising interest rates. The borrower is therefore unable to control their finances in a desirable manner, which could lead to an affordability issue for these borrowers through no fault of their own. 56. We understand that the FSA is to consult further on transitional arrangements and we certainly welcome further analysis and consultation in this area. 8

9 Affordability Assessments General Comments 57. Flexibility is key to being able to deliver the best outcome for customers. We have concerns that some of the current flexibility may be eroded by the affordability proposals. Setting prescriptive rules will inevitably lead to some creditworthy customers, with and without complex financial situations, being excluded from the market. This is not an acceptable position to place borrowers in and this will not deliver the outcome that the FSA is aiming to achieve. 58. Research conducted by the BSA 5 shows that in a high proportion of instances, borrowers experience payment difficulties following a life event (loss of employment, relationship breakdown, illness etc), as illustrated below: Forgot, 5% Spent elsewhere, 7% Divorce/ Separation, 8% Loss of income, 43% Paid other debt, 14% Ill health, 15% Other essential expenditure, 16% Increased monthly repayment, 16% Respondents could choose more than one response, so percentages add to more than 100%. 59. To try to regulate for these unforeseen life events seems impractical, and to construct a framework or model to build this into the affordability assessment is extremely challenging. It also goes beyond the remit of the lender and will result in many borrowers being excluded from the mortgage market. 60. The FSA asserts that firms failure to conduct proper affordability assessments underpins many of the issues in the mortgage market. It is not clear exactly what the FSA means by 'proper' and we would challenge this assertion. 61. A number of building societies primarily use income multiples, with credit commitments deducted from the gross income. Analysis of the lending policies of building societies shows that 51% of the sector use this approach to affordability, 11% use income multiples only, 14% use income multiples, credit commitments and household expenditure and 24% use an affordability assessment only. 62. Analysis of the arrears 6 of the societies who use income multiples only and income multiples and credit commitments, shows that the total loans in arrears (based on are 2.5% or more of the balance), averages out across these lenders at 0.87%. This is significantly lower than the CML industry average of 1.56% and in our view proves that alternative approaches to affordability can work equally well for different types of lenders. 63. In our view, the majority of the affordability proposals assume some form of automation is in place as part of the assessment. We would argue that much of the problematic lending that the FSA is trying to prevent, was originated by organisations that employed 5 Understanding Mortgage Arrears 6 Arrears data collected by the BSA for Q

10 a high degree of automation and that such processes do not necessarily drive improved consumer outcomes. In a diverse marketplace lenders use automation to a varying degree and a one size fits all approach is not appropriate. 64. Many mutuals use income multiples or a hybrid of income multiples and affordability. This ensures that the assessment can be conducted easily, is transparent for consumers and removes the likelihood of human error by inconsistent interpretation of information. 65. We would therefore urge the FSA to undertake more robust analysis of the lending policy and loan performance of smaller lenders to ensure that the approach to affordability assessments is proportionate to the risks. As drafted, the proposals do not take account of other affordability models, which work equally well for the lenders that use them. 66. The FSA should also note that assessment of income and affordability is only one part of the overall underwriting assessment of the customer. The credit score or credit assessment of the customer, is the key element of the underwriting process, providing lenders with relevant information to judge the risk of default by that customer. It is therefore vitally important that the FSA takes account of a lender's overall approach to lending policy and underwriting assessment rather than focussing on one aspect of the process. Question 1. Do you agree with our proposals for income verification? (i) General comments 67. We agree with the principle that all mortgage applications should be assessed on the applicant's ability to repay the loan. Borrowers should be required to provide accurate and genuine information about their income to their lender. An affordability assessment based without this will be of limited use. 68. However, there are several practical considerations that need further examination. The FSA must recognise that the process and format of submitting and subsequently verifying income should not necessarily take the same form for all borrowers. 69. We welcome the fact that the FSA does not propose to prescribe how lenders verify an applicant s income. As pointed out in the CP, lenders must have the flexibility to innovate and meet the needs of different market segments. 70. Therefore, it is right that the lender is able to determine: The means of evidencing income this includes deciding whether to accept electronic or paper based sources and how any shortfalls in the evidence submitted may be addressed. The source and format of the evidence lenders must be free to determine which sources of information they would deem acceptable. For most cases this will take the form of standard documents such as payslips, P60s and audited accounts for self employed borrowers. However, it may be appropriate for third parties such as accountants, employers, savings account providers or others to provide information on the borrower s income. The period of time that the evidence covers lenders should be free to decide the period of time that they wish to consider and rely upon for the purposes of verifying an applicant s income. In the majority of cases, the lender will look at current income patterns where this is regular and stable. In cases where income is variable (for example, seasonal workers or those on freelance contracts) lenders should be able to determine the period of time required to assess a realistic picture. 10

