The Financial Conduct Authority (FCA) assessed non-bank mortgage lenders and consumer credit firms.
Regarding non-bank mortgage lenders, the FCA said some firms saw arrears levels rise, and some were adversely impacted by external issues such as pressure from funding providers or group-wide issues.
It said a number of lenders considered the changing economic conditions and adapted their practices to minimise harm, demonstrating “robust business planning”.
Some firms also “actively considered” the levels of liquidity needed to run their business and had put triggers or buffer levels in place to act as warnings for potential issues.
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Assessing risk
However, the FCA said while it was understandable that smaller non-bank lenders were reliant on one source of external funding, “in several cases” this was not seen as a risk.
“Growth plans often did not consider the levels at which diversifying funding sources might become a viable option,” the regulator said.
Good examples of risk management processes were seen in some larger firms, with many putting in place a “three lines of defence approach” and external support where needed.
It said boards and management committees had clearly explained their risk appetite. Others had measures in place to set buffers, for example where a lender did not want liquidity to fall below a certain level.
Some lenders had practices in place to update their products to deal with cost-of-living pressures and high interest rates, while continuing to offer services to borrowers.
However, other firms “took actions with potentially significant impact without fully understanding the consequences because they were unable to model the impact of their actions”.
Some non-bank lenders also had flexible “intra-group funding arrangements” to manage repricing risk, but the regulator said it was not always clear if these measures created new interest rate risk exposures elsewhere or took advantage of surplus cash across the group.
Many firms were found not to have a “clearly articulated risk appetite” in place, the regulator said, with some considering their capital requirement to be lower than regulation suggested.
“Without this, it is difficult to create an effective risk management framework or make time-critical business decisions,” the FCA said.
For firms that exclusively relied on risk measures implemented by external parties, the FCA said it was important they establish their own risk appetites then measure performance against this.
Some lenders did not have a “clear understanding” of how interest rate changes could impact their business and were found to be slow to respond. The FCA observed that “this had a material negative impact on profitability”.
Plans to wind down
The FCA found examples of “well-developed” stress testing among non-bank mortgage lenders, with some using forward looking modelling as well as using past experiences to predict potential losses.
Some also had alternative funding sources in case there were issues with existing partners, while others had measures to increase regulatory capital if needed such as restricting dividend payments and raising capital.
However, it found this was sometimes limited and only considered the impact of a fall in lending, not rising arrears or interest rates.
The FCA also observed one firm exploring alternative funding options at a short notice, and said firms should “develop appropriate early warning indicators”.
While some non-bank lenders saw a rise in arrears, there was a limited rise in provisioning or capital set aside to cover losses.
The FCA also “found a general lack of wind down planning”, with some lenders only considering this to be a problem for funding providers.
“We recognise that the security held by funding providers is likely to give them a very significant stake in a wind down situation.
“However, we expect firms to consider their own responsibilities and plan to ensure that they take actions to minimise the impact of firm failure, on both customers and markets, at the appropriate time,” the regulator said.
The FCA said firms should review their arrangements against its findings and make improvements where needed.
