Financial services should take the lead on loyalty penalty charges

Posted On: 
3rd July 2019

The financial sector should not rely on the market forces, but genuinely take into account consumer outcomes to avoid regulatory interventions, which could hurt both the sector and consumers, says Maria Busca.

A recent study by Europe Economics commissioned by the Financial Services Consumer Panel (FSCP) shows that mortgages and credit cards are the two largest drivers of loyalty penalties, says Maria Busca.
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According to the FCA’s Mortgage Market Study, in 2016, there were 150,000 consumers who could potentially benefit from a better deal but were unable to switch. They were dubbed mortgage prisoners and their fate is heavily complicated by the fact that most of them have mortgages with inactive or unauthorised lenders.

But the FCA also found that about 800,000 consumers are paying a relatively high reversion rate and do not switch even when they could. The financial impact on those who do not switch is around £1,000 a year on average during the introductory rate period, the FCA found.

A recent study by Europe Economics commissioned by the Financial Services Consumer Panel (FSCP) shows that mortgages and credit cards are the two largest drivers of loyalty penalties amongst other financial products including insurance, pensions, cash ISAs. Looking widely across different financial products, some consumers could be incurring loyalty penalties in excess of 5 percent of annual income. The worst affected profile is the middle age, average income single female, for whom the costs are 10 percent of annual income.

Auto-switch services are unlikely to solve the issue

Price comparison websites and auto-switch services could arguably address the loyalty penalty. But the terms and conditions and other related fees such as arrangement, booking and legal charges also make this a much more challenging process than in the case of the utility market.

Nevertheless, trust is emerging in these technologies according to recent a survey by YouGov commissioned by Dashly. The study showed that a third of people would be happy to be automatically switched to a better deal by an online mortgage platform. But this is not an indication of whether auto-switch would work when it comes to consumer outcomes. The FSCP has pointed out that information remedies and relying on consumers to increase competition are not effective. They have also warned against the risk that auto-witching could magnify loyalty penalty for those digitally excluded.

So is this a case of market failure where policymakers should draw the lines of what are acceptable rates?

Lessons from the energy price cap are not very encouraging

The benefit of a cap would be reaching those with pre-2014 mortgages sitting now with closed book lenders and unauthorised entities. The price cap applied in the energy market since January 2019 showed that it does not affect competition and does not hinder the increased number of consumers switching despite fears otherwise.

However, it led to higher energy bills on average, as companies made up the difference in other contracts. The results are discouraging for those who were hoping price intervention was a solution, but questions remain around the calculation of the cap.

Auto-upgrade could lead to the same consequences of the cap

The APPG for Mortgage Prisoners is currently exploring two other options: auto-upgrading; and introducing a new duty of care. Both proposals are supported by the FSCP. Auto-upgrading would require firms to move consumers onto better comparable products within the company’s suite of products. The unintended consequence could be an average increase in prices to account for this policy change, similar in its effect with the price cap. 

A resolution is unlikely very soon but pressure on the industry is increasing

With the main backer of the Tory leadership frontrunner and potential future Chancellor Liz Truss calling for a free enterprise economy, it is uncertain whether the CMA reforms on consumer outcomes would be given as much attention.

However, challenging the very business models of financial services firms is a question that will increasingly emerge as tackling consumer vulnerabilities and discrimination keep making the top of the agenda.

Part and parcel of good consumer outcomes is not only access to information and advice but also the market’s willingness to use their tools from pricing to terms and conditions by taking into account consumer outcomes. The CMA has so far not seen a widespread shift taking place in the industry and urged businesses to treat customers more fairly. 

In what he thought could be one of his last speeches in office, Economic Secretary to the Treasury John Glen warned financial institutions against taking “people’s trust for granted again”. Banks in particular must realise that public expectations are growing. And across the political spectrum, there is an appetite to find radical solutions to the challenges of affordability, inclusion and access.”, he said.