11 71. We do not share the FSA s view that tighter controls on income verification will necessarily lead to consumers being more actively engaged in the mortgage application process, as we have highlighted earlier in our response. 72. Income verification provides lenders with information about the borrower at a fixed moment in time. As we have pointed out, the primary cause of repayment difficulties and subsequently borrowers falling into arrears is income shock, caused by an unforeseen life event, rather than general over indebtness, and in the majority of cases this is outside of the control of the customer. 73. We believe that further work is required to encourage consumers to make adequate provisions should they suffer an income shock. In our view the current proposals do not drive such behaviour, in fact it will do the reverse. Where a payment towards an income protection policy is known it would impact on the customer's net disposable income. Therefore, the current proposals serve as a disincentive for the consumer to adequately protect themselves. Perversely the consumer is faced with the choice of obtaining a higher loan amount, or protecting their payments. (ii) Fast Track 74. We remain unconvinced that fast track mortgages (without income verification) perform any worse than income verified or full status mortgages across the market as a whole. FSA s own analysis appears to support this. 75. Fast track, or expedited underwriting processes play an important role in allowing lenders to increase processing capacity quickly and efficiently to react to emerging market opportunities. To increase underwriting capacity without expedited processes could have a detrimental impact on the overall business, as well as the products available to consumers. 76. We recognise the potential for the system to be 'gamed' with the removal of self cert. However, we believe that lenders can minimise the likelihood of this, firstly by ensuring the process remains as an internal underwriting process and is not an advertised feature of the product and secondly by having a process of randomly selecting cases for income verification. This would be a truly random process, not selected by any specific criteria, therefore ensuring this selection could not be 'gamed'. 77. We would question why the FSA is not willing to consider allowing fast track processing to continue in a more controlled manner, ensuring it remains as an internal underwriting process and not an advertised feature of the product. The BSA is willing to work with the FSA to define appropriate parameters for this process. (iii) Competition 78. We are concerned that the proposed changes give larger lenders an advantage, particularly with regards to the use of current account data, not only from their own customers, but via credit reference agencies. 79. The majority of building societies do not offer current accounts. This benefit is therefore most likely to apply disproportionately to the large banks, particularly Lloyds Group that has a market share of approximately 30% in the current account market and outstanding mortgages. (iv) Further Advances & remortgages 80. The proposed rules do not provide flexibility for further advances and remortgages, particularly where the further advance is to the level of the initial balance. For example, if the customer originally borrowed 100,000 and would like to take the further advance back to this amount and where it is a for remortgage application. 11

12 81. It is not clear from the rules whether the lender would be required to verify the income again, or if the original evidence on file would be sufficient, perhaps supported by a telephone conversation to the employer. In our view this would be sufficient and compliant with the proposed rules. (v) Human intervention 82. It is unclear what the FSA means by human intervention. We agree that it is important that the credibility of evidence is assessed and that there is adequate protection against fraud. We are not convinced of the merit of human intervention in electronic verification from independent sources of information. 83. Automatic verification, be that of income or identification, is an important tool to mitigate the risks of fraudulent paper-based verification. The requirement for human intervention would add little value and could be detrimental to the development of these processes. 84. We believe that the benefit of requiring human intervention must be made clear. (vi) Fraud prevention 85. In terms of fraud prevention, income verification is one of a number of application checks that lenders use to detect mortgage fraud so it is likely that further income verification will reduce fraud to a degree. Certainly, false income or employment details are a common form of mortgage application fraud but these are picked up as much by automated screening including credit reference checks or fraud database checks and/or a detailed review by an underwriter. 86. Typically, verification of income is most effective against fraud for property, with individuals inflating their income in order to access a higher loan amount. However, it is less effective against fraud for profit, where loan monies are misappropriated through organised fraud, which has a higher impact. Organised fraudsters have greater access to false documentation and commonly use identity fraud to exploit any over reliance on income verification as a fraud control. 87. The HMRC document checking service pilot was a successful example of this approach. HMRC could confirm whether a case where a lender has suspicion of fraud following completion of internal checks is in fact a fraudulent application i.e. verification of suspect documents is final confirmation of fraud but not the prompt that generated suspicion in the first place. 88. We are delighted with HMRC s willingness to expand this service to all lenders, funded by lenders paying a referral fee for each case. We are currently working with HMRC and others on how this would work in practice. 89. We would also like the FSA to take forward points raised in our submission to DP 09/3 in January 2010 concerning false income verification documents that can be currently legally obtained from a number of internet based companies offering 'replica' payslips etc. If paper records are to become more important in the mortgage application process then it is important that opportunities to falsify evidence of income are closed down. 12

