Pandemic highlights need for FCA to change approach to forbearance

Last year was a record year for lenders offering forbearance measures with millions having been granted a payment holiday in some shape or form since the start of the pandemic. This has not only shone a spotlight on how such forbearance measures (however temporary) should be reflected on an individual's credit file going forward, it has also raised general questions around whether or not these forbearance measures are sufficiently clear and consistent or if the Financial Conduct Authority (FCA) needs to bring in new regulation in this area.

Christopher Woolard, the former interim chief executive of the FCA, in his review of change and innovation in the unsecured credit market highlighted the need for the UK regulator to adapt its approach to forbearance. Although the Woolard Review, which was published on 2 February 2021, doesn’t make any changes to FCA regulation, it sets out 26 high-level recommendations for the FCA and government, including the need for more clarity and consistency around forbearance.

What is forbearance?

The phrase "treating a borrower with forbearance" has no legal definition, but regulated lenders are required to do so under FCA rules when a borrower is "in default or arrears difficulties".

Treating a borrower with forbearance may involve the lender waiving its right to enforce the full terms of the loan or it may mean the lender contractually varying the terms of the loan, in either case with a view to supporting the borrower through their financial difficulty. Examples of forbearance would include reducing or waiving interest, allowing the borrower additional time to pay or permitting the borrower to take a payment holiday.

In the past, forbearance was exercised by lenders only once a borrower had gone into arrears, so it was not necessary to record the fact that forbearance was being exercised at the credit reference agencies (CRAs). In those circumstances, the key information that needed to be recorded was that the relevant borrower was in arrears.

However, for several years, lenders have been required to monitor their borrowers' repayment records and "take appropriate action" where there are signs of actual or possible repayment difficulties.  In practice, this means exercising forbearance before a customer is in arrears, but this has not been something that has been recorded at the CRAs.

Exposed failings

The pandemic has exposed this as a serious gap that needs to be filled. Early on in the pandemic, the FCA recognised the need to focus on the temporary financial impact that Covid-19 could have on people through no fault of their own. It, therefore, put in place temporary measures and guidance for lenders which required them to exercise forbearance by permitting payment holidays while ensuring that the relevant borrowers' credit ratings were not affected.  For those individuals who sought short-term forbearance as a result of temporary cash-flow issues, this masking of the technical arrears on their credit files was not only beneficial, but also meant that they were more likely to request the temporary help.

The review acknowledges, with hindsight, that this approach may have been a blunt instrument. There is no doubt, for some, that the economic impact of the pandemic has been severe and will not be temporary, and that there will be increased need and demand for suitable debt solutions to help them recover. For these borrowers, there is a concern that short-term masking could even be detrimental to their recovery in the short term, as some firms may be less willing to lend if they don’t have the full picture of the consumer.

However, it is clear that there are important issues to be resolved about how forbearance is reflected in credit information, and the role that this plays in decisions made by lenders and consumers. There is currently no way of recording short-term forbearance at the CRAs. This is just one of the ways in which, according to the review, credit information needs to be able to respond in a more nuanced way to borrowers' changing circumstances (see our previous Insight on the deficiencies identified by the review in relation to how credit information is shared, used and regulated).

Changes in light of the pandemic

There is a widely held concern that the numbers of individuals in financial difficulty are likely to increase as the various governmental support measures fall away, making effective forbearance measures more important now than ever. As a result the review says that the FCA must be ready to react rapidly as and when new harms are identified.

The review highlights that borrowers are currently faced with inconsistent outcomes from different lenders when seeking forbearance, and it recommends that the FCA makes its overall approach to forbearance more prescriptive and consistent across lenders. If this recommendation is adopted by the FCA, it will mean an interesting shift from the outcomes-based approach to regulation it usually follows. According to the review, a more prescriptive approach to forbearance will not only allow borrowers to benefit from these measures as quickly as possible, it will give them more clarity on various forbearance measures available and how and when these are sought.

On the other hand, the review recognises that lenders need to focus on ensuring that any forbearance is tailored to the needs of each individual borrower. While tailored approaches and consistency across lenders might not seem immediately reconcilable, it highlights the key role that digital technologies have to play here, as digital tools can enable smarter, more tailored ways to give consumers key information. This does, of course, mean that lenders may need to invest in this areas and overhaul their current automated and digital systems to better detect or assess an individual borrower's needs.

It is important to note that the review makes the key connection between what is required of lenders by way of forbearance, and what is required when it comes to assessing borrowers' affordability. Both are driving towards the same outcome, which is that lenders lend responsibly throughout the life of a loan. However, despite calls for greater clarity and consistency in this area from lenders, Woolard stops short of recommending that the affordability rules are made more prescriptive. While doing so would give greater clarity to firms, the review is not convinced that this would drive better outcomes for borrowers (see our Insight on what the review has to say about the regulatory framework for assessing affordability).

Next steps

It is likely that the FCA will, at some stage, review its approach to forbearance not only as a result of the Woolard Review, but also in order to identify learnings from the pandemic, although precise timings are unknown.

With many other areas coming out of the review requiring the FCA's attention and in light of the FCA's temporary measures already in place, it may be a while yet until we see any long-term developments in this area.

Our full coverage of the Woolard Review can be found here.