Topic 8: Consumer Protection

Question 1

Consumer protection:

Answer 1

There are several organisations that provide consumer protection in the UK financial services market, each with a distinct role to play:
- the regulators that set out the rules providers must follow and supervise their operations - these are called the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA)
- the Financial Ombudsman Service, which handles customer complaints about providers
- the Financial Services Compensation Scheme, which protects consumers if their provider defaults, including repaying customers’ deposits of up to £85,000 if their provider cannot
- the Competition and Markets Authority, which aims to make the financial market (as well as all other markets in the UK) work well for consumers, businesses and the economy (GOV.UK, no date).

Providers also regulate themselves by following codes of conduct such as the Standards of Lending Practice, which set out how they should act when offering and managing borrowing products

Question 2

The credit crunch and its causes:

Answer 2

Many of the consumer protection measures that are now in force were set up as a direct result of the global financial crisis that started in 2007 and is known as the ‘credit crunch’.

There were many causes of the credit crunch:

• Banks lent money to people who were likely to be unable to repay. Lehman Brothers, for example, lent mortgages to the sub-prime market - that is, high-risk customers - and then sold on this debt to other providers
• Banks used money from their retail business (that is, current accounts, savings and loans for individuals rather than businesses) to pay the losses made by their investment operations - the sections within a bank that buy stocks and shares and complex and risky investment products called derivatives. This meant that the providers did not have enough money to repay depositors when their retail customers wanted to withdraw their money

The UK market was dominated by very large banking organisations that were considered ‘too big to fail’ - the impact of their going out of business would have been disastrous for the rest of the economy

Question 3

2004 of the Credit Crunch:

Answer 3

In the USA interest rates were very low at only 1% and many US banks lent mortgages to people with poor or no credit histories. This is called the ‘sub-prime’ market because these customers are high risk and so much less likely to repay loans than the best (‘prime’) customers. Some sub-prime mortgages were nicknamed ‘NINJA loans’ because the customers had No Income, No Job or Assets

The banks that provided these mortgages sold the mortgages on to other banks and organisations around the world as investments

Question 4

2006 of the Credit Crunch:

Answer 4

In the USA interest rates rose to 5.35% and many sub-prime customers could not make their mortgage repayments. Banks tried to sell the homes that the mortgages were secured on but there were so many to sell that house prices dropped significantly. Banks lost large amounts of money and so did the organisations that had bought investment products based on the sub-prime mortgages

Banks would normally borrow money from other banks but so many banks were impacted by the sub-prime mortgages or the investments based on them that lending between banks was greatly reduced. Big global banks such as UBS and Citicorp reported multibillion-dollar losses and many banks found it difficult to access cash, also known as liquidity

Question 5

2007 of the Credit Crunch:

Answer 5

In the UK Northern Rock bank was unable to borrow the money it needed to fund its operations from other banks and turned to the Bank of England for help. The Bank of England gave Northern Rock emergency financial support and this was reported by the media

Alarmed by the media reports about Northern Rock, on 14 September 2007 many of its customers tried to withdraw all their deposits. When this happens it is known as a ‘run’ on a bank, and it was the first time it had happened to a British bank for more than a century

On 17 September the government announced that it would guarantee all deposits in Northern Rock; by doing this it hoped to reassure depositors that their money would be safe and so encourage those who had already withdrawn their funds to leave them in the bank

Question 6

2008 of the Credit Crunch:

Answer 6

On 17 February 2008 the government announced that Northern Rock would be nationalised

The largest investment bank in the USA, Lehman Brothers, became bankrupt on 15 September. Financial services organisations around the world are interconnected, partly because they lend money to and buy products from each other and partly because large banking groups own providers operating in different countries. When Lehman Brothers failed, the consequences were that providers around the world lost money. Stock market prices around the world fell as people realised the problems that the banks faced

On 29 September the British bank Bradford and Bingley was broken up and the mortgages and loans side of the business was nationalised

On 13 October the government announced it was bailing out the large banking groups Halifax/Bank of Scotland (HBOS), Lloyds and The Royal Bank of Scotland (RBS) by buying shares. This action was taken because the impact of these banks becoming bankrupt would be extremely damaging for many individuals and organisations and so for the country as a whole. HBOS was taken over by Lloyds Banking Group on 31 October. The government bought 40% of the Lloyds Banking Group and 82% of The Royal Bank of Scotland

Question 7

2009 of the Credit Crunch:

Answer 7

In February RBS reported losses of £24.1 billion, the largest annual loss in British corporate history

The Dunfermline Building Society announced losses of £26 million and was taken over by the Nationwide Building Society. The Nationwide later also bought the Cheshire and the Derbyshire building societies

