PwC UK blogs · Title: Layout 1 Created Date: 11/23/2007 5:40:00 PM
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Financial Services pwc Precious Plastic 2008 Consumer credit in the UK
Transcript of PwC UK blogs · Title: Layout 1 Created Date: 11/23/2007 5:40:00 PM
Financial Services
pwc
Precious Plastic 2008Consumer credit in the UK
Introduction page 1
Section 1: Market overview – United Kingdom page 2
Section 2: Market overview – the Euro area page 11
Section 3: The greening of financial services page 17
Section 4: Innovation page 20
Section 5: Debt/ insolvency management page 22
Section 6: The US sub-prime story – contagion or distraction? page 24
Section 7: Consumer credit operations page 27
Section 8: Regulation page 29
Conclusions page 35
About PricewaterhouseCoopers page 36
Contents
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Introduction
Today, consumers and lenders are faced with a significantly different landscape comparedto that in the recent past. Lenders, already faced with net interest yields after charge-offs at their lowest levels since the millennium, also face further threats to profitability fromcontinuing regulatory scrutiny, the contagion effects of the US sub-prime mortgage marketand the continuing high level of personal insolvencies. Consumers, meanwhile, are facedwith increased borrowing rates on secured lending (where spreads have widened due toturbulence in the credit markets) and this will put further pressure on servicing unsecureddebt. There is now evidence, as in the US, of some segments of the population dependingon revolving credit to fund normal living expenses through harder times. One thing for sureis that any growth in credit as a result of customers buying necessities is an unsustainableposition for both consumer and lender.
In light of the above, both sides of the credit agreement have some fundamental choices to make. Lenders will seek to restore profitability and this may be through higher APRs and a greater use of fees. This will seem unpalatable at first for many consumers.
As for longer term growth, more mature markets such as the UK will have to turn toinnovation (such as contactless and prepaid cards), and develop products which are moreengaging for their customers. The development of ‘green’ financial services products is oneexample where increased consumer engagement is being sought. Other sources of growthinclude continental Europe where consumer lending is relatively immature in comparison to the UK market.
After many years of rapid growth, the consumer creditmarket has well andtruly stalled. Whilstthere are a greatnumber of factors that have led to thisslowdown, we believethat consumer creditborrowing levels have reached a natural ceiling
Market overview – United KingdomSection 1
The total indebtedness of the UK population continues to rise, reaching over £1.3 trillion by June 2007 as shown in figure 1.1. This compares to UK wealth which, includingproperty, is estimated to exceed £6 trillion. The increase in borrowing represents a 9.5%increase over the previous year, broadly similar to the 9.2% growth rate observed duringthe year to June 2006.
Secured lending (i.e. mortgages) continues to be the driver of increased borrowing with agrowth rate of 11.3% during the year to June 2007. Growth in unsecured lending (i.e. creditand store cards, personal loans and overdrafts) has continued to slow, falling from 2.4% in the year ended June 2006 to just 1.1% for the year ended June 2007. These trends haveresulted in secured debt accounting for an increasing proportion of total outstanding debt,standing at around 84% in June 2007.
Total borrowingcontinues to increase
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2002 2003 2004 2005 2006
Tota
l len
din
g in
(£ b
n)
02007
200
400
600
800
Total lending Growth rate
1,000
1,600
0%
Gro
wth
rat
e
2%
4%
6%
8%
10%
12%
14%
16%
1,200
1,400
Figure 1.1: Total lending and growth rate
Source: Bank of England, PwC analysis, all dates as of June 2007
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Figure 1.2 shows total consumer credit together with annual growth rates. In 2005, wepredicted the significant slowdown in growth rates of consumer credit balances that hasnow occurred and last year we posed the question of whether a natural ceiling had beenreached for this lending. After a period of consistently high annual growth rates of around10% during the first half of the decade, much lower growth rates have been experiencedfor two consecutive years. This does tend to support the hypothesis that, for now, thisceiling has been reached.
2002 2003 2004 2005 20060%
Gro
wth
rat
e
2%
4%
6%
8%
10%
12%
14%
Total lending Growth rate
2007
Tota
l uns
ecur
ed le
ndin
g (£
bn)
0
50
100
150
200
250
Figure 1.2: Consumer credit outstanding balances and growth rate
Source: Bank of England, PwC analysis, all dates as of June 2007
The last two years have represented a challenging period for the UK credit card industry,whether assessed in terms of outstanding balances or total credit cards in issue.Outstanding credit card receivables fell slightly from £66.3 billion in June 2006 to £64.7billion in June 2007 as shown in figure 1.3. As a consequence, however, of the decliningnumber of credit cards in issue, the average outstanding balance per card hasincreased, at a compound annual growth rate of 5.4% over the last four years to June2007. This implies that the risk embedded in portfolios has increased as default risk is now spread over fewer cards. In 2006, we highlighted the increasing prevalence of balance transfer fees and consolidation following the introduction of ‘Chip and PIN’ as plausible reasons for the falling number of credit cards in issue. We also noted thatthere was anecdotal evidence of a reduction in acceptance rates and, as explainedbelow, there is now firmer evidence to suggest that this has been a feature of the market over the last 12-18 months.
Credit cards in issue andoutstanding balances
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Dec2001
Cre
dit
card
out
stan
din
g b
alan
ces
(£ b
n)
Credit card outstanding balances No. of credit cards in issue
40
45
50
55
60
65
75
70
Jun2002
Dec2002
Jun2003
Dec2003
Jun2004
Dec2004
Jun2005
Dec2005
Jun2006
Dec2006
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70
40
45
50
55
60
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75
70
No.
of c
red
it ca
rds
in is
sue
(m)
Jun2007
Figure 1.3: Credit card outstanding balances and cards in issue
Source: British Bankers’ Association, PwC analysis
2000 2001 2002 2003 2004
Exp
end
iture
(£ b
n)
10
20
30
40
50
0
Credit cards Debit cards
2007
60
2005 2006
Figure 1.4: Spending on the high street (quarterly)
Source: APACS, PwC analysis
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Debit cards have cemented their position as the dominant force in plastic card spendingon the high street. While expenditure on credit cards has remained broadly stable inrecent times, figure 1.4 shows that debit card usage continues to grow rapidly. Ironically,credit card issuers that are also debit card issuers would probably have preferred a trendtowards credit rather than debit because of the more favourable interchange environment.There are a number of possible reasons for the observed growth in debit card usagecompared to credit cards. Debit cards are probably viewed as a closer substitute for cashthan credit cards and the falling popularity of cash payments would be expected to givedebit card usage a greater boost. In addition, as discussed below, many consumers havefaced increased debt servicing costs in recent years and are reluctant to borrow further.Those attempting to reduce their overall indebtedness may be cautious about using creditcards, even if they intend to pay balances off at the end of the month. A further factor mayrevolve around the manner in which credit cards have been marketed in recent years. As part of their drive to maintain portfolio profitability, issuers have been emphasisingborrowing capability rather than their utility as a tender type. Increasingly, therefore, cards may be being seen as a method of borrowing rather than a means of payment.
Slowing rates of growth in credit card balances in recent years partly reflect the maturestate of the UK industry, along with the well-documented high overall indebtedness of the average consumer. The Bank of England has noted (through its 2007 Inflation Reports)that the ratio of household debt to annual income has risen by around a half since thestart of the decade, to 160% in Q1 2007 and that over that same period the percentage of the population becoming insolvent has risen from 0.08% to 0.27%. These factors areundoubtedly making many consumers more wary about taking on extra unsecured debt.
During 2006 and 2007, certain demand and supply factors, which we explore below inmore detail, became more pronounced and these are likely to have driven the transitionfrom subdued growth to absolute falls in outstanding balances.
Although base rates increased from 4.75% in August 2006 to 5.75% by August 2007, as shown in figure 1.5, average APRs have not increased during that period. The directimpact of base rate increases on aggregate demand for credit card borrowing wouldtherefore appear to be low.
