Excluded, distressed & underbanked: Tier 1's, it's time to evolve

A mere 6 months after the FCA published the ‘Guidance Consultation and feedback statement: Guidance for firms on the fair treatment of vulnerable customers’, Barclays have been handed a £26m fine as punishment for poorly managing a large segment of their financially vulnerable customers.

As the largest ever fine issued by the FCA for breaching customer credit rules, the penalty illustrates the FCA’s commitment to improving the harsh economic climate for financially distressed customers during the pandemic.

The Tier 1 bank have been accused of failing to properly contact customers who have fallen into arrears. As a result, customers have been entered into unsustainable payment plans, forcing individuals to prioritise their debt with the bank over other key financial responsibilities such as mortgage payments, council tax, child support, or utility bills.

“Customers should be able to trust their lenders” said Mark Stewart, the FCA’s Director of Enforcement and Market Oversight.

Around 1.5m customers of the bank were shown to have recently fallen into vulnerable circumstances, and this reflects a wider issue. They make up a small fraction of the 46% of UK adults that the FCA have highlighted as currently displaying characteristics of vulnerability.

What is a vulnerable customer?

The FCA have remained consistent on their definition of vulnerable customers since 2015. They describe this as someone who, due to their personal circumstances, is especially susceptible to harm, particularly when a firm is not acting with appropriate levels of due care.

In the last twelve months, however, the rationale behind this has changed. In following iterations of guidance document, the FCA refer to an ‘evolution of thinking’.

They have repositioned vulnerability as a spectrum of risk, indicating that anyone can fall into vulnerability given unfortunate circumstances. The FCA label these as the key drivers of vulnerability, an area which we have previously written on in our FinTech blog.

Underbanked customers

31% of UK adults have experienced loss of income during the pandemic, validating the growing concern for customers who cannot easily access mainstream financial services.

Financial firms have varying definitions for customers who are underbanked or financially excluded. In this instance, we refer to the House of Lords who describe financial exclusion as the inability, difficulty or reluctance to access mainstream financial services, which, without intervention, can stimulate social exclusion, poverty and inequality.

This has remained an area of focus for regulators in the fight to better protect underserved consumers. With unemployment rates on the increase, and local businesses liquidating on every corner, this is only set to intensify. The need for financial institutions to identify, and subsequently support the underbanked has never been greater. But, unfortunately, even with the impeding pressure of the regulators, this is far from a reality.

Research from PwC shows that between 10-14m people, roughly a quarter of the population, struggle to access mainstream credit sources, despite having only minor blemishes on their credit history. Where are they to go should they need support funds?

Part of the problem is that credit services that sit outside the ‘mainstream sources’ are often damaging to people suffering with financial distress, and rarely any more accessible than mainstream services.

For example, Near-prime credit cards, served by just four main providers, account for only 8% of all credit cards held in the UK, despite an estimate that 20-27% of UK adults would fall into the group eligible for such facilities.

The distinct lack of services results in customers often resorting to payday loans. Around 59% of payday loans are taken for something a customer could not do without, and 52% to compensate for an unexpected increase in outgoings. These consumers are at the mercy of financial institutions and are being failed from the very beginning of the process.

How do firms recognise the vulnerable or underbanked?

The trouble is (and we know from experience) financial institutions have difficulty identifying when a customer is vulnerable before it’s already a problem. The reliance on Credit Reference Agency data makes it near impossible to understand an individual’s real-time financial situation .

Although used widely, the practice is barely adequate for identifying vulnerability in large portfolios of customers, and yet it has remained industry standard for years. The pressure is now on financial institutions to find another method that better suits the nature of the pandemic. 6-month-old data is virtually useless when you consider the amount of people that have experienced a change of income during that period.

So, how are financial institutions identifying these customers before the fall into real trouble? Concerningly, recent research conducted by Fairbanking Foundation indicates they simply do not.

In the researched entitled ‘Customer vulnerability and current accounts – a review of UK practice’, six major financial institutions (Barclays, Clydesdale, M&S, Lloyds, RBS and Santander) were surveyed, representing roughly 75% of the current account market in the UK.

The financial institutions claimed to have established customer vulnerability operational frameworks to identify and support customers. There was, however, little sign that they are identifying significant numbers of customers in vulnerable circumstances or projecting future expected growth in this area.

They found that in most instances vulnerable customers are not identified until the customer has landed in the collections & recoveries department. It is not until a customer is already experiencing significant financial distress, with mounting interest charges over their head, that a more personalised/bespoke conversation is sparked.

Even then, only one of these firms proactively communicates with customers when certain trigger events have taken place on the account, either by outbound calling, letter or text, advising that assistance is available and to offer help with budgeting. The research concluded, among other outcomes, that there is no clear picture about whether customer vulnerability is routinely identified, and that there is still some way to go for financial institutions. It highlighted that financial institutions are missing the opportunity to identify vulnerable customers and offer appropriate services, support or intervention, at a sufficiently early stage.

The impact on financial institutions

At the foremost, the mounting consumer debt in the UK presents a huge level of uncertainty to financial institutions.

The FCA reported that 3.4 million people have taken payment deferrals on mortgages and other credit products. While the full repercussions of this are still not immediately clear, the growing debt book of Tier 1 banks in the UK presents a wider threat to the economy.