13 Question 2. Do you agree with our approach to assessing income? (i) General Comments 90. We agree that the FSA should not be prescriptive around the types of income, or the documents used to verify income streams that a lender may take into account. 91. In the majority of cases, we expect traditional forms of evidence to be sufficient. For example, payslips, P60, current account statements, company accounts for self employed borrowers or tax assessments. 92. We do have concerns that the proposals lead to self employed borrowers being unfairly penalised. This is not only in terms of their ability to supply evidence, but more widely in terms of the additional costs to the borrower and the willingness of lenders to amend their systems and controls to adequately assess their income. (ii) Self employed customers 93. We agree that self employed borrowers whose business is still relatively young, will have to wait to provide a track record of income. Our comments are therefore focussed on self employed borrowers with an established business. 94. Employed PAYE borrowers can provide timely and up to date evidence of income, via payslips or an employers reference. For self employed borrowers, accounts can result in evidence of income being some months out of date and it may not reflect the current income position. For example a self employed customer being assessed for a mortgage in October 2010 is likely to provide accounts from 2009 as evidence. This ignores any increases income in 2010 as finalised accounts would be unavailable. 95. In our view the proposals unfairly penalise self employed borrowers. We recognise that it is possible for the accountant to provide interim accounts or projections. However, we question whether the FSA would deem this to be acceptable. 96. Furthermore, there will likely be an additional cost to self employed borrowers in providing information via the accountant, which is not incurred by employed borrowers. Often the accountant will levy a charge on their client for providing information to the lender, particularly where the lender requires more information than just a copy of the accounts. It does not appear that such costs have been considered by the FSA. 97. We are also concerned with the lender's ability to comply with the requirement to assess the variability of income over time, particularly as the accountant is limited in terms of the amount of input that they can provide under the Institute of Chartered Accountants England and Wales (ICAEW) guidance 98. We recognise that accountants are able to make projections about likely future income. However, this practice is generally applicable to corporate clients, rather than individuals. The reports are thorough and detailed, but also tend to be contain caveats about unknown events. There are significant costs in producing such reports, therefore the costs of providing this information for a mortgage application could be prohibitive. 99. The ICAEW produces guidance notes in relation to work that can be carried out for third parties on behalf of clients, which covers the assessment of future solvency for lenders. The relevant exerts are below: Audit 1/01 Broader engagement with third parties Sometimes third parties ask accountants to sign statements concerning such matters as the future solvency or performance of the client, which cannot be supported by any amount of work performed by the accountants. By signing such reports misunderstandings may arise that accountants may become the equivalent to insurers or guarantors of the clients. obligations to third parties. Accountants do not accept this responsibility and refuse to sign such reports 13

14 Audit 4/00 The use of an accountant s report for consideration by lenders Although financial statements are normally prepared on a going concern basis, they do not give any indication of the level of future profitability or cash flows of the business or guarantee that the business will remain financially viable. Firms will not normally accept an engagement in which they are to provide wide-ranging assurances based on prospective financial information, [that] the borrower will be in compliance with the covenants for a future period. As a result of this guidance, the lender s ability to accurately assess the variability of future income is difficult. We believe that this supports the need for flexibility in verifying income for self employed borrowers The BSA, CML and ICAEW are willing to work together to agree a set of requirements to enable lenders to assess income for self employed borrowers, which satisfy both the FSA requirements and the ICAEW guidance notes and code of conduct. We expect that the CML and ICAEW will make similar comments in their responses. Question 3. Do you agree with our approach to assessing expenditure? Do you foresee any practical issues? (i) General comments 101. We agree with the principle that an assessment of expenditure should form part of the overall affordability assessment. However, we have concerns with the practical aspects of the proposals The first limitation of an expenditure assessment is that it only captures spending behaviour at the time the assessment is made. It is highly unlikely that a borrower s circumstances will remain constant throughout the life of the mortgage and that their spending patterns will not alter. Particularly in the situation of first time buyers, those relocating and those moving to a larger property; clearly their expenditure will change once they move into the property The proposals outlined in the consultation, do not explicitly state that the lender has to consider how the expenditure may change. The proposals are based on the premise that the information will be collected at application stage and is based on the customer's circumstances at that point. This may work for remortgage customers, where in theory the only change to expenditure will be the financial commitments. It does not work for home movers We do not suggest that lenders should collect information on expected outgoings, it is highly unlikely the borrower will have this information and even less likely that the lender will be able to obtain it, not to mention costs and reliability of data. However, if the FSA is committed to such affordability assessments, greater consideration needs to be given to the impact on home movers before pressing ahead with the proposals. (ii) Example of the practical difficulties 105. In relation to the assessment of tax and national insurance, the use of HMRC tax tables is not practical for all customers. In the case of an employed person on PAYE, then we agree that data is easily obtainable for the majority of customers and can be modelled into automated systems (assuming such systems are used). However, for self employed borrowers it is not as straight forward. A prime example is the Construction Industry Scheme (CIS) tax paid by sub contractors in the construction industry, as shown below: 14