What are the driversof subdued creditcard lending?
2001 2002 2003 2004 2005
%
2
4
6
0
APR Base rate
20072006
8
10
12
14
16
20
18
Spread
Figure 1.5: APR versus base rate
Source: Bank of England, PwC analysis
As far as the supply of consumer credit is concerned, in Precious Plastic 2007, wecommented on the increased focus on responsible lending and anecdotal evidence thatacceptance rates were falling. The biggest issuers have continued to focus on reducingtheir exposure to higher-risk customers by implementing stricter lending criteria and also managing risk associated with existing customers through the selective tightening of credit limits.
The more significant channel through which base rate increases have subdued demandfor unsecured credit is that many households are facing greater overall debt servicingcosts following increases in mortgage rates, and their capacity to service incrementalunsecured debt has therefore fallen. Figure 1.6 illustrates the dramatic increase inmortgage interest payments as a percentage of income over the last four years, driven byrising interest rates and house prices. As many homeowners reach the end of fixed-termmortgages they will find themselves exposed to mortgage rates that are substantiallyhigher than when they last fixed in 2004 and 2005, and these households will continue to feel stretched (we explore the potential impact of this further in section 6). Reducedcredit card borrowing is often the simplest and most immediate way in which consumerscan achieve a reduction in overall indebtedness. Indeed, consumers do appear to berepaying credit card debt to a greater extent. Research indicates that over the course of 2006, monthly repayments of credit card advances represented 97% of borrowing. This is the highest repayment rate since the relevant data was first collected in 1997.
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2002 2003 2005
% o
f inc
ome
12
1020072006
14
16
18
2004
Figure 1.6: Mortgage interest payments as percentage of income
Source: Council of Mortgage Lenders, PwC analysis
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The 2007 interim results of the largest issuers suggest that the actions taken to reduce credit exposure to riskier customers have played an important part in managingimpairment charges.
However, in improving the average credit risk of their books, issuers are likely to experiencechanges in the shape of their income statement. They can expect a reduction in bothinterest and fee income. Typically one would expect to achieve a lower interest margin on higher-quality accounts reflecting reduced credit risk. Combined with the lowerpropensity of such customers to revolve their balances, issuers are likely to experienceincreasing pressure on interest income. Since the probability of delinquency falls as averagecredit quality improves, income arising from late and over-limit fees would also be expectedto fall as impairment performance improves.
Issuers will need to manage this income statement dynamic such that the reduction in impairment is greater than any related loss in interest and fee income.
In previous issues of Precious Plastic we have commented on our expectation of anincreasing focus on selective retention of existing customers, due to the declining numberof cards in issue and the need to identify and keep profitable customers. The number of cards in issue continues to fall and other factors highlighted above will ensure thatcustomer retention will remain a key objective for many lenders. Issuers hold a great deal of information on existing customers in terms of their spending habits and repaymenthistory. This information will prove to be more valuable than ever as issuers attempt to reinvigorate expenditure and borrowing growth on existing accounts where historysuggests credit risk is lower.
We previously predicted that the drive to improve customer retention would result in issuersplacing a greater emphasis on reward and loyalty schemes, whether offered directly by the issuer or through co-branding arrangements. There is some evidence to indicate thatco-branded and affinity cards are becoming an increasingly important segment of themarket. The number of affinity and co-branded cards in issue has increased from around 7 million in 2002 to over 13 million in 2006.
We expect the growth in co-branded cards to continue. Established partnership schemeswith strong brands will continue to be attractive to issuers as the loyalty of card holders tothe partner’s product will help increase long-term retention. Competition to retain profitablecustomers with low credit risk is likely to intensify and there will be downward pressure oninterest margins for that market segment. Again, this may make co-branding arrangementsattractive as they will allow issuers to compete by offering a differentiated product, ratherthan just competing on price.
Overseas expansion by UK issuers has been a feature of recent years and we expect thistrend to continue. Credit card issuance is a scale business and those issuers currentlyexperiencing, or facing the prospect of, net attrition in outstanding balances in the UK will be keen to maintain and grow balances through other channels. We believe thatinternational issuers will continue to seek to expand their overseas customer base through direct acquisition, organic growth and partnership deals.
A renewed focus on creditquality will have an effecton the shape of the typicalincome statement
UK issuers willincreasingly focus on selective customerretention and overseasexpansion could moveup the agenda
Will card profitabilityrecover?
In Precious Plastic 2007 we talked about ‘the waterbed effect’, whereby issuers seek tomitigate the impact of ‘lost income’ from regulatory actions. There is strong evidence tosuggest that this effect was in play following the decision of some issuers to reduce lateand over-limit fees to £12 in June 2006 in response to OFT pronouncements. As a result,we have seen the selective introduction of new fees to replace this income, for example, on dormant or low-activity accounts.
Last year we reconfirmed our belief that it is only a matter of time before annual fees on credit cards become the norm, but given that lenders are reluctant to be the first to introduce fees across the board in the current competitive market, it is hard to say when this development will occur.
Whilst issuers have not yet taken the leap to introduce fees in the mainstream card market,there have been further examples of annual fees being introduced on selective products.For some years there has been a small market for ‘exclusive’ credit cards wherebyconsumers receive access to premium services (eg concierge service and access to airportlounges) for a sizeable annual fee. The exclusivity of such cards is reinforced by highminimum income requirements for applicants. A more recent development is that issuersare now introducing fees on cards which are not positioned as ‘exclusive’ and are marketedto a much wider audience. Annual fees on such cards are as low as £24 and the benefitsless sizeable (eg limited travel-insurance cover). This strategy is not dissimilar to thatincreasingly adopted by the retail banks in respect of current accounts, namely encouragingcustomers to upgrade their account for a modest monthly fee in return for a range ofmainstream benefits and preferential interest rates.
In Precious Plastic 2007, we highlighted the continuing trend of falling net interest yieldsafter charge-offs for credit cards. Figure 1.7 indicates that whilst the rate of decline over thelast 6 months has been less severe than the 12 months to December 2006 this profitabilitymeasure continued to fall.
Credit card fees
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PwC estimates that net yields after charge-offs now stands at around 2.2%, a fall of around9 percentage points over the last 7 years. This equates to 'lost profits' of around £4 billionfor the market.
Future delinquency trends will play an important role in determining whether cardprofitability will recover. Many in the industry have called the ‘peak’ in defaults after therecent increases, however, we believe that recent market turbulence, increasing mortgagecosts and a backlog of Individual Voluntary Arrangements (IVAs), which we explore in detailin section 5, could lead to an increase in impairment charges in the next 12-24 months.
Financial institutions will increasingly be put under pressure to re-price their back-book.Some of the strategies we believe issuers are likely to pursue in the near future, to combatthe above pressures, will result in costs being incurred in the short term with full benefitsbeing enjoyed later. For instance, entering into new partnerships or expanding overseasbusiness normally results in such an income and cost profile. Similarly, attempts to re-invigorate lending in the UK through enhanced loyalty schemes are likely to requireinvestment in the short term. So whilst we see clear potential for issuers to improve netprofitability in the medium term, significant improvement in the short term is less likely.
Net
yie
ld %
2%
4%
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8%
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0%Dec2000
Jun2001
Dec2001
Jun2002
Dec2002
Jun2003
Dec2003
Jun2004
Dec2004
Jun2005
Dec2005
Jun2006
Dec2006
Jun2007
Figure 1.7: Net interest yield after charge-offs
Source: Standard & Poor’s, Bank of England, PwC analysis
In April 2007, Barclaycard sold part of its Monument portfolio to CompuCredit, a UScompany that specialises in lending to consumers underserved by traditional financialinstitutions. Barclays announced that it was retaining ‘primarily higher quality accounts’ and would integrate these receivables into the main Barclaycard-branded book. Morerecently, SAV Credit acquired 338,000 credit card accounts branded as Marbles andBeneficial from HSBC.
