$pagename = “Free Essays”;
= “FSA and CCA Regulation Essay UK | Business”;
$description =”Business Essay – The effect of recent FSA and CCA regulation on the UK mortgage industry. The mortgage industry was previously a self regulated one and therefore was open to oligopolistic occurrences”;
$subject = “Business”;
The effect of recent FSA and CCA regulation on the UK mortgage industry, with emphasis on how lenders have mitigated against this
A mortgage can be defined as:
“the advance of a loan to a person or business (the borrower/mortgagor) by other persons or businesses, in particular financial institutions such as building societies and commercial banks (the lender/ mortgagee) which is used to acquire some asset, most notably a property such as a house, office or factory. A mortgage is a form of credit which is extended for a specified period of time either on fixed interest terms, or more usually, given the long duration of most mortgages, on variable interest terms.”
The mortgage industry was previously a self regulated one and therefore was open to oligopolistic occurrences; this was why government saw a need to put in place rules and regulations – the term regulation refers to the control of economic activities either by the government or a non-government body. Bearing in mind recent corporate scandals like Enron, rules and regulations are also important to act as check points against fraud and theft. Therefore this research paper will examine rules and regulations in relation to consumer credit; in particular the mortgage industry.
Hence the research objectives of this report are:
- To investigate if the CCA/FSA regulation has been a benefit to the industry i.e. lenders consumers, brokers, packagers and so on;
- To discus whether or not the industry was successful in its response to regulation;
- To evaluate if further regulation is required – whether or not the current level of regulation is too much or too little;
- To identify, explain and evaluate the likely impacts of forthcoming CCA regulation changes.
The UK mortgage industry
The UK mortgage market is an estimated £1 trillion, with around 11.6 million mortgages outstanding. House purchase and re-mortgage lending were stronger than forecasted in 2006 and were forecasted to be moderate later in the year perhaps into 2007. The industry also claims that currently re-mortgaging accounts for about 40% of total lending and is expected to continue on this trend onward into 2008. According to the information provided by the CML its members who total around 152 accounts for 98% of the residential mortgage lending in the UK and comprise banks, building societies and so on. It is important to note that most mortgages are variations on either fixed, variable or capped rates, and on capital repayment or interest-only options.
There are two main market segments within the mortgage industry; they are the prime and sub-prime markets. The prime market refers to consumers with healthy credit ratings while on the other hand the sub-prime market refers to individuals who have poor credit ratings. Typically it is the prime market that is targeted by mainstream lenders such as the banks – which current base rates are around 4.5%. However the sub-prime market is also becoming more desirable for the non-mainstream lenders and they often have exorbitant rates. However in a 2006 report the FSA predicted that generally there will be an increase prime margins and that sub-prime margins will continue to decrease due to existing lender diversification and new entrants. According to a BBC report average house prices in the UK according to design are:
- General:
£184,924 - Detached:
£285,697 - Semi-detached:
£170,650 - Terraced:
£143,512 - Flat:
£174,052
The BBC report found that generally houses in the southeast of England were the highest priced.
Who is the FSA?
The Financial Service Authority (FSA) is a non-governmental regulatory body which is appointed by and also has to answer to the Treasury. According to the FSA website , the organization has authority over ‘banking, insurance, investments, listing and other financial services matters’; and therefore it makes the policies and rules that govern these institutions and transactions. Currently the presiding body over the FSA is the Financial Services and Markets Act 2000 (FSMA).
How does the FSA operate?
The FSA operates according to the rules and regulations set out by the FSMA; and there are some very important objectives which the FSMA expects the FSA to fulfill such as the prevention of money laundering, consumer protection, impartation of knowledge and understanding of financial systems to consumers, and keeping confidence high in the economy. In particular a few acts to which the FSA owes its regulatory powers are the; Building Societies Act 1986, Friendly Societies Acts (1974 and 1992), Industrial and Provident Societies Act 1965, Enterprise Act 2002, and the Unfair Terms in Consumer Contracts Regulations 1999; also known as the Consumer Credit Act (CCA), and a few others which will be explained in greater detail further on in these research findings (report).
