Arrears Management in Consumer Credit

Arrears Management
Consumer Credit
Publication date: 12-Nov-2021
Classification: AFM - Public

Contents

Introduction 3
AFM Investigation 5
Starting Points for Safeguarding Customer Interests in Arrears Management 7
Investigation Results 14
What the AFM Expects from Providers 21
Appendix 1: Guidelines for Positive Communication 23
Appendix 2: Sources 25
Introduction
The Dutch Authority for the Financial Markets (AFM) advocates for the sustainable financial well-being of consumers, focusing particularly on the most vulnerable customer groups. For the AFM, it is important that customers – even during crisis periods – maintain a vision of a debt-free future. To determine the extent to which consumer credit providers in the Netherlands place customer interests at the center of their arrears management, the AFM conducted an investigation into the design and implementation of their policies regarding payment arrears on consumer credit. A direct trigger for this investigation was the coronavirus crisis and the predicted negative economic consequences thereof. These can lead to an increase in the potential vulnerability of consumers. A deteriorated financial situation for consumers can result in a rapid increase in the number of customers with consumer credit who fall into payment difficulties. By the end of 2020, nearly 8.8 million Dutch residents had consumer credit, and 4.49% of all residents over the age of 18 had registered payment problems, according to the BKR Foundation.1 This amounts to nearly 800,000 customers with payment problems. Follow-up Investigation The AFM published its guideline "Consumers and Collection Procedures" in 2016.2 In the investigation that followed in 2016-2018, the AFM looked at arrears management among consumer credit providers. The conclusion at that time was that customer interests were not sufficiently central for all providers. Additionally, the AFM annually monitored the Customer Interest Dashboard until 2018 to assess the extent to which financial enterprises place customer interests at the center. In 2018, enterprises scored an average of 2.5 out of a maximum of 5 regarding their policies on payment arrears. In the autumn of 2020, the AFM therefore started a new investigation into arrears management among consumer credit providers in the Netherlands. The ultimate goal of the investigation is that customers with payment arrears are offered a good and sustainable solution. This means that the customer receives a solution that contributes to a debt-free future within a reasonable timeframe. Vulnerable Consumers The coronavirus crisis requires intensified attention for consumers in vulnerable situations, such as in arrears management and payment problems. A stress test jointly conducted by the AFM and the Central Planning Bureau in 2020 showed that at least 75,000 households would fall into financial problems within three months after a loss of income.4 To prevent households from ending up in a financially unsustainable situation, careful treatment of customers by financial enterprises is of great importance. At the same time, both consumers and financial service providers have shown a high degree of resilience, partly due to the use of government support packages. According to figures from the Dutch Banking Association, more than 12,000 consumers have received a payment pause for
the repayment of their consumer credit since the outbreak of the coronavirus crisis.5 It is not yet known how the situation will develop in the coming time; payment arrears may (still) increase. New Insights The focus of the current investigation was on examining whether consumer credit providers sufficiently contribute to securing a debt-free future within a reasonable timeframe for customers with consumer credit who have payment problems. Important elements to achieve this goal are establishing and maintaining contact with customers, identifying the cause of the payment problems, and offering a sustainable solution based on the customer's current (financial) situation. This report outlines the conclusions of the investigation. The AFM describes what it observed during the investigation on an anonymized basis, providing good examples from practice. The report also shares various insights from behavioral sciences. This report is structured as follows. Chapter 2 elaborates on the investigation. Chapter 3 discusses the topics relevant to arrears management. Chapter 4 presents the results of the investigation. Finally, Chapter 5 indicates what the AFM expects from the market. 5 https://www.bankinbeeld.nl/thema/corona-monitor/
AFM Investigation
The AFM conducted an investigation in 2020 and 2021 with 9 consumer credit providers (banks and providers of credit with an AFM license) into how these providers handle payment arrears and how 3 providers followed up on an investigation into arrears management conducted in 2018. The AFM chose a differentiated approach, conducting investigations of varying depth with different providers.
Approach
In the investigation, the AFM distinguished between the following 3 groups. Consideration was given to (the results of) previous investigations into arrears management that the AFM had conducted in the past.
1 The AFM had already conducted an extensive investigation into arrears management with 3 providers in 2018. These providers implemented improvements following this investigation. In October 2020, the AFM held a discussion with these providers on the status of affairs. The AFM did not conduct new research in this context.
2 With 3 providers selected based on risk, the AFM started an extensive investigation in November 2020 into how arrears management is designed and executed. For this purpose, written questions were asked and documents were requested. To obtain a good picture of practice, the AFM also examined ten files per institution and conducted interviews with employees and management.
3 With 6 providers, the AFM started a limited investigation in February 2021 into how arrears management is designed. For this purpose, the AFM asked written questions and requested documents.
Assessment Framework
The AFM conducted the investigation using an assessment framework, evaluating the extent to which providers act in accordance with the starting points for safeguarding customer interests in arrears management (see Chapter 4 for more information). These starting points were based on the aforementioned Guideline "Consumers and Collection Procedures," the AFM's experiences from previous investigations into arrears management, the "Locked up" project6, and literature from behavioral sciences. 6 This project focused on customers with revolving credit on which no or limited repayment is made, and consumers who are over-indebted according to (current) lending norms and are suffering negative consequences, including the inability to refinance ('locked up' in their current credit). The Dutch Banking Association and the Association of Financing Companies in the Netherlands implemented new policy measures at the sector level based on this to prevent and resolve the identified problems. These are anchored in the codes of conduct.