Portfolio sales and purchases designed to reduce or increase exposure to certain market segments are an increasingly prominent feature of the credit card market. Rapidlyincreasing impairment charges have forced issuers to revisit the risk mix of their portfolios.Many issuers have tightened lending criteria over the past year or so and this wouldsuggest that issuers are exposed to legacy loans that they would be unwilling to granttoday. Whilst the revolving nature of credit card loans means that exposure to legacyrecruitment will reduce quickly compared to other forms of lending, issuers may find debt sales an attractive way of achieving their desired risk exposure quickly.
The price achieved for any debt sale will obviously reflect the risk of the loans being sold.However, there are real benefits to be harnessed if the purchaser of debt is able to extractmore value from legacy portfolios when compared to the original issuer. For instance, a speciality lender may be in a better position to adopt more efficient collection strategiesfor the worst-performing debt and may be more willing to adjust interest rates such thatthey better reflect the risk profile of the portfolio.
Credit card portfoliosales and othertransaction activity
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Con
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er c
red
it /
GD
P
0%
2%
UK
Greece
SpainFranceGermany
Italy
Consumer credit growth (CAGR 2003-2007*)
4%
6%
8%
10%
12%
14%
16%
18%
20%
-5% 0% 5% 10% 15% 20% 25%
Austria
LuxembourgNetherlands
Finland
SloveniaPortugal
Ireland
Figure 2.1: Consumer credit growth versus consumer credit /GDP
Notes: Size of circles represents total consumer credit relative to other countries* With the exception of Slovenia with a CAGR between 2004-2007
Source: Bank of England, Eurostat, Deutsche Bundesbank, PwC analysis
Market overview – the Euro area
The Euro area has enjoyed a period of robust growth over the last two years and the consensus forecast GDP growth rate for 2007 was 2.4% as of September 2007.Unemployment has fallen by nearly two percentage points since its peak in 2005, with improved employment growth. The European Central Bank (ECB) predicts that thispositive trend will continue, although it notes a number of mainly external downside risksin the longer term. The ECB notes that the European Commission measure of consumerconfidence has risen sharply and by May 2007 had reached its highest level since 2001,before declining slightly in June and July 2007.
Below we compare consumer credit as a percentage of GDP to consumer credit growth(between 2003-2007) for a number of countries:
Whilst, logically, countries with consumer credit as a lower proportion of GDP may be expected to sustain higher growth rates in consumer credit, the plot of data pointsprovides little evidence of such correlation and cultural factors remain a key influencer.
Consumer credit acrossthe Euro area
Section 2
Figure 2.2 shows consumer credit as a percentage of GDP for a number of EuropeanCountries. The general picture is one of subdued growth – largely explained by the fact thatunderlying private consumption has been subdued. In an environment where consumersappear unwilling to spend, significant increases in consumer credit balances are unlikely.
It is difficult to pinpoint the reasons for subdued consumption in the Euro area, especiallygiven the fact that consumers appear to be more confident about the future performance of the economy. The reasons are more complex and less homogenous than one would firstbelieve due to specific cultural and regulatory differences. The drive to make labour marketsmore flexible in many European countries is one plausible explanation put forward by theECB. Whilst consumers may feel that the outlook for the economy as a whole is positive in terms of rising employment and strong growth, the increasing prevalence of temporarywork, changes to pension provisions and other social security reforms mean thatconsumers fear some volatility in their own households’ future income-streams.
Rising interest rates across the Euro area may have constrained demand for consumer debt in some countries. The main ECB bank rate has doubled from 2% in June 2003 to 4% in June 2007. Whilst base-rate increases have not been passed on in full, mortgagerates have risen and this has resulted in a rise in the debt-servicing burden since 2003.
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Con
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er c
red
it /
GD
P
0%2002 2003 2004 2005
2%
4%
6%
10%
12%
UK
2007
14%
20%
16%
Greece
Spain
France
Germany
Netherlands
Italy
2006
8%
Ireland
18%
Figure 2.2: Consumer credit as a percentage of GDP
Source: Eurostat, OECD, Deutsche Bundesbank, PwC analysis, all dates as at December (except 2007, June)
Debt servicing burden hasincreased in recent years
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The extent to which consumer credit markets are impacted by the return to a higher interestrate environment varies between different countries. Higher rates will tend to constraindemand in countries such as Spain and Ireland where variable rate mortgages are popular,a high proportion of households own their houses and house-price inflation has been rapidin recent years. By comparison, the impact would be expected to be much smaller in acountry like Germany where home ownership is lower, mortgage interest rates are generallyfixed and the housing market has been weak. In France, cultural preferences towardslonger term fixed rate mortgages and both product specific and cultural restrictions on the institutional ‘pushing’ of credit are potential causes of the lower growth in credit.
However, specific countries need to be analysed further to understand whether consumercredit will grow. We expect, for example, the recent change in co-branding rules in France to have an impact on the overall levels of consumer borrowing. Until 1 October 2007, co-branded credit cards were not permitted in France and general purpose credit cards wereonly offered by banks to their current account customers. With co-branding now permitted,we believe this offers a significant growth opportunity and we are likely to see a proliferationin the number of co-branded cards on offer in the next 12 months. For example, in October2007, Société Générale, via its subsidiary FranFinance and the tour operator NouvellesFrontières, was one of the first co-branded cards to be launched. The partners have set a target of 150,000 cardholders for the new card by June 2008. Most of these will berecruited from among holders of the existing Nouvelles Frontières charge card.
19910
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1993 1995 1997 1999
6
1992 1994 1996 1998 2000 2001 20032002 2004 2005 2006
Interest payments Capital repayments
% o
f dis
pos
able
inco
me
Figure 2.3: Total debt servicing burden of the Euro area
Source: ECB, PwC analysis
The continued reluctance of consumers in some European countries to extend exposureto unsecured debt contrasts with their increasing willingness to use plastic cards as a means of payment. Expenditure on plastic cards has grown steadily in recent years, in most European countries.
There are a number of possible reasons for the increasing willingness to use plasticcards. The rise of e-commerce over recent years has undoubtedly played a part, asplastic cards are the natural payment method for products and services bought on-line.Increased international travel has also tended to increase the attractiveness of creditcards associated with the major international card schemes. In the longer term,generational factors will also tend to lead to the increased use of plastic cards.
The relationship between expenditure and borrowing on credit cards across Europe is a complex one. Generally, increased expenditure on credit cards is necessary, but not sufficient in itself, to result in an increase in revolving balances. Many consumers use credit cards for a large proportion of everyday expenditure, but pay off the balancein full every month, meaning that they will never actually incur interest charges.
Expenditure onplastic cards
Expenditure versus borrowing
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Figure 2.4 shows the relationship in a number of European countries between growth ratesin credit card expenditure and the growth rate in consumer credit balances. As one mightexpect, the chart indicates some correlation, however a strategy of actively encouraginghigher levels of spend is unlikely to be sufficient to acquire interest-earning balances in the longer term.
Overall, the picture in Europe remains fragmented. While some countries – such as Italy,Greece and Spain – seem to be following the UK model, others – such as Germany andThe Netherlands – have seen reluctance amongst consumers to significantly increase theirborrowing. Indeed, in the case of Germany, there has actually been a contraction in theconsumer credit market.
The consumer credit markets of Central and Eastern Europe have expanded rapidly overrecent years, although data for a complete picture of consumer borrowing is hard to obtainon a like-for-like basis. The growth in credit card usage – whether measured by the numberof cards in issue, or by the value of expenditure – is impressive. Our analysis in figure 2.5 of a number of emerging countries illustrates the potential for significant increases in creditcard penetration as GDP increases.
