Mortgage arrears-handling failures cost Lloyds dearly – Abdulali Jiwaji, Tom Snelling and Johnny Shearman

By Abdulali Jiwaji & Tom Snelling

Partners Abdulali Jiwaji and Tom Snelling, and Professional Support Lawyer Johnny Shearman, discuss the recent FCA fine against Lloyds Banking Group and argue that the market can expect to see the FCA come down hard on rough treatment of customers by financial institutions during the current economic climate.

Abdulali, Tom and Johnny’s article was published in Compliance Monitor, July 2020, and can be found here.

The recent fine issued by the Financial Conduct Authority (“FCA“) against Lloyds Bank, Bank of Scotland and The Mortgage Business (together, “Lloyds“) for historical failures in relation to their handling of customers in payment difficulties is a warning to other regulated firms.  This is particularly so as we risk entering another period of global financial instability, caused by the Covid-19 pandemic

What went wrong for Lloyds?

On 11 June 2020, the FCA fined Lloyds approximately £64 million. Following an extensive investigation, the FCA found that, between April 2011 and December 2015, Lloyds’ systems and procedures for gathering information from mortgage customers in payment difficulties or arrears had resulted in failures to obtain adequate information to assess the affordability of repayments in light of these customers’ circumstances. This created a risk that customers were being treated unfairly.

In addition, Lloyd’s system for calculating arrears repayments was inflexible and not subject to adequate oversight.  As a result, call handlers may have failed to negotiate appropriate payment arrangements for vulnerable customers.

The FCA found that these risks were exacerbated when, as part of a “simplification programme”, Lloyds lost a large number of experienced mortgage collection and recoveries personnel, after which point nearly all of their mortgage arrears call handlers were “new-to-role”.

Lloyds was found to have breached Principle 3 and Principle 6 of the FCA’s Principles for Business, which require firms to:

  • take reasonable care to organise and control its affairs responsibly with adequate risk management systems; and
  • pay due regard to its customers’ interests and ensure they are treated fairly.

During the four year period that Lloyds was found to be in breach of these Principles, approximately 38% of customers were treated unfairly.

It is notable that even before the FCA’s findings Lloyds had implemented a group-wide redress scheme for those affected. The redress scheme, set up in July 2017, has compensated approximately 526,000 customers and the payments under the scheme total some £300 million.

Therefore, while the fine against Lloyds is not a record in its own right (we have seen larger fines for FX manipulation and money laundering issues), when coupled with payments Lloyds made under the redress scheme, the cumulative total is one of the largest financial hits recently suffered by a UK bank around “treating customers fairly” issues – and that is without any follow-on litigation claims.

Firms are on notice

Mark Steward, the FCA’s Executive Director of Enforcement and Market Oversight, has made it clear that firms should take note of the FCA’s recent action and ensure that their own treatment of customers meets the FCA’s expectations.

This warning comes at a point in time in which the UK’s GDP fell by a record 20.4% in a single month. This figure was recorded in April of this year when the economy had started to suffer from being in lockdown as a result of the Covid-19 pandemic. Approximately 9 million workers are currently subject to the Coronavirus Job Retention Scheme (commonly referred to as the furlough scheme). It is therefore inevitable that financial institutions are dealing with significant numbers of customers in financial difficulties.

In responding to situations of customer financial distress, banks are obliged to treat their customers fairly.  Indeed, it is when a customer is in financial difficulty that the duty may be at its highest.

Accordingly, firms are on notice that enforcement action will follow where there is evidence of customers being treated unfairly.

What lessons can be learned?

The FCA’s action against Lloyds illustrates how important it is for firms to have robust and reliable systems and procedures in place to identify the personal circumstances of customers in financial difficulty. Firms should be identifying whether, in order to treat those customers fairly, any specific, and individually tailored, measures are required. Decisions made should be properly documented and then stress tested to establish if either a change in approach is required.

Firms must also ensure that appropriately trained and experienced employees are dealing directly with their customers. Clearly, the degree of training and experience required should be considered on a sliding scale, with a higher bar being set for those employees dealing with customers at risk of being treated unfairly. An obvious example from the present case is that those dealing with customers in mortgage arrears should be suitably qualified.

Lessons can also be learned from how Lloyds responded to the issues once discovered, how it handled the matter internally and how it dealt with the FCA.

Some of the failings were identified by Lloyds as early as 2011, but the steps they took failed to rectify the issues. The failings were then identified by the FCA in 2013. During 2014 and 2015, Lloyds took a number of additional steps to address the concerns raised and, on several occasions, informed the FCA they were on track to implement those improvements. However, a further review by the FCA in July 2015 found that sufficient progress in addressing the problems had not been made.

It is reasonable to assume that had Lloyds dealt with the failings more effectively at the time they were identified, then it would have seen a reduction in penalty.  This reflects the current regulatory zeitgeist in which the FCA smiles upon good and swift remedial behaviour, whilst very much frowning on what it perceives as heel-dragging and lack of competence from big players in the sector.

Equally, the level of a financial penalty will depend on the firm’s willingness to accept the FCA’s findings. Lloyds did so and benefited from a 30% discount. Otherwise, it would have faced a financial penalty of over £91 million.

Outlook – enforcement and litigation risk

On the enforcement front, there can be little doubt that the FCA is mindful of the impact of pandemic related issues and we can expect to see the FCA come down hard on rough treatment of customers by financial institutions during the current economic difficulties.

Financial institutions are at risk of a ‘double whammy’ effect: what is required to demonstrate fairness is heightened because of customers’ difficulties due to Covid-19 when, at the same time, the pandemic and lockdown has put greater strain on those within banks tasked with ensuring and evidencing effective compliance.

In recent years, we have seen FCA investigations and enforcement activity dragging over several years.  Part of the reason for this is that the FCA has been dealing with significant legacy issues from the financial crisis over 10 years ago.  The FCA has needed to prioritise resources and that has slowed progress on a number of investigations.  Looking at the Lloyds fine, it is noteworthy that some of the conduct in question took place almost 10 years ago.  However, in the latest FCA Business Plan 2020/21, two of the FCA’s key objectives include protecting the most vulnerable and ensuring consumers are treated fairly. Therefore, it would be prudent for firms to anticipate a swifter response from the FCA going forward.

The FCA has also clearly signposted its intention to target misconduct by Senior Managers. Senior Managers will be in the firing line if they fail to take reasonable steps to prevent conduct breaches in relation to the area of business for which they are responsible.

History suggests that where we see a fine issued by the FCA, some degree of litigation risk typically follows. That was certainly the case following the fines relating to the issues of FX manipulation. In this instance, the collective redress scheme instigated by Lloyds will have mitigated that risk as a large number of customers have been compensated. However, the risk remains real that some customers may not have been and may pursue a claim through the courts.

Firms must also bear in mind that the propensity for group or representative actions is increasing and litigation funders are increasingly willing to finance these types of claims. Therefore, with the FCA on high alert and the threat of litigation, any wrongdoing in the current economic climate may prove costly.

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