Firms offering incentives could face FSA enforcement

13 July 2010 | By Natalie Thomas

Speaking today at the British Bankers’ Association conference, Adair Turner, chairman of the Financial Services Authority says if it finds incentives, structures or products that are likely to lead to poor customer outcomes, it will take tough action, including using its enforcement powers, to ensure that customers are protected.

He says: “We are examining firms’ business models – following the money – to understand the drivers of profitability and the implications of firms’ strategies.

“And as part of this work later this year we will scrutinise reward structures for in-house sales staff, to assess whether sales incentives are well-designed to guard against mis-selling.”

It will also be looking at whether firms have product development and approval processes well-designed to weed out harmful or inappropriately marketed products.

He adds: “And where we find incentives, structures or products that are likely to lead to poor customer outcomes, we will take tough action, including using our enforcement powers, to ensure that customers are protected”.

He has criticised its approach to mortgage market regulation in the past which he says involved a set of trade-offs and balances between consumer choice and consumer protection, consumer and producer responsibility.

He says at the time, in the years of the credit boom, the net effect of all those decisions was a dynamic, competitive market in mortgages, with maximum freedom of choice and easily available credit, which most of society seemed happy with.

But Turner says: “We are signalling today a significant shift away from that approach; but how much we shift is not a purely technical issue which can be left to technicians; it is a social and political choice which should merit extensive debate.

“In the boom years, many customers in the UK − not as many as in the US but still many – were sold mortgages they could not afford – mortgages which could only make sense for them if we assumed that house prices were a one-way bet.”

In the past its philosophy was that, as long as product terms were clear, then borrowers themselves would be well placed to assess affordability; and that lenders would rationally offer products which customers could afford – because it was in their self-interest to manage credit risks responsibly.

He says: “Now, however – for consumer protection as well as prudential reasons – we are proposing to significantly strengthen the requirement for lenders to assess affordability, to ensure that the borrower is likely to be able to repay the loan.

“This amounts to a major shift in our willingness to intervene in the free market relationships through which borrowers and lenders would otherwise make their own free choices about appropriateness, risk and return.”

The FSA also plans to look at whether easy credit should be available in the mortgage market, and how much capital and liquidity banks should be required to hold, without holding back the economic growth necessary for recovery.

Turner says it investigated whether particular product features – mortgages with both high Loan to Incomes and Loan to Values for instance, were strongly correlated with loan losses, and it found some relationship but not enough.

He adds: “We believe, to justify outright bans based on simple quantitative rules, preferring instead to rely on affordability assessments as our key regulatory tool.

“But the fact that we did the analysis and considered that option signals that if the correlation had turned out to be stronger, we believe ratio-based limits could have been appropriate.”