A closer look at Europe’semerging markets
Con
sum
er c
red
it gr
owth
(CA
GR
200
2-20
05)
5%
UK
Greece
Spain
Finland
Germany
Netherlands
Italy
Credit card expenditure growth (CAGR 2002-2005)
10% 15% 20% 25% 30%0%
5%
10%
15%
20%
25%
30%
35%
0%
-5%
-10%
Figure 2.4: Consumer credit CAGR versus credit card expenditure
Source: ECB Blue Book, December 2006, PwC analysis
Expansion of credit card lending in less established European markets will not be withoutrisk, however. Rapid expansion of credit over short periods of time tends to increase therisk of issuers making sub-optimal lending decisions. The consumer lending crisis thatgripped South Korea in 2003 demonstrates that these risks are not trivial. The risk ofmaking poor lending decisions is higher where the consumer credit market is in the earlystages of development, as there is less historic data available regarding consumers’behaviour. Since credit card penetration is significantly lower in emerging Europeancountries than in mature markets, simply issuing more cards is a key lever for growth. It will take some time for issuers to build payment history data on these customers, many of which will never have held a credit card before. Indeed, the case for some of the larger local banks to support the development of local credit-rating agencies is not at all clear, as doing so would only make customer acquisition easier for the less established competitors.
In the coming years, issuers will need to maintain a careful balancing act between therisks of default versus the rewards of growing the customer base. History suggests thatthis may be best achieved through measured expansion, rather than a dash for growth.
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Cre
dit
card
s p
er h
ead
(200
5) UK
Czech Republic
LithuaniaPoland
HungaryItaly
GDP per head v 000s (2005)
10 20 30 400
0.2
0.4
0.6
0.8
1
1.2
1.4
0
France
Figure 2.5: Credit cards per head versus GDP per head
Source: Blue Book 2006 (ECB), PwC analysis
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The greening of financial services
The recent launch of GE’s new Earth Rewards credit card in the US is one of a number of initiatives by financial services companies to take advantage of increasing consumerawareness of green issues. We expect to see many more in the upcoming months.
Global warming and climate change is undoubtedly a hot topic in many territories aroundthe world and fast becoming an electoral issue in countries such as the US and Australia. In the UK, the number of climate change related articles published has increased sharplyover recent quarters as highlighted by figure 3.1. It is clear that the tipping point has nowbeen reached both in terms of awareness of the issue and also concerns as to the impactand therefore the need to take action.
Ethical causes have come and gone in the past, but we believe that this is an issue that is here to stay. What was once the preserve of eco-warriors has gone mainstream. The core values of financial institutions now increasingly include protecting the environment and limiting the impact of their business activities on climate change. Whilst the rationalefor some adopting such a stance may be driven by true concern, others recognise thepositive impact that investment in this area can have on their image with current and futurecustomers and staff.
One of the first major global banks to go carbon neutral was HSBC, which in May 2007announced a five-year, US$100 million programme to tackle climate change worldwide with the support of various NGOs and environmental organisations.
Most of the green initiatives to date have been at a corporate level, focusing internally on company operations such as declarations of programmes geared to achieving carbonneutrality. However, thinking on this issue is evolving and banks are increasingly identifyingcommercial opportunities linked to the introduction of ‘green’ products that capitalise on the increasing green awareness of their customer base.
Media interest in climatechange related topicscontinues to growexponentially
Section 3
0 1000 3000
Per
iod
Number of media articles
60004000
Q1 2007
2000 5000
Q4 2006Q3 2006Q2 2006Q1 2006Q4 2005
Q3 2005Q2 2005Q1 2005
Q4 2004Q3 2004Q2 2004Q1 2004Q4 2003Q3 2003Q2 2003Q1 2003
Figure 3.1: Number of media articles on climate change related topics
Note: Number of media articles containing one or more of the following phrases in the United Kingdom(source: Factiva): climate change, global warming, greenhouse gas, greenhouse effect or Kyotoprotocol. The search covers the first 50 words of any major UK media sources recorded by Factiva
Source: PwC analysis
‘Green’ credit cardpropositions areevolving rapidly
A number of UK businesses have launched innovative financial products such as ‘green’mortgages and car insurance policies that offer some off-setting of the impact of car usage.Probably the biggest area of opportunity though is in the credit card market. Early adoptersof eco-friendly consumer solutions opted for simple ways to help the environment, such asintroducing paperless statements and recycling plastic cards. However, financial institutionsare currently launching more complex propositions which offer incentives to make being‘green’ easier for their customers.
Consumer research, carried out in the UK by PwC in May 2007, illustrates the growingappetite for financial products aimed at addressing climate change. For example, whenasked whether they would take up a credit card that makes their purchases carbon neutral,53% of PwC’s survey respondents said they would be quite, or very, likely to do so (see figure 3.2 below).
Customers were also asked whether they would convert their existing loyalty programme or cash back to a carbon-neutral card, with around 40% responding positively to this. This suggests that ‘green credit cards’ have significant potential to displace existing cards.
In July 2007, Barclaycard launched the Breathe credit card, which donates 50% of itsprofits to environmental projects dedicated to reducing carbon emissions around the world.Barclaycard has committed to donating a minimum of £1 million in the first year of theprogramme. It is too early to comment on how successful this initiative will be, but otherbanks will most probably be following it with interest.
An example with a longer track record can be found in The Netherlands, where LaSer (a subsidiary of BNP Paribas) in partnership with Repay launched the GreenCard in 2004.Through the card, the issuer commits to investing in a compensation fund to directly offsetthe carbon footprint associated with individual spend on the card. Customers receivemonthly information on their carbon footprint and details on how this is offset. Seeing thesuccess of the GreenCard, Rabobank, one of the largest banks in the Netherlands, is in the process of converting their entire card base to the GreenCard concept using the carbonfootprint calculation model developed by Repay. Repay is currently rolling out the conceptin the major credit card markets.
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Don’t know
Unlikely
Neither/Nor
Likely
0% 10% 20% 30% 40% 60%
2%
32%
13%
53%
Question: If a card supplier was able to offer you a credit card which enabled you to makecarbon neutral purchases at a competitive APR and with similar terms to your current creditcard, how likely or unlikely would you be to take up the card?
50%
Figure 3.2: Carbon neutral credit card survey
Source: PwC analysis
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A winning proposition will be one that promotes real engagement with customers, givingthem a sense of personal responsibility towards the environment and empowering them to do something about their impact on the environment. A successful product must educateconsumers on the effect their actions may have on the environment and, at the same time,enable them to consider how to ‘do their bit’. In view of the many differing opinions on howbest to offset carbon emissions, the credibility and transparency of such offerings willclearly be vital.
While brand image and reputation might have triggered environmental responsibility policiesto begin with, the phenomenal level of public attention currently focused on global warmingis certainly having an impact on the culture and values of financial institutions. Recentrecognition of new business opportunities attached to climate change issues is rapidlyincreasing interest and investment in this product space.
Whatever the motivation behind the introduction of innovative ‘green’ solutions, successfulproducts will have some common key elements: strength of the proposition, connectionwith customers and credibility. We believe that successful ‘green’ products have thepotential to generate true customer loyalty.
Brand image, true belief,or business opportunity?
In September 2007, Barclaycard launched its contactless payment card in London. Inaddition to allowing customers to pay for transactions of £10 and below simply by wavingtheir card over a reader, significantly reducing payment times, it also acts as a generalpurpose credit card and can be used on London transport. In today’s convenience-drivensociety, anything that reduces payment queuing time is likely to prove popular withconsumers. More recently, Halifax announced that it would also begin issuing its firstcontactless payment cards to customers in London, with a plan to roll-out contactlesspayment technology across the rest of the UK from the middle of 2008.
Others are also adopting the contactless payment model in innovative ways. In London, the Evening Standard newspaper has launched a closed-loop contactless payment system,called Eros, which offers consumers discounts for buying papers with the card. A furtherexample is a new government initiative to help disadvantaged young people take part inpositive activities of their choice by making funds available to nine local authorities aroundthe country in a pilot project that includes pre-paid debit and contactless cards. Bolton is one of the local authorities taking part in the scheme. Using its existing 'Bolton Smart'card, the Council is to include a specific e-purse facility provided by sQuidcard, the e-money provider. £35 per month is uploaded to the card, to be spent on activities which include leisure centres, museums and theatres. The council is also working withManchester Passenger Transport Authority to have the sQuid-enabled card accepted on buses as well. In addition, the sQuid purse will further enable any Bolton Smart cardholder to make tap-and-go payments for newspapers, cups of coffee and a myriad of other low-value purchases. sQuid's partnership with Bolton Smart is spearheading a national roll-out planned for 2008/9.
