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Risk Based Pricing – Who’s Keeping Score?

Andrew Hagger, Head of News and Press at moneyfacts.co.uk, comments on the growing number of providers switching towards a risk based lending approach, and the need for independent regulation to confirm that 66% of consumers accepted for borrowing are receiving the advertised typical rate.

“As if shopping around for a personal loan or credit card is not complicated enough with varying terms, conditions and rates, consumers should also be aware they may not receive the headline rate which may have initially attracted them.

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“Most recently we have seen two big household names adopt the risk based pricing approach, firstly, Sainsbury’s Bank moving their cards away from fixed pricing. And secondly Egg’s personal loan pricing is no longer a one price fits all scenario.

“With 80% of loan providers already adopting typical rates, the cards market seems a little way behind with only 35% of providers pricing this way. However, with the need to stem the tide of rising bad debts, but at the same time increase interest income, card providers may soon to move towards this type of pricing structure, which better reflects the risk involved.

“Surprisingly, Cahoot is the only provider to initiate this approach on overdraft rates. Seemingly a fairer deal for some consumers who may benefit from rates at 9.8%, 2% lower than their typical rate, while the upper limit stretches to 14.8%, a rate at a level often seen within the current account arena.

“The CCA guidelines state that 66% of consumers accepted for a personal loan or credit card should receive the typical rate; however until now, there is no evidence that this rule is being adhered to.

“If there is no visible evidence that this rule is being monitored by the OFT, then the rules are open to potential abuse, which would be detrimental to consumers.

“With the latest OFT report focusing on reducing penalty fees, a substantial source of income for lenders, risk based pricing could provide an alternative ‘backdoor’ way to increase revenue, by advertising low rates to attract consumers, but with much higher rates being charged to more than 33% of accepted applicants. In other words a flexible lending approach, which could be steered more towards profit rather than risk.

“Consumers should be aware they might in some cases pay a premium of a few percentage points over the advertised rate but there are two sides to the coin, as some will be lucky enough to be offered a rate lower than the typical rate. It will depend on a combination of the individual’s credit rating and the provider’s score card.

“For consumers to know the rate they will pay, a credit application must first be processed, so for those chasing the best rate available, the market has become much less transparent.

“But consumers whom mainstream lenders may in the past have turned down may now find themselves being accepted for a loan, albeit at a higher rate to reflect the additional risk. The risk based pricing approach opens up a wider market for both providers and borrowers.

“The adoption of this approach, if regulated in a manner that protects consumers, would appear a sensible and responsible method of lending, providing added protection for lenders and rewarding consumers with clean credit histories.

“Moneyfacts continues to be in contact with the OFT, to reiterate the need for the 66% rule to be proactively monitored if it is going to do what it was designed to do, i.e. protect consumers.

It is simply not sufficient to rely on individual complaints and other bodies such as Trading Standards and Citizens Advice to highlight discrepancies within the ruling; a much more visible approach is required, especially with more and more providers now using typical rates.”