Responsible lending is a key priority for market conduct supervisors around the world. While the promotion of transparency in the marketing and selling of credit products and services is still considered to be an essential component of financial consumer protection, particularly in contributing to minimising information asymmetry, it is also acknowledged that disclosure duties should be complemented with other obligations on financial service providers to actively consider the consumer’s interests and needs in the provision of credit. Responsible lending requires that firms do not act solely in their own interests, but focus on the consumer, evaluating whether the credit product is suitable and affordable to the consumer before entering into the credit agreement. Responsible lending gained considerable traction following the 2008 Global Financial Crisis, and is once again at the heart of regulatory and supervisory concerns in the current context of financial recession caused by the COVID-19 pandemic.
The obligation to carry out a thorough assessment of the consumer’s creditworthiness is a crucial element of responsible lending. Apart from the prudential analysis of credit risk, which focuses on the ability of the lender to recover funds in situations of credit default, CWA obligations require firms to assess whether the borrower is likely to be able to repay the debt without undue financial hardship. This consumer-focused assessment implies that the lender would need to evaluate the consumer’s ability to comply with the repayment obligations under the credit agreement, preventing over-indebtedness and eventual default situations. It may also require lenders to refuse to enter into the agreement if it is likely that the consumer will not be able to repay the debt within a reasonable time and/or in a sustainable way, even if, from a strict prudential perspective, the risk of the credit agreement is acceptable.
Responses to the ‘Questionnaire on supervisory approaches to consumers’ creditworthiness assessments’ indicate that most jurisdictions around the world impose an obligation upon lenders to carry out consumer’s CWA before entering into a credit agreement with a consumer, or increasing the loan amount of an existing credit agreement. The level of detail and granularity of the regulatory solutions vary across jurisdictions. Some jurisdictions follow a principles’ based approach, setting out the main outputs that must be pursued by firms, but allowing some flexibility in the definition of the procedures and criteria to be taken into consideration, while others set out precise requirements on how firms should carry out CWA. Those requirements also vary depending on the type and characteristics of the credit agreement that is being offered, as well as the characteristics of the potential borrower.
In general terms, existing regulatory approaches tend to require firms to follow a traditional approach to ‘CWA’, taking into consideration the consumer’s actual financial situation. Most jurisdictions require firms to obtain relevant information and documents about the consumer’s financial situation in the context of CWA – income, debt service obligations, living expenses and other financial circumstances – and to take necessary action to verify if the information provided is accurate and up-to-date. Consultation of available data, including credit register databases, is also a common requirement.
Market conduct supervisors generally make use of conventional tools to oversee compliance with CWA obligations, especially on-site and off-site inspections, which are frequently complemented with meetings with the senior management of the inspected firms. Complaints’ handling and the analysis of data reported by firms are also considered to be important tools, allowing supervisors to follow an approach focused on the firms and products which are likely to present higher risks for consumers.
In the context of a “new wave” of digitalisation of credit products, fostered by technological developments and the increasing availability and use of consumers’ data, firms are changing the way they assess consumers’ creditworthiness. Policymakers and supervisors are following this process with great attention. CWA is increasingly relying on alternative and non-financial sources of information, which may include the consumer’s digital footprint, social networks data and/or consumption habits. Additionally, the use of sophisticated algorithms, enhanced by cutting-edge technology, including ML and other AI based tools, allow considerable amounts of data to be analysed very quickly and efficiently.
While innovation in this field may provide benefits and opportunities – greater accuracy, quicker credit decisions, reducing the risk of human errors or frauds - it is certainly not exempt from new challenges and risks to consumers and to market conduct supervisors. Besides data protection and privacy concerns, the use of complex ML algorithms, if not adequately regulated and supervised, may lead to potential obscure, discriminatory and subjective lending policies.
The COVID-19 pandemic, which arose during the preparation of this report, has made it even more relevant to address this topic. Some of the measures implemented in response to this pandemic led to a decline in economic activity, with a significant effect on unemployment and the reduction of income of households around the world, requiring firms to take special attention to the analysis and monitoring of the financial capacity of consumers. Additionally, the context of uncertainty and instability caused by this pandemic challenged the importance of consumers’ credit history and other sources of information traditionally used in CWA. These circumstances, as well as the rapid increase in digitalisation accelerated by social distancing requirements, placed pressure on firms to speed-up the process of automation of their CWA models and the search for alternative sources of data. Regulators and supervisors need to be vigilant in order to keep up with the pace of innovation and adequately respond to the challenges ahead.
