Abstract

Banks and financial institutions are embracing new business models to launch innovative products and services to cater to the changing needs of customers.

However, not all these products and services are designed keeping consumers’ best interests in mind; some may be more aligned to the organization's goals. Moreover, many of these products come with complex characteristics that could result in financial harm to consumers due to a lack of understanding of the implications. 

To enhance retail consumer protection, UK’s Financial Conduct Authority (FCA) has introduced the data-led, outcomes-based Consumer Duty regulation. The intent is to set higher standards of conduct for financial services firms and ensure fair customer outcomes. The regulation comes into force in July 2023 and will necessitate large-scale changes to the way products are designed, marketed, sold, and serviced. We discuss what banks and financial institutions must do to comply with the regulation and meet the expectations of the FCA.

Why Consumer Duty

Existing regulations have not been completely successful in protecting consumers from financial harm.

In response, the Financial Conduct Authority (FCA) has introduced the Consumer Duty regulation to strengthen focus across three dimensions—reducing and preventing serious harm, setting and testing higher standards, and promoting competition and positive change in the UK financial market.

The regulation will come into effect on July 31, 2023, for new and existing products or services that are open for sale or renewal, and July 31, 2024, for closed products or services. It includes three key elements—a new consumer principle, three cross-cutting rules, and four outcomes (see Figure 1).

Figure 1: The Consumer Duty regulation at a glance

Impact on banks

Compliance will require financial institutions to significantly change the way they design, price, and sell their offerings.

Financial institutions may not have a complete view of how customers use their products, the impact of their offerings on customers in vulnerable situations, and the resultant harm. Regulators want financial institutions to gain this understanding by reevaluating the adequacy and effectiveness of their existing customer support services and communications in enabling customers to clearly understand a product’s value, suitability, risk, and financial impact.

For banks, this will mean adopting a more humane approach, with the focus shifting to offering customers financial advice that ensures their financial health or wellbeing. With increasing reliance on credit in the prevailing environment, banks need to be empathetic, enabling customers to make decisions that help them tackle their financial challenges effectively. This will help banks win customer loyalty and drive lifetime value. In principle, customers should be empowered to assess product fitment themselves to promote sustainable growth and healthy competition based on higher standards of conduct. 

An approach to compliance

Banks must define a compliance strategy with a strong focus on ensuring positive customer outcomes.

A thorough evaluation is essential to determine if existing processes are delivering positive customer outcomes or not. Also, as banking products cut across various services and involve multiple partners and ecosystem players, banks must assess the impact of the rule across the entire customer journey and rethink processes and technology accordingly (see Figure 2). 

Figure 2: A five-step approach to compliance

Assess product adequacy and design: Banks should evaluate their products and services to determine if they deliver the benefits customers expect and analyze the adequacy of their governance frameworks. To ensure this, banks must:

• List the retail banking products impacted by the Consumer Duty rule, including their own as well as partners’ products.
• Conduct a detailed product analysis encompassing the product’s nature, characteristics, risk profile, and complexity. Further, map products to the right target customer group to ensure that the right products are being offered to the right customers, which will enable better product fitment.
• Map the entire customer journey across the value chain of their products to identify factors that may lead to poor customer outcomes and work towards mitigating them. For example, consider the case of first-time home buyers. This segment often faces challenges of low credit rating and inability to make huge down payments. Limitations in existing mortgage products may lead to poor outcomes for this segment. To address this, banks can design products and services that will help overcome the challenges and close the gaps in the existing product, in turn leading to positive customer outcomes.        

Develop or enhance the value assessment framework: Banks should review their pricing models considering the benefits and value their products offer customers. Banks should develop or enhance their value assessment framework to determine whether a product or service delivers fair value for the price paid—the price must not outweigh the benefits realized. To assess the fair value of products from customers’ perspective, banks must:

• Identify all the factors (internal and external like market demand and economic conditions, customer circumstances, and competition) and attributes of a product that may impact its value.
• Identify how the information impacting value will be collected from distribution and value chain partners.
• Collect data from customer research, customer feedback and complaints, and competitor product analysis.

Also, while developing the value assessment framework, banks must consider certain aspects mandated by the regulation, such as the nature of the product, its limitations, the expected total price over the lifetime of the product, and any other vulnerabilities characteristic of the target customer groups that may impact fair value. For example, loan repayment plans should be customizable to an individual borrower’s situation, such as unemployment, chronic health issues, and life-changing events. The value assessment should also consider costs, including non-monetary costs as well as market rates and charges for comparable products. Products should be periodically assessed to ensure they consistently deliver fair value—if a product fails to deliver fair value, it should either be enhanced or discontinued.

Evaluate communication: Complying with the customer understanding mandate of the regulation will require banks to:

• Ensure customer communications are clear, easily understandable, and not misleading. This is especially crucial for consumer credit and mortgage products as FCA has noticed potential bias and information asymmetries that could result in consumers making poor financial decisions.
• Assess, test, and monitor existing contract documentation, disclosures, and ongoing communications through various channels across the product lifecycle to ensure the average customer clearly understands the implications of buying or using the product. For example, for mortgage products, the advice process needs to be consistent across all channels (digital and physical) to ensure identical understanding irrespective of the channel chosen.  

Reimagine customer support: Banks should identify and reduce the pain points to ensure customers are able to fully utilize the products and services they purchase. To achieve this, banks must:

• Define metrices to evaluate the quality of their support processes and services.
• Analyze complaints data and customer feedback from partner channels (distributors, dealers, realtors, brokers) to gain insights on the causes of subpar services.
• Re-engineer and enhance customer support processes based on the insights gained. The quality of service should remain consistent across the pre- and post-sale stages and enable customers to easily make an enquiry, claim, complaint, or switch providers. Ideally, the exit process should be as convenient as the entry (purchase) process.
• Build positive friction in the product sales process to prevent potential harm to customers. However, this should not result in sludge practices that adversely impact customers. For example, KYC and financial verification processes are positive friction; however, asking for hard copies of financial documents despite having digital versions can delay the loan approval process and create unnecessary barriers.
• Leverage data insights for a 360-degree customer view and offer the next-best action recommendations personalized to individual customer contexts.

Embed controls to monitor outcomes: Post the assessment, banks should take steps to address the issues identified and ensure fair outcomes. To accomplish this, banks must:

• Identify the gaps that lead to poor outcomes, determine the new requirements, and define risk and performance KPIs, thresholds, and compliance criteria.
• Address the gaps through relevant policy or process changes, putting in place the right controls (inclusive of distribution or outsourcing partners).
• Embed automated controls in the day-to-day business processes for easy monitoring, reporting, and demonstrating compliance with the related Consumer Duty outcome. For example, a rating system could be introduced in the initial stages of the loan process with a rating below a predetermined threshold triggering a call to walk the customer through the document to ensure better understanding. 
• Perform root cause analysis and initiate remediation measures where the metrics indicate poor customer outcomes.
• Establish a review process and governance model to assess, test, and understand the data metrics required for effective monitoring and proof of compliance.