PwC estimates that by the end of 2008 there will be 5-6 million contactless enabled cardsin issue in the UK and it is expected that there will be around 100,000 accepting merchants.With Visa estimating that around 80% of the 27 billion cash payments made annually by UK consumers are for £10 or less, contactless payments look set to become the norm. The United States has seen rapid adoption of contactless payment technology. At the endof 2006, there were 26 million contactless-enabled credit and debit cards with a further 35 million expected to be issued during 2007.
There will be a limit to the number of different schemes that are successful, and we expectfirst movers to have a significant competitive advantage. The keys to success will be a clearcustomer proposition and a wide range of accepting outlets.
Over the past decade mobile phones have revolutionised consumers’ habits, withsignificant penetration rates. Mobile phone functions have expanded rapidly and are nowmoving into the payments space, with the aim of providing an alternative to cash andcards. Some financial institutions already allow customers to retrieve account balances and a history of transactions via their mobile phones, as well as purchase instant top-upsfor pay as you go mobiles.
In order for mobile payments to become attractive and successful, customers need to be reassured that making payments through their mobile phones is secure. Transactionsshould be easy and understandable, with low and transparent tariffs and user-friendlyhandsets. While customer needs may differ depending on territories and demographics, the range of services offered is a key element and should include basic services such as retail payments, person-to-person transfers, withdrawals, deposits and transfers to other accounts.
Mobile
Innovation
Contactless
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Section 4
Contactless, mobile and pre-paid: the beginning of the end for cash?
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The UK’s five largest mobile phone companies have recently introduced a payments systemthat allows for the purchase of goods and services with a value of up to £10. While initiallyit is expected that this facility will be used to pay for ringtones, train tickets and parking, in the future it is expected that it will be used for payments on websites and in shops.
There have been a number of similar roll-outs throughout Europe. In 2006, Visa Europelaunched the first secure mobile payment system, ‘Verified by Visa’, in Switzerland. The firstEuropean shop to offer this innovative service was Sunrise music finder, where consumerscan look for songs via their mobile phones and order CDs. The new service covers thewhole purchase process, allowing consumers to select, order and pay for the productthrough their mobile phones.
Mastercard has already established relations with the major US banks to offer mobilepayments in 51,000 shops and restaurants globally, and is considering trialling mobilepayments in the UK. PwC believes that integrating and converging mobile paymentsrepresents the next wave of strategic innovation in the payments arena.
There is another challenge to the continued widespread use of cash in the UK: pre-paidcards. In Precious Plastic 2007 we commented on the growing popularity of pre-paid cardsfor use abroad. Since then, the use of pre-paid cards has expanded into other segments,with immigrants to the UK and young adults seen as key growth areas (since thesecustomers would typically not be able to obtain a standard credit or debit card). 2006 sawthe launch of a number of pre-paid cards aimed specifically at these customers, including a number of cards co-branded with youth television stations and magazines.
As pre-paid cards become more popular, they will become increasingly important tools for customer acquisition. Issuers will be able to build brand loyalty and gather data oncustomers using these cards; with the potential to move them onto a revolving facilityshould they meet the lender’s credit acceptance criteria.
Pre-paid
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2002 2003 2004 2005
Volu
me
5,000
10,000
15,000
20,000
30,000
0
Total Bankruptcy IVAs
2006
25,000
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2
35,000
2007
Q3
Figure 5.1: Quarterly volumes of personal insolvencies (seasonally adjusted)
Source: Insolvency Service, PwC analysis
Debt/insolvency management
Total insolvencies reached a peak in Q4 2006, with 29,715 filed insolvencies. A total of44,332 IVAs were recorded in 2006, representing an increase of 118% on the prior year. By contrast, in the first three quarters of 2007, we have witnessed a fall in the number ofIVAs and bankruptcies. However, PwC currently believes that there is insufficient evidenceto confirm whether the long-term trend is now downwards.
The rapid increase in IVAs became a board-level issue in 2006 at many of the large retailbanks. 2007 saw mounting pressures between banks and insolvency practitioners (IPs),although we believe this is now subsiding. Average returns from IVAs in most instances are expected to be higher than in bankruptcies, and lenders are faced with the dilemma of voting against IVAs, and potentially seeing a consequent increase in bankruptcies.
The banks’ main focus has been on the fees levied by IPs, which many felt to bedisproportionate to the work involved and the returns offered. This led to the rejection of many IVAs in 2007. An initiative by the British Bankers’ Association and the InsolvencyService is attempting to reach a compromise, particularly, but not solely, on fees. Thesediscussions, as well as fairly flat levels of unsecured borrowing in the past two years, are contributing factors to the downward trend in IVAs witnessed in recent quarters. If agreement is reached on fee levels, IVA numbers may begin to rise again, particularlygiven recent mortgage interest rate rises and the consequent added pressure on household budgets.
Personal insolvenciesappear to havestabilised, but thisisn’t necessarily the full picture
Section 5
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One bone of contention for the banks has been the high-profile advertising campaignslaunched by IPs on television, on the internet and in the press. There have been a numberof complaints to the advertising watchdog and four have been upheld. In particular, thepractice of claiming that borrowers can write off ‘up to 75%’ of their debts has angeredlenders who see it as an invitation to dump debt, regardless of whether it can actually be paid. Whilst advertising did contribute to the huge rise in IVAs between 2004 and 2006,we believe that in many cases it merely assisted in satisfying a demand for debt solutionsthat had been building since 2000. Advertising created awareness of the solution, theinternet and freephone numbers gave borrowers access, and, as numbers increased,acceptance of formal insolvency grew amongst the public.
The trend over the next 12 months will partly be influenced by the outcome of thenegotiations between banks and IPs. If there is no agreement, we expect that IVAs willcontinue to fall, possibly with a consequent increase in bankruptcies. However, onceresolved, there is potentially a backlog of IVAs which would result in an increase in early 2008. A further factor will be interest rates. Successive hikes in 2007 are likely to be putting pressure on those people who have over-borrowed and increases the likelihoodof them spilling over into insolvency. Whilst the Bank of England may now be underpressure to lower interest rates due to recent market turbulence, widening interest ratespreads look set to increase further in 2008 and therefore we do not foresee any majordecrease in insolvencies in the near future.
Advertising pressures
Forecast trends inpersonal insolvencies
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The US sub-prime story –contagion or distraction?
The state of the US consumer lending market is changing day by day. Driven primarily bylending to sub-prime mortgage borrowers and investor demand for mortgage-related debt,the US mortgage market is now undergoing a significant correction which has impactedinvestor appetite for all forms of debt. We consider below whether the US story could have a contagion effect for the UK, with specific reference to unsecured lending.
At the time of writing, US delinquencies have continued to rise across US prime and non-prime mortgage products, but are particularly pronounced in sub-prime. Delinquencyrates on residential lending are at their highest levels since 2001. In addition there is a significant amount of uncertainty driving capital markets’ perceptions and appetite for consumer-related debt. There are concerns about house price falls, the estimated US$1 trillion of Adjustable Rate Mortgages (ARM) resets coming over the next year and poor housing market statistics. Given that most forms of consumer lending in the US arefunded through the capital markets, rather than by the balance sheets of the issuing banksor financial institutions, this has resulted in both contraction and higher prices for almost all consumer debt in the US today (including credit cards, auto loans and student lending).
