FCA raises concerns that lenders rely to heavily on computers for mortgage applications, risking systemic problems going undetected
In July 2014 the £200 billion-a-year UK mortgage market had tougher lending rules enforced upon it, including new affordability tests and lending criteria. The regulator accepts that since the changes were introduced, a move to avoid future banking crisis following the market crash in 2008, and the subsequent collapse of Northern Rock and the taxpayer bailout of The Royal Bank of Scotland, lenders have engaged positively with its ‘responsible lending rules’.
Even though there have been tough new rules and practices imposed on the industry, the Financial Conduct Authority (FCA) continues to conduct reports into the mortgage market, including its competitiveness. The latest report by the FCA believes that even more can be done to increase competition, including improving consumers’ ability to make better choices about the mortgage deals available.
In its latest report the FCA warned of the dangers of Britain’s biggest mortgage lenders relying too heavily on automated computer systems to decide who is acceptable for a mortgage. The danger of becoming far to reliant on computer systems and complex algorithms when processing applications was highlighted by the FCA who cited a firm that overstated a borrower’s income, without realising after it omitted part of an affordability assessment designed by the lender for a certain type of customer.
The FCA said: ‘Most firms’ systems result in underwriters being unable to view the internal workings of the system. This means the system outputs are not necessarily being questioned as part of the decision process. Unless firms test the accuracy of the system outputs – for example, affordability calculations – at least on a sample basis, there is a risk that a systemic problem could go undetected.’
However, one lender said that the UK regulatory regime discourages the effective use of new technology, in particular the MCOB rules discourage some online interactions with lenders or brokers because they could be deemed as giving advice. Another lender stated that it is hard to justify investment in execution-only and digital innovation because of regulatory risk. There was a view that if this could be resolved, digital innovations could be helpful in presenting mortgages in a simpler way.
On positive news, there was no evidence of previous poor practices like self-certification of income or interest-only lending without a credible repayment strategy where lending is affordable. There was also no evidence that the rules had prevented firms lending responsibly across particular groups, for example older borrowers and the self-employed.
The FCA did however find room for improvements that can be made to some aspects of firms’ affordability assessment process, monitoring and record keeping. Most lenders are using the flexibility afforded by current rules when dealing with their own existing mortgage customers. However, some firms could be more proactive and consistent when making use of exceptions. Market data has shown that the responsible lending rules do not appear to have had a material impact on lending volumes. However, it is anticipated that the rules will have a greater impact as interest rates rise and affordability is stretched.
On the other side of the reviews report many respondents were highly critical of the relationships between brokers and estate agents. Criticism was directed in particular at situations where a consumer may be under the impression that consulting a certain mortgage broker is necessary in order to view, or submit an offer on, a property.
Respondents also commented on the relationships between brokers and providers of other ancillary services, for example conveyancers and surveyors. Concerns were raised when these services are provided by the same group of companies to which the broker also belongs, with respondents stating there should be further safeguards in place to ensure that consumer choice is not limited either as a result of ownership ties or commercial arrangements.
Both lenders and intermediaries expressed further concerns about relationships between firms in the new-build sector, claiming that developers have close relationships with certain brokers. These brokers tend to place business with a limited number of lenders who they are confident can meet tight timeframes imposed by the developers, making it more difficult for new lenders to enter the market, limiting the choice available to consumers.
If the firm is or should reasonably be aware that there are likely to be future changes to the income and expenditure of the customer during the terms of the mortgage, the firm must take this into account when assessing affordability.
Some respondents felt that lending to customers whose mortgage term extends beyond their likely retirement age raised difficulties in accounting for known or likely changes to income and expenditure over the life of the loan, particularly where only a small portion of the term extends beyond retirement age.
Indeed, two lenders questioned whether it is necessary to account for changes many years in the future, given that many customers remortgage well in advance of the term end. Respondents felt that these issues were compounded by the combination of first-time buyers entering the market in their 30s and increasing average terms.
In a separate report the FCA raised concerns about the challenges consumers face in making effective and informed choices, when it comes to picking the best mortgage product. The issues facing consumers, according to the regulators investigation, included not being able understand the complexity of products, then correctly assessing and acting on information about the mortgage products being put to them. Also, a lack of transparency in relation to fees and charges, or behavioural biases were also highlighted by the FCA report.
Christopher Woolard, the authority’s director of strategy and competition, said: ‘While it was encouraging to see firms embrace the spirit and the letter of the FCA rules.
‘There appears to be more to be done to improve competition in the mortgage sector, with competition playing a key role in ensuring that the sector works well.’
Potential issues relating to lending to older borrowers and the affects of lending on the ageing population may have, will also be included in a new market study which is expected to be launched at the end of 2016. The study will also address whether existing tools, such as price comparison websites, help consumers and if more intermediation in the mortgage sector would have a positive or negative effect.