From an internal perspective, as we intimated in an earlier section, the volume of customers being funneled into collections teams is only set to increase. Firms are being forced into investing significant capital into their debt recovery operations and the cost of serving each customer is on the rise.

Currently, collections teams spend a large volume of time with customers assessing their repayment potential, and what their discretionary and non-discretionary spend looks like. In an attempt to keep repayments low, customers are prone to downplaying spend or deliberate misrepresentation. Ultimately, the process is widely inefficient for all involved. The operating costs of collections teams are high and are set to increase with the rising number of customers who are financially vulnerable.

Increasing the number of customers passing through collections and recoveries - a process widely described by consumers as distressing, cumbersome, and far from customer centric - is also a sure-fire way to damage the relationship between firms and their customers. Debtees are usually dragged through hours of back-and-forth calls with collections teams to reach an agreement on repayment potential, an arduous and often embarrassing process, as intimate details of their financial lives are pored over.

When considering the poor customer satisfaction during collections, the capital being flooded into debt recovery operations, and the rigorous back-and-forth nature of the process, ultimately, this must have an adverse effect on the relationship between firms and their customers, and subsequently, operating profit.

The impact on customers

In an independent research study on consumer credit markets by Citizens Advice Bureaux, conducted in response to the FCA’s recent vulnerability guidance, it was identified that high-cost products are more likely to be used by vulnerable consumers. Furthermore, lending decisions often don’t consider financial vulnerabilities, or even wider vulnerability. Over a quarter of those receiving uninvited credit limit increases are already in financial distress.

With customers being forced to resort to High Cost Short-Term Credit (HCSTC) or payday loans, they are more likely to be left in a vulnerable position than those with access to traditional means of credit. This feeds back into a circle of debt that becomes increasingly difficult to escape and often ends with significant financial distress.

This leads back to the collections department, after which they begin prying out the financial commitments of a customer with the intention of recouping the debt. After years of being underserved by financial institutions, banks are going to have to work smart to rebuild the trust of their vulnerable customers.

The solution

Firms need to become more proactive, and a large part of this is being able to spot anomalies in real-time.

This is not just on an individual basis; it goes for a higher-level view of an entire portfolio of customers. With the accuracy and speed required to process this level of data, manual processes and late interventions won’t cut it.

The FCA, Citizens Advice Bureaux, Fair Banking, all cited within our article, highlight the huge opportunity for firms to work with 3^rd party companies, namely FinTechs, to help achieve this.

We’ve worked with financial institutions in the past and witnessed first-hand the timely impact of using Open Banking insights to monitor customer habits in real time. This isn’t slow digital transformation projects trudging through hundreds of compliance requirements and revisions, it’s an immediate solution that can quickly react to the evolving challenges of the pandemic.

The starting point is within the internal culture, teams, and operations. Retraining customer facing teams to better spot vulnerability doesn’t necessarily solve the issue. Most of these customers are already in vulnerable circumstances by the time they reach that first touch point.

Firms must enable their teams with the technology to identify key indicators of emerging financial distress, and allow them to intervene before it reaches the collections team. With the right tools, much of these trigger alerts can be automated, providing huge operational savings and costs for firms.

The exciting part is the complexity of the solution. Leveraging a tech enabled platform to help with specific categories of vulnerability allows firms to start to build a very detailed picture of an individual’s financial situation, both in real-time and over the last 12 months .

Insights on financial patterns, normal vs abnormal behaviours, affordability, and disposable income start to contribute to a clear picture of who the customer is in real-time and how their situations has changed, and why. When solely reliant on CRA data this is incredibly difficult, if not impossible.

At this stage firms can build a much more accurate view on their portfolio of customers, recognising clusters of vulnerability, segments that are underbanked, and groups showing signs of emerging financial distress. From there, firms can take a more personalised approach and offer customers the requisite help to evade difficult financial situations before they happen.

With Open Banking, underwriting teams can start to shift their reliance to real-time data, so individuals who are limited in access to credit by minor credit history blemishes can be assessed on their current financial circumstances. With less bad debt at the tail end of the cycle, this equates to more business for financial services firms with much higher profit margins.

Conclusion

Just as the FCA have over the last year, financial services firm must also evolve their thinking around customer vulnerability. Waiting for a customer to become vulnerable and then offering them tailored services is a practice harming all the parties involved. It’s bad for profits, bad for satisfaction, and adversely impacts the already fragile relationship between banks and their customers.

Change must start from internal culture. It’s not enough to limply enforce new policies aimed at giving those in tough situations a route out, it needs to be a step further than that. Firms need the technology to identify financial distress early and prevent customers from falling in these pockets of vulnerability.

With the help of Open Banking FinTechs, such as Atto, firms can follow the FCA’s advice and partner with 3^rd party companies who can provide the required insights and implement this at speed.

On a portfolio level, firms can prevent large groups of customers from falling into financial distress. This is only possible when teams are enabled by the tech needed to monitor customer patterns in financial vulnerability and make early interventions.

This only strengthens the relationship between firms and their customers, and this is mutually beneficial. Satisfied customers who are better supported are less likely to fall into debt, and with that extra financial freedom, customers can start to reinvest their money back into financial products and services from the bank.

It’s really up to financial services firms to understand that there is a huge opportunity here to solve a wide range of internal issues surrounding customer vulnerability. We just ask that they reach out their hand and grab the right tools to do so.