Getting affordability right in the age of challenger banks

By Matthew Drage, head of external engagement, Huntswood

18 September 2019

In August, challenger bank Monzo announced it will begin offering short-term loans to its 2.5 million customers. This is an interesting move for the challenger bank, particularly considering the animosity felt towards many payday lenders following the collapse of Wonga last year.

In January 2015, the UK's Financial Conduct Authority (FCA) introduced new rules for short-term lenders. Interest rates were capped at 0.8 percent per day and customers could never be made to repay more than twice the amount borrowed. Despite this, many people still find themselves in financial peril due to the high-cost loans and charges they have committed to.

However, Monzo has reassured customers and regulators that their new short-term loans won’t be available at Wonga rates – far from it in fact. Before the new rules were introduced, Wonga and other payday lenders charged interest rates equal to an APR of 1,000 percent. Monzo, instead, will charge a maximum of 24 percent APR on loans up to £7,500, and loans worth between £7,500 and £15,000 will be charged as low as 3.7 percent APR.

Understanding vulnerability in all its forms

Banks must get creditworthiness and affordability right, especially in an age of heightened regulatory scrutiny. The FCA is increasingly putting the onus on lenders to show that they are treating individuals fairly and appropriately according to their individual circumstances. It is also prioritising the treatment of vulnerable customers. In July, it launched a consultation guiding firms on the fair treatment of vulnerable customers, meaning this will continue to be an area of focus for the regulator over the coming years.

It is important to note that ‘vulnerability’ has a broad definition. A customer may be categorised as ‘vulnerable’ because they are living with life-long physical conditions and disabilities, but a person may also become ‘vulnerable’ due to temporary life events such as divorce, redundancy and bereavement.

When it comes to the world of short-term loans, individuals with low incomes or insecure jobs tend to be those who most require a loan to help with cashflow and are those who struggle the most to pay it back. It is imperative that these people have a wider awareness of the affordability of loans, to ensure that they don’t spiral into unaffordable debt. In addition, appropriate support is required from companies if individuals do find themselves in financial difficulty.

The importance of affordability and accountability

An interesting challenge is how affordability and vulnerability strategies can be implemented in a digital business such as Monzo. How can customers be protected if banks never actually meet them face to face? How can vulnerable customers be identified and helped if all interactions are online or via a mobile-phone app? Businesses cannot rely entirely on self-declarations of vulnerability, especially not if customers cannot (or will not) accurately identify themselves as being in a position of vulnerability.

In reality, many who seek short-term loans from digital-only challenger banks may indeed be ‘vulnerable’ and therefore the bank must put robust measures in place to safeguard these customers. Ensuring front-line staff are equipped and trained to identify and support vulnerable groups is imperative to success. Developing a robust vulnerable customer framework should be a major consideration for any bank wanting to build a responsible, customer-first business. This is doubly important in the world of consumer credit.

In addition, providers must ensure they perform due diligence on their customers and are checking their creditworthiness and suitability for loans. Firms must be sure that they are offering credit only to those that can absolutely afford to repay and whose financial wellbeing doesn’t rely on the loan itself.

Monzo has made it very clear that it will not be targeting individuals who would typically turn to high-cost short-term loans. The firm’s chief executive, Tom Blomfield, hopes that the company’s new loans will appeal to customers who, for example, need emergency electricity repairs but don’t want to charge it to their existing credit card or dip into expensive overdrafts. The company has also scrapped fees for late repayments and has put in place a specially trained financial difficulties support team that can be contacted through the app, ensuring customers have access to advice when required.

Doing the right thing by all your customers

It is always tricky to navigate a new offering but, to date, Monzo has provided a vast amount of information to its customers and seems to be mindful of the pitfalls encountered by other credit providers. It has been transparent from the start and we can hope that this approach will act as a catalyst for change in other banks, whether they be challengers or incumbents.

By ensuring that all information is relayed clearly, customers will be more likely to understand the pros and cons of taking out short-term loans. This will result in fewer defaults, better customer satisfaction and freedom to re-allocate staff and resources currently used to explain complicated terms and conditions to customers elsewhere.

What does the future hold?

As with everything that challenger banks do, there is a freshness and agility about their approach. This move clearly demonstrates a growth in confidence from the challenger sector – building a banking proposition that is set to rival traditional banks on a whole new level.

We will watch with anticipation to see if Monzo’s competitors move into this market and whether some of the more traditional high street banks copy its flexible and transparent approach.

Whatever the future of the short-term lending market, it is vital that banks put people above profit and ensure affordability and accountability at every turn.

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