Question 8

Responses to the credit crunch:

Answer 8

There were so many consequences of the credit crunch for the financial services market that in June 2010, the government set up an Independent Commission on Banking, led by Sir John Vickers, to recommend how such a situation could be avoided in the future. This included ways to make the market better able to withstand future banking crises and to ensure that the industry, rather than the taxpayer, bore the cost of any losses

The commission reported back in September 2011; its key recommendations were:
- Improve regulation of providers
- Make sure banks are able to absorb any losses
- Make it easier and less costly to deal with banks in financial trouble
- Reduce the amount of risk banks take
- Separate retail banking from investment banking

The aim was that reforms would lead to greater stability in the financial services market and this in turn would help to support a sustainable UK economy

Question 9

Implementation of the recommendations of the Independent Commission on Banking:

Answer 9

The government passed the first legislation to implement these recommendations, the Financial Services Act, on 19 December 2012. This legislation came into force on 1 April 2013 and focuses on regulation. Further legislation, the Financial Services (Banking Reform) Bill, was introduced on 4 February 2013 and focuses on the structure of the UK banking sector. The Bill includes these main changes:
- UK banks must separate everyday banking activities from more risky investment bank activities, such as trading in stocks and shares and other risky products. This is called ring-fencing
- Depositors who are covered under the Financial Services Compensation Scheme (FSCS) must be repaid as a priority if the bank fails
- The government will have powers to ensure that banks can absorb losses more easily, for example by keeping larger reserves of cash

In a press release issued by HM Treasury on 4 February 2013, the Financial Secretary to the Treasury, Greg Clark, is quoted as saying:

The Banking Reform Bill, introduced to Parliament today, will bring about the biggest shake-up of the structure of banking for decades, making the banking sector safer and better able to serve the needs of individuals and businesses

The Bill will mean that taxpayers are never again on the hook when banks fail. The Government will implement the Independent Commission for Banking’s recommendation to ring-fence [separate] day-to-day banking from investment activities. To ensure that banks do not flout the rules the Government will ensure that the Bank of England has a reserve power to completely separate an individual bank if necessary (GOV.UK, 2013)

The Banking Reform Bill received Royal Assent in December 2013, and its requirements came into effect on 1 January 2019

Question 10

Regulators:

Answer 10

Regulation is the process of supervising the actions and businesses of financial services providers. It is desirable because a well-regulated financial system operates more safely, enhancing financial stability and averting crises; the credit crunch timeline indicates that problems in the financial system can quickly timeline serious. Regulation also promotes consumer confidence and protects people from dishonest, incompetent or financially unstable providers

Question 11

Overview of the regulatory system:

Answer 11

The Financial Services Act 2012 established the new system of regulation that came into force on 1 April 2013. The system is set up in the following way:

• The Financial Policy Committee (FPC) is part of the Bank of England; it was formed in 2010 in anticipation of the regulatory changes that followed. It monitors and responds to risks posed to the whole of the financial services market. Because it looks at problems that could arise for the market as a whole (rather than individual providers only), the FPC is called a macro-prudential authority
• The Chancellor of the Exchequer in the Treasury has powers to direct the Bank of England to take action if there is a serious threat to the financial stability of the market and public funds (such as the money raised from taxes)
• There are two regulators that work together: the Prudential Regulation Authority (PRA) is a part of the Bank of England and the Financial Conduct Authority (FCA) is an independent organisation. The PRA is responsible for micro-prudential regulation - this involves looking at the risk that individual providers might present to the stability of the financial services market. The FCA is responsible for ensuring that all providers conduct their businesses in a way that benefits consumers and the market as a whole

Question 12

The PRA and FCA:

Answer 12

The PRA and FCA replaced the Financial Services Authority (FSA), which was the single financial services regulator from 2001 to 2013. The FSA has acknowledged that it was too slow to react to risks in the market. It also failed to identify misconduct by providers that led to a series of scandals. These included providers selling an insurance policy called payment protection insurance (PPI) to people who could not claim under it, or charging customers for PPI when the customer was unaware it was included in their product. Providers who mis-sold PPI compensated customers, and the FSA estimated that over £5 billion would be paid in compensation by the time the scandal was resolved. In fact, by 2021 over £38 billion had been paid in PPI compensation (FCA, 2021a). The Financial Conduct Authority (FCA) has taken over the FSA’s role as supervisor of individual providers and delivered on its promise, stated by Margaret Cole of the FSA, to be more proactive and interventionist than the FSA was (BBC, 2011). It also has powers to ban or impose restrictions on financial products and promotions

Question 13

The work of the regulatory system is supported by the:

