Regulation  

FCA concern over lenders unable to quantify ‘zombie’ threat

Lenders do not yet have sufficient systems in place to quantify the threat of sharp rises in the base interest rate on so-called ‘zombie’ households, the Financial Conduct Authority has warned in the latest published findings from its ongoing review into the sector.

In a paper published today (25 February) the regulator states it is concerned over risks to mortgage borrowers from potential interest rate rises, saying it wants to ensure lenders have strategies in place to ensure those borrowers likely to be affected will be treated fairly.

It adds that although all eight firms in the review support the principle of treating customers in financial difficulty fairly, most were found to not have “robust strategies in place to fully assess the impact of potential interest rate rises on borrowers in arrears or those susceptible to arrears”.

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The watchdog does praise two unnamed lenders which it says have made changes to processes to identify affected borrowers.

One firm has developed a performance tracking system to “proactively segment their pre-arrears population”. Scenario testing was undertaken to assess the impact that stressed conditions would have on those groups, the FCA explains.

Another firm is actively developing a “proactive contact strategy which used the outputs of an analytics model”. The regulator says the firm contacted borrowers if there was a high risk the loan would move from performing to being one or more payments in arrears in a defined period.

The FCA said both these strategies allowed the firms to develop “effective early engagement strategies and offer proactive solutions or money advice which increased the chance of better outcomes for both customers and the firm”.

Concerns over the effects of rate rises have lingered over the past several years as experts warn of an increasing number of ‘zombie’ households which have seen cost of living outpace wage rises and have avoided default on their mortgage only by virtue of the record-low base rate.

Fears came to a head recently when unemployment unexpectedly lurched close to the 7 per cent threshold below which initial Bank of England forward guidance suggested it may consider increasing rates.

Governor Mark Carney has since sought to assuage fears of a rapid rise being imminent by issuing further guidance stating rates will not be hiked until “spare capacity” in the labour force has been absorbed and then any increase would be ‘gradual’ and “limited”.

The FCA warns that household debt-to-income remains high and unsustainable levels of debt remain a “key driver” of financial distress for UK borrowers.

This, and the possibility of further debt accumulation, leaves some households exposed to potential interest rate increases, income and expenditure shocks and changes to credit conditions, the regulator adds.

In particular, lower income and ‘credit-hungry’ borrower groups will be particularly affected as they have a “higher than average concentration” of negative equity.

The regulator added that low rates and improvements in funding conditions for lenders are likely to have supported firms’ forbearance strategies. The overall cost of forbearance to borrowers can be high once fees, charges and interest costs are included as well as any loss on sale.