How does the CCA and the FSA influence the industry?
- The CCA 1974 provides protection for credit not exceeding £25 000. Therefore once the following criteria are met consumers are protected:
If an informal agreement has been made; for example if a consumer has signed to an agreement while at home, rather than through a formal means such as an office – the consumer has the right to cancel the agreement since it can be considered illegitimate. In this instance the consumer is entitled to a full repayment of any deposit paid once the agreement is cancelled in time.
Other points to note are that under the CCA:
• Consumers must be given at least seven days notice before any attempts to repossess goods can be made.
• If a consumer believes a credit agreement to be unfair he/she can lodge a complaint with the courts
• Consumers must be furnished with information such as: the total charge for credit, the Annual Percentage Rate (APR) and the cash price for the goods.
However in any event if a credit agreement is not kept the court will have two main options to either; (a) Give the borrower extra time to repay the creditor or (b) order the borrower to return the goods to the creditor.
More specifically with regard to the main focus of this report the Consumer Credit Act (CCA) 2006 has new requirements for lenders, which includes the requirement to ensure that there is not a biased relationship whether towards or against the borrower. Among other things the amendments also propose to abolish the protection limit of £25,000. On the Council of Mortgage Lender’s (CML) website it hints about the inherent need to reduce disruption within the lender operating environment which such a measure may cause and at its concerns about dual regularisation.
On the other hand with regards to the FSA the CML announced that it was pleased with its regulations and had a few minor complaints such as the increased mortgage interview time by an additional 30 minutes and the rigidity of the rules which the FSA wants to impose – even though some detractors argue that the FSA regulations fall short e.g. “home reversion schemes and buy to let mortgage” are not within the scope of the FSA as they are not defined as investments.
Insurance Conduct of Business (ICOB)
The FSA made the ICOB rules I response to European legislation i.e. the Insurance Mediation Directive (IMD).The ICOB are a set of rules which relate to the conduct preceding selling and administering of non-investment insurance e.g.; marketing; sales; providing literature to customers on products; and handling claims.
Once an activity is deemed to fall within the Regulated Activities Order, it then needs to be determined whether it is defined as non-investment insurance; if it does then the ICOB will apply; such as: general insurance contracts e.g. auto or household insurance; or pure protection contracts.
Among other things the ICOB guides firms on how they can avoid breaching the rules on imposing an excessive charge or unfair inducement. It highlights the issues firms should consider and when determining whether a charge is excessive, consideration must be given to:
- the amount of the charge compared with similar charges elsewhere in the market;
- the degree to which the charge is an abuse of the trust the retail customer has put in the intermediary; and
- the nature and extent of the disclosure to the retail customer
Unfortunately commissions paid out on premiums are not covered.
For the mortgage and investment business markets ICOB states:
- Mortgages mortgage firms can only call themselves independent if they offer a ‘whole of market’ service and give consumers the opportunity to pay a fee for this service. This applies to both advised and non-advised sales;
- Investment business A firm that calls itself independent in relation to investment business must offer ‘whole of market’ advice and give customers the opportunity to pay a fee for this service.
Mortgage Conduct of Business (MCOB)
The MCOB rules were also created by the FSA so that ‘business loans only apply where the loan is for a business purpose. The MCOB covers the following areas:
- “Opting to comply with our standard rules for the entire loan. Where necessary, the firm could seek individual guidance or a waiver where the business part of the borrowing does not fit within the standard requirements.
- Dividing the two purposes into two separate transactions. The firm could then structure these so only one of the transactions is a regulated mortgage contract (for example, taking some other form of security for the business lending).
- Dividing the two purposes into two separate transactions, writing both of these as regulated mortgage contracts (using the same first charge as security) and taking advantage of the tailored rules for the lending that has a business purpose.”