Answer 13

• Financial Ombudsman Service - to handle customer complaints
• Financial Services Compensation Scheme - to compensate consumers if their financial services provider fails and so rebuild trust in the industry
• MoneyHelper - a consumer information service set up by the government to help people make informed financial decisions

These three bodies receive funding from providers via levies (fees that must be paid) and, for the Financial Ombudsman Service, by providers also paying case fees

Question 14

The Prudential Regulation Authority (PRA):

Answer 14

Since 1 April 2013 the Prudential Regulation Authority (PRA) has been responsible for the prudential regulation of banks, building societies, credit unions, insurers and major investment firms. The PRA is part of the Bank of England and the Board of the PRA reports to Parliament. It is funded by fees paid by providers

The Financial Services Act (2012) identified two objectives for the PRA:
- promoting the safety and soundness of providers
- securing an appropriate degree of protection for insurance policyholders

The purpose of the first objective is to ensure that the UK financial system is better able to cope in a crisis and can support a successful economy. The PRA has not been given the responsibility of preventing providers from failing - its task is to ensure that, if a provider does fail, it does not cause significant disruption to the UK’s financial services

The PRA sets standards and requirements that providers must meet to manage risk including ‘threshold conditions’ for continuing in business - in other words, a minimum requirement. These threshold conditions include:
- holding enough cash (also known as liquidity) and having enough capital (that is, funds) to absorb a certain level of losses
- having suitable management
- being fit and proper
- conducting business prudently, that is, managing risk well to ensure the business is safe and sound

The PRA uses a judgement-based approach to assessing the risk that providers pose. It is forward-looking, taking into account risks that could arise in the future. It has a focused approach, concentrating on the providers that pose the greatest risk to the stability of the UK financial system. It has powers to take action to reduce the risks it identifies. For example, it has required banks to raise extra capital from their shareholders so that they are less likely to fail in a crisis. The PRA could also require providers to change their lending criteria if it judges they are lending to people or businesses that cannot repay the loans

The Financial Policy Committee (FPC) can direct the PRA to investigate and take action to manage the risks it has identified for the financial system as a whole. The PRA also works with the other regulator, the Financial Conduct Authority, which focuses on preventing misconduct by providers, such as selling inappropriate products to consumers

Question 15

The Financial Conduct Authority (FCA):

Answer 15

The Financial Conduct Authority is an independent body. It reports to the Treasury and can receive direction from the Financial Policy Committee. Providers that are regulated by the FCA have to pay fees to cover its running costs

The FCA describes its aim as ‘to make financial markets work well so that consumers get a fair deal’ (FCA, 2022). The FCA has a single strategic objective, which is to ensure that the relevant markets function well. This is supported by three operational objectives:
- to secure an appropriate degree of protection for consumers
- to protect and enhance the integrity of the UK financial system
- to promote effective competition in the interests of consumers

Since 1 April 2013 banks, credit unions and building societies have been regulated by the FCA and must be authorised by it before they can carry out activities such as accepting deposits, or advising on and offering mortgages. From 1 April 2014, regulation of all consumer credit (ie borrowing products) moved to the FCA from the Office of Fair Trading. The FCA also regulates independent financial advisers (IFAs) and providers that are not regulated by the Prudential Regulation Authority, such as individuals who manage investments

The FCA meets its objectives by supervising providers to ensure they are conducting their businesses appropriately. It sets out rules relating to the way they carry out their business activities. It has investigative powers to gather information from providers and consumers. It also has enforcement powers so that it can take action when it discovers providers have broken rules. These actions include:
- imposing fines on providers and/or individuals
- withdrawing or suspending a provider’s authorisation to operate
- ordering providers to compensate customers

Question 16

The FCA continued:

Answer 16

It describes its regulation as forward-looking (in other words, it aims to prevent further problems from arising) and judgement-based. For example, the FCA has fined a bank £4.2 million for failing to put in place suitable money laundering controls - that is, measures to prevent criminals from using the banking system to hide money (FCA, 2021b). It has also made a bank contact customers to clarify information about a product that the FCA judged was unclear (FCA, 2016). It has banned an individual from being a director of a firm for 15 years after they acted as an unlicensed consumer credit lender (FCA, 2017a)

The way that the FCA supervises providers varies according to their size and the type of business they conduct. There are three categories of provider, from largest to smallest, with less intense supervision for smaller providers. This is partly because the largest providers have the largest number of customers and partly because their actions can have the biggest impact on the market as a whole. Large providers are assessed continuously while the smallest providers are assessed at least once every four years

