Historically, Consumer Credit (CONC) firms and Non-Bank Mortgage Lenders (NBML) have generally assessed regulatory capital and liquidity requirements on either a relatively simple formulaic approach, or a principles-based approach. For instance, the MIPRU sourcebook places the need on Home Finance firms to ensure that they "at all times maintain liquidity resources which are adequate, both as to amount and quality, to ensure that there is no significant risk that its liabilities cannot be met as they fall due", whilst Principle 4 within the FCA's Principles for Business (PRIN) also states that "a firm must maintain adequate financial resources", meaning that this population of firms has generally been able to apply a lighter touch approach to prudential requirements, despite the FCA's Finalised Guidance 20/1: Assessing adequate financial resources (FG20/1) publication. That is until the FCA's recent Multi-firm review of Consumer Credit firms and Non-Bank Mortgage Lenders ("the Multi-firm review"), dated 23-October 2024, on its risk management and prudential expectations for CONC and NBML firms.
The purpose of this article is to briefly consider how the FCA's expectations have shifted, what firms should be considering doing differently as a result of this, and what are the likely implications of this shift.
How has the expectation shifted?
There is one argument that suggests that the expectation of these firms has not shifted and that the FCA's previous Business Plans have been consistent in identifying financial resilience and the need to reduce harm from firm failure as amongst its key priorities. However, it was generally considered – rightly or wrongly - that the more detailed expectations contained within FG20/1 were more applicable to firms subject to more prescriptive prudential regimes, i.e., MIFIDPRU investment firms under the Investment Firm Prudential Regime. As a result, the expectations set out in the Multi-firm review represent a mind-set / cultural shift away from the adherence to the baseline prudential requirements of CONC 10.2 and MIPRU 4.2, towards more of an ICAAP / ICARA-type assessment, as per the banking and investment firm regimes respectively, where firms are required to consider specific risks to the business, assess these risks, and set capital and liquidity accordingly - over and above the regulatory minimum requirements.
As part of this risk assessment, CONC and NBML firms are also required to set risk appetite accordingly, and ensure that they have an appropriate and proportionate risk and control framework in place to manage these risks, as well as the use of stress-testing, scenario analysis and performing wind-down planning to ensure that the firm is able to exit the market in an orderly fashion with minimum disruption.
What firms should be doing differently?
Whilst we would advise all CONC and NBML firms to read and digest the Multi-firm review, our key take aways from the Multi-firm review are summarised, as below:
- Focus on assessing economic capital required per the firm's risk profile, using the firm's own metrics, not the regulatory minimum.
- Perform granular analysis against a holistic set of principal risks, taking a granular approach.
- Be aware of your firm's vulnerabilities and stresses, through the performance of stress testing.
- "Wind-up" wind-down planning, using realistic assumptions.
- Embed this risk management process and apply governance in your day-to-day business operations.
What are the likely implications?
Given the economic backdrop, the FCA is clearly concerned around the financial resilience of this population of CONC and NBML firms and so wants to ensure that these firms either have adequate regulatory capital and liquidity buffers to absorb any such shocks. It therefore follows from the Multi-firm review that these firms will be held to a higher standard of prudential risk management going forward, meaning that relative levels of regulatory capital and liquidity will need to increase to meet the FCA's expectations and objectives. We would however note that fundraising to increase regulatory capital could also be prove increasingly challenging in the current economic backdrop, so we would urge firms to start thinking about regulatory capital / liquidity planning as soon as possible.
Given this is clearly a regulatory priority for the FCA, to reduce the harm from firm failure, it is also likely that they will take proportionate steps to increase prudential standards. Quite what form this takes is still yet to be seen; however, there are multiple tools available to them within the supervisory toolkit, including use of thematic / SREP-type visits, third party diagnostic reviews, benchmarking of regulatory returns etc., so our advice to firms would be to proactively invest in up-skilling and upgrading in this space, as it will be difficult to play "catch-up" once under regulatory scrutiny.
We can, and do, of course assist our clients with regulatory capital and liquidity matters across a broad range of areas. Should you require support, our team of experienced industry practitioners and former regulators is ready to support CONC and NBML firms. Please contact the authors if you wish to discuss further.