These concerns fuel speculation that consumer spending patterns are shifting enough toaffect the issuers of unsecured debt, as well as driving a broader downturn in the economy.Data from Q2 2007 indicates, however, that debt-servicing problems were mostly confinedto mortgage-related products for the first half of the year. Credit card delinquencies are stillbelow levels witnessed during the early nineties (as highlighted by figure 6.1), and weresteadily falling between 2001 and 2005. However, credit card delinquencies stopped fallingin 2005 and between June 2006 and June 2007 have remained steady. As a result, UScompanies that participate in the consumer lending market are, on the one hand, dealingwith the fall-out on their first and second mortgage portfolios and, on the other, reassessingtheir unsecured products in terms of risk profile, pricing and profitability.
But why would the above have repercussions for the global economy? Part of the problemis that US mortgage portfolios were sold through securitisation vehicles and bought byglobal financial institutions. Uncertainty exists as to who the ultimate owners are of theserisks. This has caused banks to be more cautious and hesitant when financing is requestedfrom other banks. This, in turn, is limiting the supply of both secured and unsecured lendingto consumers.
In the UK, this has led to an increase in credit spreads, particularly on mortgages. Faced with a credit squeeze, customers often review their debt on a hierarchical basis –with their mortgage repayment taking priority due to the obvious importance this assetholds for them. However, this can be at the expense of any unsecured lending they have.Delinquencies on US credit card lending appear to be steady, but when the US$1 trillion of mortgages start to re-price in the coming year, we may see delinquencies rise in the US as people struggle to meet higher mortgage repayments.
What has beenhappening in the US mortgage space?
Section 6
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Parallels between the UK and US markets have often been made, particularly in theconsumer lending market. Similar to the US market, a developed sub-prime mortgagemarket exists in the UK, as well as established securitisation programmes. We have alsowitnessed a sustained period of house price appreciation and a period of competitivemortgage incentives offered to customers which are due to re-price in the coming years.
There are two potential areas we should consider from the US sub-prime mortgage story.Firstly, the indirect impact has been a liquidity crunch which has resulted in higher spreadsabove base rates for variable-rate mortgage products. In the UK, there is an expectationthat the Bank of England will lower base rates early in 2008. However there is some doubtthat this will have any significant impact because variable rate margins above base ratehave increased significantly in response to the credit crisis. What is certain is that withconsumers facing likely increased mortgage costs in the UK, there will be increasedpressure on their ability to service unsecured lending repayments. In addition, from a lender’s perspective, there may be mounting pressure to offload consumer financeportfolios if willing buyers can be found. On first reflection, one may think that in thiscontext consumer lending would be subdued further; however, there are indications that the opposite is true in the US. According to data published by the Federal Reserve,revolving credit usage increased after the sub-prime crisis because people borrowed moreto fund normal living expenses – an unsustainable situation for both consumer and lenderand there are signs we are witnessing the same in the UK which clearly highlights some of the dilemmas faced by lenders in today’s market.
The second lesson we can learn from the US market is in relation to the US$1 trillion of ARM mortgages (discounted) set to re-price in the coming year and the impact ondelinquencies. Below, we draw a parallel with the UK market and estimate the potentialimpact on those customers coming to the end of their discounted or fixed-rate period. The average mortgage loan over the last 18 months to June 2007 has been around£120,0001. Fixed mortgages offered in January 2006 were on average 138 basis pointsbelow the average June 2007 Standard Variable Rate (SVR). For discounted mortgages, the average margin between the discount offer rate and the SVR rate in 2006 is lesssignificant at around 60 basis points.
Mortgage re-pricing in theUK could cost customersan extra £140 a month
19910
1
2
4
5
6
1993 1995 1997 1999
3
1992 1994 1996 1998 2000 2001 20032002 2004 2005 2006
US credit card delinquency rates
2007
%
Figure 6.1: US credit card delinquency rates
Source: Federal Reserve, PwC analysis, all data points are as at 30 June
1 Source: Council of Mortgage Lenders, Banksearch regulated mortgage survey, 4 September 2007
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Whilst some people will re-mortgage and others may have made capital payments againsttheir mortgage, the analysis shows that if mortgage customers do not re-finance they arelikely to face a significant increase in their monthly mortgage repayments (around £140 per month on fixed-rate mortgages taken out in January 2006). Over 1.4 million fixed-ratemortgages were completed in 2006 alone and a further 276,000 of discounted mortgages.When these re-price, an individual’s ongoing commitment to service mortgage repaymentsmay result in unsecured lending arrears increasing, or the use of unsecured facilities to fundthe additional mortgage cost. It is not clear how significant this will be compared to the US.However, when the US$1 trillion of ARM mortgages re-price over the next year in the US,UK lenders should keep watch with a careful eye.
Queues of people outside every Northern Rock branch in the UK highlighted an importantbehavioural factor – the impact of consumer confidence and adverse publicity. Consumerconfidence has been hit by market turbulence in the UK economy. This fear could result in lower spending on the high street and increased savings. Faced with the Northern Rockexample, banks will look to close their funding dependency on the credit markets and this could result in higher savings rates offered to customers with a consequent impact on consumer spending.
We are now in a period of economic uncertainty and the degree to which this will hit retailbanks and their customers is open to debate. Keeping a watchful eye on the US mortgagemarket and its impact on unsecured delinquency performance could become increasinglyimportant in predicting and being prepared for what might happen in the UK market.
Other contagion effectsfaced by lenders
0%
1%
2%
3%
4%
5%
DiscountFixed
Average rateJanuary 2006
Repriced average rateat June 2007
6%
7%£140 monthlyrepaymentimpact
£60 monthlyrepaymentimpact
Figure 6.2: Estimated impact of mortgage repricing
Note: Fixed rate repricing based on difference between average fixed rate January 2006 and SVR rate June 2007;discount rate repricing based on average discount margin compared to SVR for every month in 2006
Source: Council of Mortgage Lenders, PwC analysis
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Consumer credit operations
Business operations From an operational response perspective, outsourcing and joint ventures representestablished routes for seeking cost reduction. Looking forward, we expect to see business models increasingly outsource the bulk of commodity credit operations and reinvest these cost-savings in customer facing activities. We are seeing a number of the more sophisticated credit operations introduce increasingly refined tiered customerservice models.
At a process level, credit exposure processes and single customer views remain a priority.This is seen as an industry-wide trend for the multi-line providers to move all consumercredit operations to a single consumer finance model, with a corresponding reduction in the number of technology and processing platforms.
In its 2003 White Paper ‘Fair, clear and competitive – the consumer credit market in the21st century’, the Government committed to creating a fair, clear and competitive consumercredit market in the UK. The Consumer Credit Act 2006 marks one of the key stages in the Government’s programme by laying the foundations for a new legislative framework.Specifically, it reforms the UK’s consumer credit laws by amending and augmenting theConsumer Credit Act 1974. The 2006 Act is based around three main changes:
• Enhancing consumer rights and redress by empowering consumers to challenge unfairlending and the provision of more effective options for resolving disputes;
• Improving the regulation of consumer credit businesses by streamlining the licensingsystem, requiring minimum standards of information provision to consumers and throughtargeted action to drive out “rogues”; and
• Making regulation more appropriate for different types of transactions by extendingprotection to all consumer credit and by creating a more proportionate regime for business.
Impact of ConsumerCredit Act
Section 7
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Provisions which come into force either on 6 April or 1 October 2008 may be the mostchallenging for lenders to comply with. In a survey of lenders undertaken by PwC, the impact of implementing the changes required by the Act was felt to be significant, with major systems changes being required. The provisions focus on the post-contractinformation obligations which require lenders to provide specific information about credit accounts to their customers at required points in time. The changes are designed to provide consumers with information throughout the life of their credit agreements,including when default sums are applied to their accounts and when their accounts are in arrears or default. Key requirements from the 2006 Act include:
• Periodic statements setting out specified information about the account for fixed-sumcredit accounts which last for one year or more;
• Additional information in running account statements, relating to the implications of not making required or part-payments;
• Notices of sums in arrears for fixed-sum and running account credit agreements –provided after a specific threshold of arrears has been reached and which will includespecific information about the account and the implications of being in arrears for the consumer;
• Default sum notices, which will be required when the consumer incurs a specified level of default sums;
• Additional information in default notices issued under s87 of the 1974 Act are requiredbefore the lender can enforce the agreement;
• Notices in relation to post-judgment interest; and
• Removal of the £25,000 individual threshold for inclusion under the Act, including a newdefinition of an individual.