The FCA gathers information by making supervisory visits to providers, monitoring transactions, contacting consumers directly, and monitoring markets and the economy. It manages risk in two ways:
- by investigating individual providers or linked providers
- by investigating themes or issues in the market

The FCA takes a proactive approach to identifying issues that affect many providers in the market. For example, it requires providers to give it data on the number of complaints they receive and what the complaints are about. This data is published on the FCA website so people can see how many complaints their provider received

As larger providers have the most customers, statistically they are likely to receive the greatest number of complaints, so data needs to be interpreted with care. Data published in September 2014 (FCA, 2014), however, clearly shows that there were more customer complaints about payment protection insurance (PPl) than any other issue. The FCA supervised how providers gave customers compensation for PPI mis-selling and fined providers for failing to handle complaints fairly

As of the first half of 2020, PPI was still most complained about financial product (FCA, 2021c). The FCA deadline for customers to make PPI complaints passed on 29 August 2019, bringing to a close over a decade of such complaints (FCA, 2017b)

Another example of how the FCA protects consumers is the cap it has imposed on the loan charges that can be made by payday lenders (Peachey, 2015). The cap is set at 0.8% per day of the amount borrowed, and borrowers will pay back a maximum of twice the amount of the loan. Prior to this cap, payday lenders could charge very high rates that meant some borrowers were unable to ever repay the loan in full

The FCA does not get involved in resolving individual customer complaints (that is the role of the Financial Ombudsman Service). Instead, it investigates the market as a whole and the conduct of individual providers

Question 17

Financial Ombudsman Service (FOS)

Answer 17

The Financial Ombudsman Service (FOS) is an independent body set up by Parliament under provisions in the Financial Services and Markets Act 2000. The FOS was ‘set up by parliament to sort out complaints between financial businesses and their customers’ (FOS, 2022). The service the FOS provides is free to consumers. It is funded by levies on providers and case fees paid by the providers that have complaints brought against them. These case fees are payable whether the FOS finds against the provider or not

The FOS promises ‘We won’t take sides - and we’ll look at every problem with an open mind’. It considers both sides of every complaint - the customer’s and the provider’s. If it decides that the provider has treated the customer fairly it will explain why. If it finds that the provider has acted incorrectly, and the customer has lost money as a result, it will order the provider to put things right

The FOS can order providers to pay compensation up to a specified maximum, which depends on when the case was brought to the FOS. This does not include any interest or costs that the FOS might order the provider to pay on top of compensation. If a complaint is upheld and the compensation needs to be greater than the maximum to cover the customer’s losses, the FOS can ask the provider if it is willing to pay more but it cannot force the provider to pay. The customer could take the provider to court to claim the compensation

Question 18

Customers who wish to make a complaint about their provider should follow these steps:

Answer 18

1. Contact the provider directly

Customers should contact the provider as soon as possible, explaining the situation and asking the provider to put things right. Providers that are regulated by the FCA must respond to the complaint within eight weeks. Whether or not they offer compensation or another form of redress, providers must advise the customer how to refer their complaint to the FOS if they are dissatisfied. If the provider fails to respond within eight weeks, the customer can refer the matter to the FOS immediately

There are companies that will make complaints on a customer’s behalf, called claim handlers, claims firms or claims management companies. These are businesses that make a charge, either as an upfront fee or as a percentage of any compensation. Customers can get free, impartial help to make a complaint, however, from places such as Citizens Advice

2. Contact the FOS

As outlined above, if the customer is dissatisfied with the provider’s response, or if the provider has not responded eight weeks after the customer complained, the customer can refer their case to the Financial Ombudsman Service. This service is free but there is a time limit. Customers must take complaints to the FOS within six months of receiving a final response from the provider, or within six months of making the initial complaint if the provider did not respond. The FOS will contact the provider for an explanation and then make a decision

FOS decisions are binding on providers - so if the FOS orders the provider to pay compensation to the customer or take other action, it must do so

3. Take the matter to court

Customers do not need to accept FOS decisions in favour of the provider. They can take the provider to court; however, this is a costly process and the court might not find in their favour

Question 19

The Financial Services Compensation Scheme (FSCS):

Answer 19

The Financial Services Compensation Scheme (FSCS) will repay customers their deposits in providers authorised by the Financial Conduct Authority (FCA) if the provider is unable to do so or is likely to be unable to do so. This is usually because the provider has stopped trading, has insufficient funds or is insolvent. The FSCS covers deposits in banks, building societies and credit unions. The Financial Ombudsman Service deals with complaints against providers that are still in business

The FSCS was set up under the Financial Services and Markets Act 2000 and started operations on 1 December 2001. It is an independent body that makes no charge to consumers for its service. It is funded by levies on regulated providers which are made in proportion to the size of the provider. This means larger providers pay more in levies than smaller ones because the costs of compensation if a large provider became insolvent are much higher than for a smaller one