The MCOB also stipulates the requirements for disclosing early repayment charges e.g. cash repayments and maximum early repayment charge. Lenders must also make information comprehensive and available, early repayment charges and any special disclosure requirements. Therefore at the end of the day the FSA intends to accomplish it goals ‘to promote efficient, orderly and fair markets and to help retail consumers achieve a fair deal.’
The effect of recent ICOB and MCOB rules, and CCA regulation on the UK consumer lending (mortgage) industry
Prior to the FSA regulations certain areas of mortgage lending and its conditions went unregulated – such as:
- first legal charges
- loans secured on properties in the UK;
- loans secured on property where at least 40% is residential accommodation to be occupied by the borrower
- loans granted for terms planned to run at least five years from when the loan is made
Therefore the Treasury and the government decided that: mortgage lenders must be authorised by the FSA; and that mortgage advice will no longer be regulated hence mortgage intermediaries will not need to be authorised.
Currently in this industry there are 11.6 million mortgages outstanding and the CML projects that at least 12000 mortgages will be repossessed per year; which does not even begin to put a dent in profit earnings. However no figure could be obtained for an average of how many people finish paying their mortgages each year in the UK but on the downside the number of applicants for first-time home loans each year has been decreasing.
The need for industry regulation can be attributed in part to the improved incomes of consumers and has the growth and availability of consumer credit:- and although the idealistic notion would have been towards self regulation it has in it a big void – called accountability – without individuals, firms and industries can become corrupt and collusive. These regulatory impacts can be broken down into three broad categories: direct costs, compliance costs and indirect costs.
What are the operational and financial implications to systems and processes?
Compliance costs – the costs to firms and individuals e.g. the costs of any additional systems, capital, and training.
Indirect costs – are those costs that are hard to quantify in terms of cash. They include: reduced competition (e.g. the welfare loss associated with increased charges), the costs of imposed uniformity (e.g. the welfare loss associated with foregone purchases or purchases of items that barely meet the purchaser’s requirements) and the costs of moral hazard (e.g. the cost of reckless deposit placing caused by compensation schemes that lack an element of self insurance).
“A regulatory measure will only be cost-effective when its economic benefits exceed its economic costs by more than the sum of the direct and compliance costs.”
Many in the industry feared that they would now be subject to dual regularisation and in fact this is not the case today. However there is concern amongst industry members that the Treating Customers Fairly (TCF) initiative does in fact slow operations down a little bit. From an economic standpoint some may argue that the biggest opportunity cost has been the financial resources which could have been allocated to local area councils (LAC) who in turn could have used it to build affordable housing or provide scholarships.
Another area that was impacted by the regulations was endowment handling firms. Such firms mitigate in circumstance where borrowers believe they have been wronged and entitled to some sought of endowment as a result. The original idea was that better regulation would result in fewer complaints however these firms have been seeing an increase in business and where endowment settlements are won they often time take as much as a 30% cut in their clients’ settlement. The end result has been increased profits for such firms and a relative increase in costs for lenders; a new trend worth watching closely.
The Debt Service Coverage Ratio (DSCR), is currently the key financial ratio for the industry and although it may be too early to ascertain the exacts if any that the regulations have had on the DSCR it is important to note that an acceptable ratio is considered to be 120% or above since in this case lenders believe they will create a sufficient margin for ‘unforeseen financial demands’. The DSCR is calculated by dividing the annual rental payments by the annual capital and interest payments. DSCR is the amount of cash flow above the required cash to service the mortgage.
Essay Conclusion
Generally the economic benefit to consumers of regulatory measures is an increase in the consumers’ surplus. This is “the excess of the amount consumers would be willing to pay for the regulatory measure over the amount they have to pay for it.”
According to FSA it has highlighted forecasts for all of the stakeholders involved in the industry as follows :
“Consumer appetite for debt will persist but there will be no material increase in bargaining power.
• Intermediaries will continue to grow market share.
• The number of advisers will remain stable but concentration will increase slightly.
• Lenders will eventually attempt to rebuild captive distribution.
• Overall margin across the value chain will remain stable.
• Intermediary margins for non-conforming business will grow steadily.
• There will be a slight increase in product complexity.