15 If you are a sole trader or partner in a firm Paying tax as a subcontractor under CIS HMRC treat the CIS deductions from your invoices as up-front payments towards the tax and Class 4 National Insurance contributions (NICs) due from your business. To make sure you pay the right amount of tax for the year as a whole you'll need to submit the appropriate Self Assessment Tax Return for your business. When you work out the tax payable by your business, you use the full amount of the invoice. Credit will be given against the tax due for any CIS deductions that contractors have deducted. When your allowances and expenses are taken into account you may be due a tax repayment. If you owe any additional tax it'll be due by 31 January following the end of the tax year. If your business is a limited company You should offset during the tax year all CIS deductions taken from payments made to the company against any PAYE (Pay As You Earn) and Class 1 NICs due or CIS deductions the company has made from its own subcontractors. HMRC will repay any deductions that the company is not able to set off against its PAYE liabilities during the tax year when the company sends in its Employer Annual Return (form P35) at the end of the tax year. HMRC treat the CIS deductions from your invoices as up-front payments towards the tax and Class 4 NICs. Source: HMRC 106. In practical terms it would be extremely difficult for the lender to accurately assess the tax situation for some customers. As highlighted in the information above, a self employed person can result in under or over paying tax for the year, which may impact on the information used by lenders. Using generic tax tables could be inappropriate as it may further distort the situation, especially as CIS tax tables are not available on the HMRC website The assessment of tax and national insurance is further complicated with lenders own criteria where only part of an income is included in an affordability assessment. For example where only 50% of overtime or bonus payments are considered. Further consideration needs to be given to how lenders would be expected to assess the tax payable in these situations This demonstrates the limitations of a 'one size fits all' approach. We believe that the other variables suggested by the FSA that the lender should consider are equally likely to also have limitations when applied to certain customers. We are therefore not convinced that the proposed rules have been fully considered at a practical level We would re-iterate that such calculations are not practical for lenders who operate manual assessments of income and expenditure and the FSA must conduct further analysis in this regard. (iii) Expenditure assessment categories 110. We do not believe the categories identified in the draft rules will achieve the FSA objective of having control over the affordability assessments undertaken by lenders Whilst we are not convinced that prescriptive categories will always be practical, equally the use of broad and generic categories will lead to inconsistencies across lenders in terms of the information taken into account. 15

16 112. The majority of lenders will ensure that their affordability assessment is robust and will include a wealth and breadth of data, this may also involve substantial financial investment. Furthermore, this will have a negative impact on smaller firms that have less resource and monies available to access the same amount of data or models and therefore suffer a competitive disadvantage with larger lenders Such disparities will also leave the possibility of some firms having minimal data in their models, gaining the competitive advantage of taking on customers who 'fail' affordability elsewhere As such we do not see how the rules can result in the FSA achieving the intended outcome or promoting fair competition. Question 4. Should lenders be required to ensure that credit commitments being cleared by debt consolidation are repaid as expected? Would there be significant additional costs in implementing this for further advances? 115. In principle we agree that the lender should take steps to ensure the funds are used as intended, in particular with debt consolidation and where the loan is only affordable if the debts are repaid The proposed rules, as currently drafted require the lender to either repay the creditors directly or via the solicitor. It is important to note that the draft rules and the wording of the CP itself refers to the payment being made directly to the debtor. This would actually result in the payment being made to the borrower, defeating the purpose of the revised rules. Therefore this should be amended to the creditor In terms of using the solicitor, this is not possible. The solicitors handbook section 3.10, sub section 3.19 (Types of Instruction which may be accepted), also confirmed by section E3 of the Conveyancing Handbook, states that the solicitor is unable to accept an instruction from a lender involving the repayment of unsecured debts In practical terms, many of our members report that they already have processes in place to repay creditors, both for a remortgage and further advance. However, it is undertaken primarily where the affordability assessment only passes on the basis that the debts are repaid. Where the affordability assessment would pass if the debts were not repaid, the lender typically leaves the customer responsible for allocating the funds We believe this is a sensible approach and would minimise the administrative burden upon lenders. Furthermore it would still allow customers to take charge of their finances, which is fundamentally important We also believe it is important to understand that the lender undertaking this process, does not stop the borrower becoming over indebted in the future, as some may choose to take on new unsecured borrowing. We would therefore urge the FSA to consider carefully precisely the outcome they hope to achieve Question 5. Do you agree with our approach to calculating free disposable income? 121. We agree with the principle of using free disposable income (FDI) if an approach to affordability uses a detailed income and expenditure assessment as proposed by the FSA However, we would draw attention to our previous comments regarding the assessment of expenditure and our views on the validity of other approaches to affordability. The use of FDI under the definition in the consultation, as part of other approaches to affordability, would not be practical. However current practices of deducting credit commitments from income before applying the model, seek to achieve the same outcome and should be considered further. 16