There are limits to the amount of compensation that the FSCS can provide, depending on the type of financial product involved. Deposits, investments and mortgages are covered up to a maximum of £85,000 per person per provider. A single provider is one that has an individual authorisation with the FCA. The brands that belong to a banking group may have just one authorisation. This may mean that customers with current and savings accounts in different brands may only be covered to the maximum of £85,000 for all their accounts. People can check provider authorisations by visiting the FCA website

Most foreign banks operating in the UK have UK subsidiaries with FCA authorisation so deposits are covered under the FSCS. For example, Bank of Ireland UK is authorised with the FCA; this means deposits in the savings accounts that it operates for the Post Office are covered by the FSCS. Deposits in foreign banks that are not authorised by the FCA are covered by the compensation scheme operating in the country where their headquarters are based

Savings in joint accounts are assumed to be split equally between account holders. For example, Beverley and Jim have a joint savings account with Penway Bank and no other products with this provider. If the bank failed their savings would be covered up to a maximum of £85,000 each, that is £170,000 in total

If a provider becomes insolvent, the FSCS automatically refunds savings up to the limit of £85,000 within 7 days. According to the FSCS website, 98% of the UK population have savings of less than £85,000 and would therefore be covered in full. In the first 10 years of its operation, the FSCS has paid out more than £26 billion in compensation and helped 4.5 million people (FSCS, 2022)

The FSCS does not only cover deposits. It can also provide compensation to consumers if they lose money because their insurance, investment or mortgage provider goes out of business

Question 20

Competition and Markets Authority (CMA):

Answer 20

The Competition and Markets Authority acquired its powers on 1 April 2014, when it took over many of the functions of the Competition Commission and the Office of Fair Trading (OFT)

The CMA is an independent, non-ministerial government department that works to promote competition between providers for the benefit of customers. The CMA’s role is to ‘ensure consumers get a good deal when buying goods and services, and businesses operate within the law’ (GOV.UK, no date)

It is responsible for:
- investigating mergers that could restrict competition
- conducting market studies and investigations in whole markets where there may be competition and consumer problems
- bringing criminal proceedings against businesses and individuals who take part in cartels (when competitors agree to fix prices, rig bids, share markets or limit output at the expense of customers)
- enforcing consumer protection legislation to tackle practices and market conditions that make it difficult for consumers to exercise choice
- co-operating with the government and sector regulators and encouraging them to use their competition powers

The CMA is continuing market investigations started by the Office of Fair Trading (OFT), for example by launching an inquiry into competition between banks.
The OFT investigated whether there is enough competition between providers in the bank current account market (BBC News, 2013). In January 2013 it found that the major banks Lloyds, RBS, Barclays and HSBC held 75% of the market. The OFT made a number of recommendations, including ways to make it easier for customers to switch accounts. This change was implemented in September 2013 when the Payments Council launched its switching service

The CMA launched a further inquiry due to concerns that the retail banking market was still not working well for customers (BBC News, 2014). For example, the CMA stated that:
- many customers saw little difference between the largest banks in terms of the services they offer
- switching between banks remains low - at just 3% a year for personal accounts
- current account overdraft charges are very complex, making it harder for bank customers to choose the cheapest or most appropriate accounts

In 2017 the CMA implemented a number of reforms to improve the banking system for consumers, including:
- open banking to make it easier for people to find out which bank account is best for them;
- publication of banks’ data on the quality of their service

Question 21

Voluntary codes of conduct:

Answer 21

As well as formal regulation by the consumer protection organisations discussed in this topic, providers regulate themselves by agreeing to voluntary codes of conduct. There are a number of codes, such as the Standards of Lending Practice that set out minimum standards of good practice for banks, building societies and credit card providers

The Standards of Lending Practice were created by the former British Bankers’ Association (BBA), the Building Societies Association (BSA) and the former UK Cards Association. They cover good practice for loans, credit cards, charge cards and current account overdrafts. The providers that subscribe to the Standards tell their customers that they follow the principles and give them information about the service they should expect

This includes:
- advertising that is fair, clear and not misleading
- giving customers information before, at and after the point of sale about how products work, including terms and conditions, interest rates and charges
- giving customers information about any changes to their product or service, such as a change in interest rates
- lending responsibly
- dealing with customers quickly and sympathetically when things go wrong and acting sympathetically and positively when considering a customer’s financial difficulties
- keeping personal information on customers private and confidential and providing secure and reliable banking and payment systems
- training their staff to put the Standards into practice