• Home Information Packs (HIPs) will give a significant boost to intermediary business.
• Lender concentration will increase marginally as smaller lenders will exit prime and larger lenders consolidate”.
Consumers will be more aware of product options but will continue to seek advice and decision support from intermediaries "The numbers of customers who need advice will be sustained as the percentage of borrowers who don’t fit standard criteria grows. This will lead to competition between lenders trying to leverage their brands, and brokers."
Increased product choice and complexity will sustain consumer demand for intermediary advice “Intermediary distribution will continue to dominate – primarily because there is nothing to suggest that product range or affordability will reduce the complexity of products. Consumers have the final call on which distribution channels will dominate going forward – and it will not be the banks, even though some of their efforts might reduce the current intermediary market share from 70 percent to 65 percent”
Lenders will attempt to increase branch productivity by streamlining sales processes through simplified KFI processes, implementing more effective valuation technology and offering free HIPs “Productivity gains among lenders are hampered by slow progress in developing a Common Trading Platform (CTP). Some are investing in XML data services to interface to back office solutions for proposal tracking, contract enquiry and commission reconciliation systems but although 17 lenders are funding ORIGO mortgage standards development; the battle between Mortgage Brain and Trigold has stifled development… the market needs an Exchange-type solution. Currently although most GI and protection is transacted on-line, mortgage cases have to be re-keyed. On top of this, FSA/DPA restricts growth of CTP: ideally brokers would fire a loan application to several lenders but the FSA is concerned that this would lead to a credit footprint”
Having previously been self regulated, the mortgage industry was open to fraudsters and merciless lenders which was why it became regulated so that all lenders must declare themselves and their business so as to ensure it adheres to industry standards. The FSA is the body which currently oversees this industry and therefore stipulated a set of rules and regulations to ensure all the stakeholders get an adequate measure of comfort and security; namely the ICOB and MCOB. This research paper then examined these rules and regulations in relation to consumer credit; in particular the mortgage industry. The research objectives of this report then investigated if the CCA/FSA regulation has been a benefit to the industry i.e. lenders consumers, brokers, packagers and so on; discussed whether or not the industry was successful in its response to regulation; evaluated if further regulation was required – whether or not the current level of regulation is too much or too little; and identified, explained and evaluated the likely impacts of forthcoming CCA regulation changes. It was found that generally the FSA is doing a good job and perhaps they could still pass more regulations in a few areas.
Bibliography
Alfon I. and Andrews P. (1999) Cost-Benefit Analysis in Financial Regulation: How to do it and how it adds value, Occasional Paper Series 3 [Journal], Financial Services Authority.
Encyclopædia Britannica Library; Consumer Credit, Encyclopædia Britannica 2005 Ultimate Reference Suite DVD, Encyclopædia Britannica, Inc. [Available: January 31, 2007]
Collins internet-linked Dictionary of Business, (2005, p.282)
http://www.fsa.gov.uk/Pages/About/Who/Accountability/legal/index.shtml [Available: 29th/ Jan/ 2007]
Consumer Credit Act http://www.fisa.co.uk/downloads/CCA%201974.pdf#search=%22%22Consumer%20Credit%20Act%201974%22%20licensing%22
http://www.opsi.gov.uk/acts/acts2006/ukpga_20060014_en.pdf [Available: January 31, 2007]
http://www.ukregulation.co.uk/topics/Mortgages_Conduct_of_Business_FSA_Handbook_MCOB_/21297?PHPSESSID=319e703bb98d4c4839ccf845bba71bca [Available: January 31, 2007]
http://212.59.24.64/Bendra%20prieziura/prieziura8.pdf [Available: January 31, 2007]
http://www.qualitative-research.net/fqs-texte/1-06/06-1-32-e.htm [Available: January 29, 2007]
http://www.fsa.gov.uk/pubs/cp/cp70_newsletter.pdf [Available: January 29, 2007]
http://www.politics.co.uk/campaignsite/council-mortgage-lenders-cml-$364298$2.htm [Available: January 29, 2007]
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