The myths of credit checking

We read constantly in the media about how easy it is to access our personal information, so it is hardly surprising that most people assume that credit checking by loan companies is comprehensive and thorough.

You fill out an online loan application form and instantly the computer wizardry of which they are so proud checks your story and confirms you are a suitable person to receive £500. Isn’t that what happens?

Not true.  Not by a long way.

And therein lies the real problem at the heart of the Financial Conduct Authority’s efforts to improve regulation of the payday loans industry.

A loan company doesn’t listen to you and work out if you are credit worthy.  They don’t start with you at all; they begin with a business model.  They are a commercial enterprise whose job it is to make profit, so they need to know where they will make that profit most effectively. 

They have a profile, a detailed definition of the person they want to lend money to.  When you fill in your application form, they work out how closely you match their ideal customer.  And on that basis you will get your loan or be turned down – or in some instances, you may be offered a different product with a profile that looks more like you.

Most importantly, there is no central clearing system where all your financial information is held and can be checked.

Companies like Experian and Equifax have access to public registers, such as the electoral roll, the Register of Judgements and Fines, and the Insolvency Register.  But the credit history information they compile on individuals is supplied to them, and requires the person to have given permission for someone to view it and share it. 

They have no legal right to access your financial information, and the FCA cannot force lenders to share information with credit checking companies.

 Credit reference agencies are commercial companies that have relationships with (amongst others) banks, building societies and loan companies to buy and sell data.   All of these financial organisations are in fierce competition with each other – they only share sensitive information if there is an overwhelming benefit to themselves. And that is not necessarily the case for unsecured loan companies like payday lenders.

There is no proposal by the FCA to set up some new mechanism which would allow all loan companies to see how many other loans a potential borrower has taken out. 

And the small size of payday loans (and therefore the individual profit levels from them) means the kind of due diligence carried out by mortgage lenders – with “decisions in principle” followed by validation checks - would render the whole business unviable.

So what is likely to change?

The new rules proposed by the FCA will force the lenders to re-evaluate their target customers.  They will be less likely to want to lend to certain types of people in the future.  Faced with rigorously applied rules rather than the old OFT guidelines, they will fashion their application forms rather more carefully and tighten up their staff training and compliance – because the risks and penalties associated with lending to the “wrong” people are now higher.

They will flex and change - moving into new areas and devising new products which will grow more successfully in the new regulatory landscape.

In fact most of the pressure from the new regulations will fall on the consumer.  If the rules are applied strictly by short-term lenders, customers may find themselves answering more or less the same questions on their application forms as they would if applying for a bank loan or a mortgage.

The rules will make it harder for people to fudge the information they give about their own financial circumstances.  It will be more difficult for borrowers to bury their heads in the sand about how much they are committed to paying out each month already when they apply for another loan.  

But the big question, as always, is - what are the alternatives?  Where will struggling families go when they need credit to see them through the month?  And how do we reduce the levels of problem consumer debt in the UK?