The starting points for safeguarding customer interests in arrears management are:

There is productive contact between the provider and the customer.
The solution is based on the (financial) situation of the specific customer.
The resolution policy is of good quality.
Employees are capable of providing a good solution.
Agreements with collection partners are focused on customer interests.
Multiple control mechanisms, including a four-eyes principle, were applied in the assessment.
The starting points are intended to provide direction. The translation of these starting points into daily practice must be made by the credit provider themselves. The described starting points are not necessarily the only way to place customer interests at the center of payment arrears. If a credit provider does or wants to do this in a different way, this is possible, as long as the credit provider adheres to applicable laws and regulations. The guidelines and examples discussed by the AFM often go beyond what the Financial Supervision Act (Wft) requires of providers.

Starting Points for Safeguarding Customer Interests in Arrears Management
The AFM considers it important that providers help customers with payment arrears in a good manner. Below, the AFM outlines the 5 starting points with which providers can safeguard customer interests in arrears management. In the blue boxes, the AFM adds insights from a behavioral science perspective to the starting points.
The AFM points out that these starting points provide guidelines, but it is also important that providers continuously investigate how they can best approach and help customers with payment arrears. After all, the same approach is not suitable in every situation. For example, in one situation, it may be necessary to make the entire financial situation transparent, while in another situation, a few test questions may suffice. It is up to providers to (continuously) investigate which approach works best in which situation and what is needed to help the customer toward sustainable recovery.
There is productive contact between provider and customer
To reach a sustainable solution with a customer, it is crucial first and foremost that providers communicate constructively with customers who have payment problems. A provider takes into account the customer's circumstances.
This means that, on the one hand, providers remind customers with initial payment arrears of them as soon as possible and make it easy for them to pay immediately; a QR code or payment link can help with this.
On the other hand, for customers with more structural problems, it is important that they feel that solutions are available and that the provider really wants to help them. A demanding or threatening tone often has the opposite effect because these customers often feel ashamed of their situation, and such a tone only reinforces this. A provider therefore creates a safe and constructive environment. An empathetic tone is appropriate here. A provider applies this in both oral and written communication. From a behavioral perspective, it is known that contact with customers can be promoted if the provider's website shows possible solutions the organization can offer (such as a payment arrangement or payment pause). Providers also make sufficient efforts to get in touch with the customer. They ensure, among other things, that enough call attempts are made at different times of the day and days of the week. Providers can also use more innovative methods, such as using WhatsApp or an app where the customer can make payment arrangements in a low-threshold manner. In Appendix 1, the AFM has included several guidelines for providers that can help with a positive approach to customer communication.

Why don't customers always cooperate well?
From behavioral sciences, we know that people often do not take action, even when it is actually necessary or beneficial. This behavior is called inertia, and it can have various causes: people are, for example, not motivated to take action, or they find it unimportant ('What's in it for me?'). But even if people know they need to do something because otherwise big problems will arise, inertia can occur.
There can be various reasons why people with payment arrears refuse to cooperate with the provider (Keizer, 2016):

Shame about their own situation. People see receiving help, being reprimanded by the provider, or setting up a payment arrangement as a form of failure.
Unrealistic optimism. People with payment arrears often assume (too long) that they can solve their problems themselves. Shame also plays a role here: often, people want to solve their problems themselves so much that they prefer not to talk about these problems with others.
Lack of (experienced) control. People with debts often can no longer see the big picture and do not know where to start solving it.
Denial or underestimation of their own problem. People with payment arrears do not always realize that they have a (large) problem that needs to be solved.
Negative information. Some people with payment arrears know negative stories from their environment about, for example, collection agencies and debt counselors. This can lead to uncertainty about the possible consequences of contacting the provider.
If these problems arise, doing nothing often seems the safest option. Also – and perhaps especially – when a creditor insists on action. The feelings mentioned above are reinforced if the tone of the providers is 'hard' and accusatory: especially at the beginning of a collection procedure and/or with a relatively low debt, the use of incentive techniques seems more effective than a strict tone. Furthermore, providers must be aware that people with payment arrears sometimes deal with multiple creditors, each with their own way of doing business. This can lead to the feelings mentioned above being further strengthened (Goosens & Van Geuns, 2019). Finally, it plays a role that people generally attach more value to the present than to the future. This means they often make choices that are favorable for them now but can have negative long-term outcomes. Cooperating with a provider can – in the consumer's eyes – have unpleasant short-term consequences (such as having less disposable income). For most people, this weighs more heavily than the positive long-term consequences (living without financial worries).

