What was the FCA’s overall finding?

The FCA’s overall finding was that the majority of firms could improve their approach to risk governance and risk management. Firms did not always identify and monitor their firm’s risks and financial metrics to give a greater insight into the challenges they face.

How can Hogan Lovells help?

At Hogan Lovells, our combined legal and consulting Financial Services team helps firms navigate and comply with their prudential and regulatory requirements including in relation to financial resilience. If you would like to know more about the Hogan Lovells team and how we can help you with the operational practicalities of the FCA’s findings, please get in touch.

Financial resilience: what are firms required to do?

Consumer credit firms and non-bank mortgage lenders are required by Principle 4 (of the FCA’s Principles for Businesses) and the Threshold Conditions to maintain adequate financial resources at all times.

Firms are required to assess the adequacy of their financial resources against the risk of harm and the complexity of their business, starting with whether they have enough assets to cover their liabilities.

The FCA’s key findings

Whilst the FCA identified many areas of good practice, it’s clear that there is work to be done by firms to improve their approach to risk governance and management. The FCA found that:

• Some firms had inadequate systems in place to measure and monitor risks which resulted in a sub-standard approach to risk identification;

• The risk management framework for most firms was not fully developed;

• Stress testing was inadequate or non-existent;

• There was a lack of adequate wind down planning which meant firms were at greater risk of a disorderly failure.

Examples of good and bad practice

The FCA has identified examples of good practice as well as areas for improvement. It’s important that consumer credit firms and non-bank mortgage lenders review these and apply any learnings to their own processes and approaches. Some examples include:

Identifying risks relevant to the business

• Consumer credit firms:

  • Good practice: Most firms had a good understanding of the credit risk they undertook with effective credit assessment of borrowers.

  • Areas for improvement: In the absence of specific regulatory requirements for capital and liquidity, the FCA found some firms had not considered or set their own financial risk metrics for adequate levels of capital and liquidity.

• Non-bank mortgage lenders:

  • Good practice: Some firms had undertaken robust business planning and produced forecast financial statements that clearly showed their regulatory capital and liquidity position.

  • Areas for improvement: Smaller firms were often understandably reliant on a single source of external funding but, in several cases, did not identify this as a risk. Growth plans often did not consider the levels at which diversifying funding sources might become a viable option.

Setting of risk appetite and establishing appropriate systems and controls

• Consumer credit firms:

  • Good practice: There were some examples where the Board/management team had set a clear risk appetite, outlining their desired risk profile and the types of risks the firm was willing to accept.

  • Areas for improvement: Many firms did not have a clearly articulated view of what level of financial resource they considered to be adequate and at which points they would become concerned. Without this, it is difficult to create an effective risk management framework.

• Non-bank mortgage lenders:

  • Good practice: There was some evidence of the assessment of financial resources needs being balanced against growth objectives.

  • Areas for improvement: Many firms did not have a clearly articulated risk appetite in place. Some firms subject to a capital requirement from the Mortgage and Home Finance Firms, and Insurance Intermediaries prudential sourcebook (MIPRU) considered this amount to be materially lower than their own risk appetite but were unable to articulate what their own capital requirement should be. Without this, it is difficult to create an effective risk management framework or make time-critical business decisions.

Undertaking stress testing and considering wind down planning

• Consumer credit firms:

  • Good practice: Some firms considered interest rate risk and had carried out stress testing to identify the impact on margin and profitability of changes in the cost of funding and the rate charged to borrowers on loans.

  • Areas for improvement: Many firms had an underdeveloped approach to stress testing which meant that they were under-prepared for changes in economic conditions. 

• Non-bank mortgage lenders:

  • Good practice: There were examples of well-developed stress testing. These used multiple scenarios against a range of factors, including demand for products, loan performance, house prices and the impact of interest rate changes.

  • Areas for improvement: Stress testing was often limited and did not cover the firm’s risk profile. Some firms stressed a fall in lending but did not have scenarios for rising arrears or interest rates.

Next steps

The FCA expects relevant firms to review their arrangements against these findings and make any improvements that may be necessary. It will continue to consider firms’ approaches to managing financial resilience and the risk of harm to consumers as part of its ongoing supervisory work.

Authored by Julie Patient and Aine Kelly.