In response to all these pressures, design of the operating model combined with strategiccost reduction skills are key capabilities that many consumer credit operators are looking to develop.
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Unauthorised overdraft charges
Regulation
2007 brought further scrutiny to the consumer credit and retail banking sectors in the UK.Several new investigations were launched and others continued from last year. Regulatoryattention was also turned to this sector at the European level, and across other EU member states.
As the old adage states, ’there’s no such thing as a free lunch’. This is especially true as far as banking and credit products are concerned. But, whilst consumers may be happy to pay no direct fees for banking and credit card services, the recent increase in consumercomplaints suggests they appear unhappy (and in some cases unwilling) to pay defaultcharges or unauthorised overdraft charges. However, in order to provide the basic productfor ‘free’, providers need to recover their cost-base elsewhere.
The Office of Fair Trading’s (OFT) and Competition Commission’s (CC) focus on specificfinancial services products and charges through their market reviews suggests that theybelieve there remain pockets of excess profitability within the retail banking and credit card sectors. What is not implied by their actions to date is that they believe there is fundamental excess profitability in the banking sector as a whole, nor any seriouscompetition concerns. If this was the case, we would expect the authorities to be bearingdown on the entire portfolio of charges and fees, instead of undertaking more focusedinvestigations. John Fingleton, the OFT’s Chief Executive, stated that ‘the UK retail bankingmarket performs well in many dimensions, especially relative to international norms’, whenannouncing the launch of the OFT’s market study into unauthorised overdraft charges.
Nevertheless, banks and credit card providers take a holistic approach to optimising their fee structure, and so any direct price regulation of specific charges may lead to a ‘waterbed effect’ across the portfolio of charges a consumer faces. In other words,remedies which come in the form of direct controls on particular pricing mechanisms may have consequences on other prices faced by consumers. There is already evidencethat the ‘effective’ £12 limit imposed on credit card default fees by the OFT last year hasled to price increases in other areas. Therefore, it may not be the case that regulatoryinterventionism on specific fees and charges will benefit consumers as a whole, even if proposed remedies are beneficial to consumers who currently incur specific fees.
In September 2006, the OFT indicated that the broad principles it had applied to credit carddefault charges could be relevant to other standard agreements, and that it was thereforeturning its attention to current account unauthorised overdraft fees. In March 2007, the OFTbegan an investigation into whether terms in personal current account contracts relating to unauthorised overdraft fees and returned item fees are ‘unfair’ under the Unfair Terms in Consumer Contracts Regulations 1999.
In July 2007, the OFT started proceedings to establish the legal principle in the high court. The test case, against eight of the UK’s largest personal current account providers,covers about 90% of the personal current account market. The OFT said: ‘Tens ofthousands of complaints that these charges are unfair have been received by the countycourts and the Financial Ombudsman Service. The banks do not accept that the unfairnessrules of the Unfair Terms in Consumer Contract Regulations apply. The OFT believes thatthey do and is seeking to establish this legal principle clearly in the court.’
There’s no such thingas a free lunch
Section 8
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In November 2006, the CC published its final report into the home credit market. The investigation was started following an OFT referral, which itself was the result of a super-complaint by the National Consumer Council. Home credit providers typically lend small amounts to deep sub-prime consumers (typically between £100 and £300 per customer), employing a network of ‘agents’ to visit their homes in order to distributeloans and collect repayments. Instead of paying interest, borrowers are charged fixedadministration fees.
The CC found that profits in excess of the cost of capital were costing the UK’s 3 millionhome credit users in the region of £75 million a year. The CC noted the high total cost ofcredit – a better measure of the cost of borrowing via home credit than APRs – varied from£30 to over £100 for each £100 borrowed. The CC suggested weak price competition andincumbency advantage as being the main reasons for earnings in excess of cost of capital.
The CC has imposed a number of remedies. From the end of 2007, home credit lenders will be required to use credit reference agencies in order to share data on the paymentrecords of their borrowers, improve the information they provide to their customers on thecost of their borrowing, and change the terms of ‘early settlement rebates’ to make themmore favourable to the consumer.
In 2006 the OFT referred the PPI market to the CC following their six-month market studyof the £5.5 billion a year market. They concluded that many customers were being ‘failedby PPI’, often receiving a poor deal and less protection than they think. As such, the OFTmade initial estimates that around £1 billion of ‘excess’ profitability existed within themarket and throughout 2007 the scrutiny of PPI has gained momentum.
We believe the impact on the PPI market from the inquiry is likely to be significant (and much greater than the £1 billion estimate of excess profitability). Various consumerorganisations and media commentators have perpetuated the view that this product is poor value for money and this publicity has resulted in a reduction in customer appetitefor the product with lenders seeing significantly lower penetration rates.
The extent to which PPI genuinely subsidises personal loan profitability for each customersegment is difficult to assess, but we believe the continuing reduction in PPI sales is certainto lead to an increase in personal borrowing rates. In that event, PwC believes that equitywithdrawal and the second-charge mortgage market are likely to be the main beneficiariesas consumers switch to cheaper forms of borrowing.
The OFT, in outlining its reasons for referring the issue of PPI to the CC, noted that therewere currently few available alternatives to the PPI product. Looking forward, the continuedregulatory and media focus on PPI is likely to encourage issuers to introduce new optionsfor customers offering greater payment flexibility in return for a fee. Some issuers alreadyoffer schemes in return for a fee comparable with PPI rates, which provide the option offreezing their account for a set period in the event of certain life events such as sicknessand unemployment. The customer is not charged interest and fees during this freezeperiod. Such schemes are generally not considered to be insurance and do not pay-downoutstanding balances.
Meanwhile, the FSA has ordered changes in the way PPI is sold. Sales staff must haveconversations with customers about the cost of the products; the cancellation period hasbeen extended to 30 days from 14; and when buying through websites, customers mustnow opt-in to the service, as opposed to previously being required to opt-out.
Home credit inquiry
Payment protectioninsurance (PPI) incomeunder pressure
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In April 2007, the consumer campaign group Which? submitted a super-complaint to theOFT about the way credit card companies calculate interest charges. It stated that the top 20 credit card providers were using 12 different methods to apply interest charges to their customers’ accounts, and that consumers were confused by this. In response, the OFT announced a programme of work with the credit card industry and consumerbodies to make the costs associated with borrowing via credit cards easier to understand.This work is expected to last until the end of 2007.
Which? also accused credit card companies of raising other fees to compensate for a reduction in income from default fees after the OFT’s investigation in that area. Theypointed to the introduction of new fees such as annual fees, low-usage fees, and balance-transfer fees. The banking industry responded that the introduction of such fees wasinevitable after the OFT’s actions, which effectively capped default fees at £12 per instanceof default. This illustrates the ‘waterbed’ effect, of regulatory pressures on particular feeswhich we have referred to many times before.
The OFT continues its ongoing investigation into credit card interchange fees. In February2007, the OFT announced that the scope of the inquiry would be broadened to includedebit cards. The investigation already covered Visa and Mastercard’s interchange fee arrangements.
Other fees are likely to move up the agenda as we move through the next 12 months. For example, we have seen media attention in relation to foreign exchange charges leviedon customers withdrawing money from an overseas ATM. The charges customers face lacktransparency due to the different exchange rates used by both the UK and overseas bank,plus any conversion fees charged. For this reason alone we expect increased scrutiny in this area.
Other developments
Other developments
Lessons from Europe
The European Commission completed its inquiry into the European retail banking sector inJanuary 2007. The Commission concluded that ‘the sector inquiry has identified a numberof symptoms suggesting that competition may not function properly in certain areas of retailbanking. The inquiry has confirmed that markets remain fragmented along national lines,including in retail banking infrastructures such as payment systems and credit registers’.The report followed an 18 month investigation into the v275 billion market.
The Commission had several main areas of concern: the high variation in interchange feesacross member states and structural barriers in payment card networks; the differences in quality and access to credit registers across member states; the level of cooperationamongst retail banks; and the setting of prices and policies, in particular the transparencyof fee setting and the existence of barriers to switching, including product tying.
The Commission stated that it had found ‘high and sustained profitability’ in the paymentcards industry, suggesting that in some member states banks enjoyed significant marketpower. Meetings had been held with banks in some member states, and the Commissionstated that prospects for self-regulation in some countries were good.
The Commission has not ruled out pursuing antitrust enforcement in order to address its competition concerns, although in the case of cooperation amongst retail banks, it suggests it may need more evidence before it considers such action. The proposedSingle European Payments Area is expected to correct several of the issues identified in the sector inquiry, particularly in relation to payment cards.
The Nordic competition authorities published a report into the Nordic retail banking marketin the August of 2006. In the report, they argued that improved transparency was needed in order to facilitate greater competition between providers; that the switching burden forconsumers was too high; and that payment card systems needed to be both transparent,and non-discriminatory to new entrants. In addition, the report suggested that aharmonised Nordic banking market would improve competition between providers.
In January 2007, the Polish Office of Competition and Consumer Protection concluded that banks had been acting anti-competitively in jointly setting the level of interchange feesfor transactions involving Visa and Mastercard payment cards over a period of 13 years.The Polish authority fined 20 banks around £29 million in total as part of the remedy, as well as ordering the disputed practices to stop.
The Hungarian competition authority (the GVH) also launched a sector inquiry in thebanking sector in 2007. It suggested that competition was distorted by a lack of customermobility, and that high interchange fees might weaken competition. The GVH said that it would be relying on international experiences, as well as its own analysis.
European Commissionsector inquiry – retail banking and payment cards
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In 2007 the banking industry reacted positively to the OFT’s recognition that retail bankingin the UK compared well with other countries. A restatement of the OFT’s position seemedto be accompanied by a recognition that piecemeal regulation of individual fees andcharges might have unintended consequences for consumers. However, regulatoryattention is still heavily focused on the retail banking and consumer credit industry, and the conclusions of the many ongoing investigations will have very significantimplications for the companies in this sector.
As we have noted, remedies which come in the form of direct controls on particular pricingmechanisms may have unintended consequences in terms of the other prices faced byconsumers. Although, in several cases, remedies have focused on improved informationand transparency to consumers.
Even without direct intervention the intense media scrutiny on fees and charges hasprompted increased consumer activism. This has, in turn, led to some institutions pre-emptively modifying their fee structures.
Regulation continues to be a key issue for the industry. PwC believes that the impact of regulation on revenue is likely to be underestimated by many market participants and we expect continued scrutiny. The ‘waterbed effect’ is likely to be a feature of consumerfinance products as further rulings on fees and charges come into force. Whether this effect will be acceptable to the regulators remains to be seen.
Conclusions on regulation
Those seeking consumer finance growth in Europe will experience increasing regulatoryscrutiny. We have seen a number of new regulatory bodies and legislation which makes the legal and regulatory environment across Europe increasingly complex; however, overtime we are likely to see greater harmonisation of the regulatory environment – not leastbecause of the European Commission Consumer finance directive.
We outline below some of the key recent regulatory changes in some European countries:
PortugalConsumer credit in Portugal is currently regulated by disparate pieces of legislation. The Portuguese Government has therefore set up a committee that will aggregateregulations on this matter. A preliminary draft of the consumer code was submitted for public discussion in March 2006, but has not yet been approved.
ItalyRecent changes in Italian law in 2006 mean that, as a general provision in credit cardagreements, the consumer will have the right to withdraw from the contract at any timewithout incurring penalties or charges. Furthermore, in order for any unilateral amendmentsto the contractual terms and conditions to be effective, the consumer must be informed of any intended unilateral amendment made by the lender with at least 30 days prior notice.If the consumer does not then terminate the contract within 60 days (in which case nocharges would be levied) the amendment will be approved.
BelgiumOne of the most recent changes in the legal regime was provided for in a Royal Decreedated 11 January 2006. This decree implemented the requirement that the lender shouldprovide any potential debtor with information about the credit agreement in a separatedisclosure document before the credit agreement is signed. A creditor must also provide a consumer with monthly overviews of the amount of credit provided, the payments made,as well as the amount of interest and other charges due. This is evidence that changes inlegislation give rise to operational issues which need to be addressed, as well as productdesign and pricing.
FranceA Decree of 24 December 2006 provided for six new standard agreements to be used by credit institutions and consumers as from 24 June 2007. These six agreements replaced the nine previous standard agreements.
Source: Simmons & Simmons
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Regulatory changes in Europe
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Conclusions
1Although total borrowing in the UK market continued to grow by nearly 10% per annum, consumer credit lending has clearly stalled, having reached a natural ceiling. PwC does not expect to see any significant growth over theshort to medium term.
2There are a large number of households that are currently benefiting from fixedor discounted mortgage rates that will expire over the next 12 months. Thewidening of credit spreads in response to the US sub prime crisis will result in increasing mortgage costs for many. PwC estimates that unless customersrefinance, those on fixed rate deals will suffer an increase of £140 a month inmortgage repayments. Against this backdrop customers could decrease overallexpenditure or turn to existing credit card facilities to fund the increased cost.Either way, PwC expects to see customers under more pressure with thepotential for a consequent effect on bad debt charges.
3Banks do appear to be taking action in response to the above through acontinued tightening of their credit acceptance policy. This means that theaverage person on the street is now more likely to be refused credit than they were 12 months ago.
4Credit card net yields after charge offs are at their lowest levels since the start of the millennium – the result of a highly competitive market and increases incharge offs. The “lost profit” amounts to £4 billion for the market as a whole. PwC continues to believe that it is only a matter of time before annual fees on cards becomes the norm.
5Future growth in consumer credit will have to come from innovation to displaceexisting propositions or through entry into less mature markets in Europe wheregrowth potential still exists. PwC predicts that contactless cards will provesuccessful with around 1 in 10 people regularly using a card in the UK by theend of 2008. PwC also sees the ‘greening’ of financial services as a significantopportunity if the proposition is credible and engaging with the consumer.
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About PricewaterhouseCoopers
With an increasing regulatory spotlight and fierce competition amongst financial institutions, the consumer credit market is undergoing a period of change, demanding participants to be more competitive and innovative. The Consumer Financeteam of PricewaterhouseCoopers is a leading adviser in the consumer credit market. We offer a unique perspective derivedfrom working with all types of market participants across multiple functions, including major banks, card issuers, retailersand other non-financial institutions, specialist lenders and brokers.
The team has extensive experience advising and assisting clients with:
• Strategy and business plans
• Due diligence
• Transaction & investment decisions
• Market and economic analyses
• Partnership strategies
• Contract negotiations
• Valuations
• Regulation
• Performance improvement
PwC’s Consumer Finance team Richard ThompsonPartner+44 (0) 20 7213 [email protected]
Peter SimonDirector+44 (0) 20 7213 [email protected]
Robert BouldingAssistant Director+44 (0) 20 7804 [email protected]
Consumer Finance Panel of ExpertsJohn HitchinsUK Banking Leader
Pat BoydenPersonal Insolvencies
Steve DaviesUS Consumer Finance
Andrew GrayPerformance Improvement Consulting
Tim OgierRegulatory Economics
Nick PageTransaction Services
The authors would also like to thank the following for their contributions: Alex Baker, Ben Burston, Liam Colley, Luke Edwards, Rob Field,Claudia Zambon, as well as Mark Dewar and his consumer finance team from Simmons & Simmons.
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This report has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the informationcontained in this report without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completenessof the information contained in this report, and, to the extent permitted by law, PricewaterhouseCoopers LLP, its members, employees and agents accept no liability,and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this report or for anydecision based on it.
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