Solution is based on the (financial) situation
A provider makes sufficient efforts to get to the bottom of the cause of the payment arrears. A large part of the success of a offered solution depends on how appropriate the solution is. In asking about the cause, it is important to probe further. This is necessary to determine clearly whether there is a temporary or more structural problem. When the customer, for example, states that they fell into arrears due to a one-time higher expense, the cause of the problem is likely not the one-time higher expense, but rather that the customer has no buffer to absorb such expenses. If the underlying problem is not examined, the chance increases that the customer will fall into problems again. Besides asking about the cause, it is important to have insight into the personal and financial situation of the customer. How extensively this is asked can vary per situation, as long as it is applied consistently. When the cause indicates a more structural problem, the AFM expects at least an extensive income/expense test to be conducted. Also, when the customer repeatedly falls into arrears, there is likely a more structural problem, and an income/expense test is appropriate. For a more limited problem, it can be chosen to ask orally for the information needed to reach a good solution. Carefully mapping the personal and financial situation It is important that the mapping of both the personal and financial situation of the customer is done carefully. Many customers experience barriers in sharing their personal situation with a provider. This can be exacerbated if there are payment arrears. Asking questions can seem threatening to them and provoke resistance. Carefully employing different strategies can help to map the personal and financial situation of customers. Examples of such strategies are:

Act from a position of trust.
Show empathy.
Explain what happens with the information the customer provides.
Do not make assumptions, but ask open questions.
Do not apply pressure.
Be patient.
Ask about the customer's needs.
Emphasize that help is available.
Once the underlying problem has been mapped, it is also important that something is done with it (demonstrably for the customer). In other words: the solution offered to the customer must subsequently take this problem into account. If this is not done, it can significantly damage the customer's trust.

Resolution policy is of good quality
To offer customers in payment arrears a prospect of a debt-free future, it is important to have a high-quality resolution policy and, in particular, concrete policy on 'hopelessness'. Having a high-quality resolution policy means that employees have access to a wide range of solutions, including payment arrangements, payment pauses (interest and/or repayment), interest stops, restructuring, budget coaching7, and final discharge. It must be clear to employees in which situation which solution can be applied. It is also clear how they must apply these solutions. For example, with a payment arrangement, it is important that a customer has enough money left to provide for their livelihood. The cause of the payment arrears and the customer's financial situation are used to determine the best solution. Here, the provider does not only consider the customer's proposal but also actively thinks along about what the best solution is in the customer's interest. After all, the provider knows better what possibilities they can offer the customer. 7 Budget coaching as a solution will generally be combined with other solution directions. Combining Repayment with Automatic Saving Some credit unions in the United Kingdom use an automatic savings system called 'Save as you borrow,' where consumers with a loan automatically have a portion of their monthly repayment deposited into a savings account (The Fairbanking Foundation, 2017). Through this system, they develop the habit of saving, and upon full repayment of the loan, the accumulated savings amount is released. A case study (Lee & Carlisle, 2020) shows that this is an effective way to help people for whom eviction is threatened due to rent arrears. In this study, 94 of the 109 households repaid the loan in full, while simultaneously building a financial buffer.

For a concrete policy on hopelessness, it is necessary for providers to establish guidelines from which it follows under which circumstances customers no longer have a prospect of improving their financial position within a reasonable timeframe. It is also relevant here that a provider determines the maximum duration that it is appropriate for customers to remain in payment arrears. Providers have recorded in their policy how they handle these situations. Finally, providers safeguard measures with their procedures to ensure that customers are treated consistently, meaning that customers in comparable situations receive comparable solutions. Aim for Achievable Payment Arrangements It is important to search together with customers for a solution that really fits them. This goes beyond the question of whether a solution is financially feasible, but also includes the question of whether it is mentally feasible. To make a solution a success for both the customer and the provider, it is important to take into account the (possible) circumstances of people with payment arrears (AFM, 2018). Circumstances that can play a role include:

Belief in one's own ability. For people with little belief in their own ability, it is extra difficult to solve payment problems. The moment they experience failures in setting up a payment arrangement, they enter a vicious circle. The fewer successful experiences, the stronger the conviction that they cannot do it, and the more likely it is that problems persist or even grow (Bandura, 1977). Consumers who have little confidence in their ability to solve payment problems can regain (this) confidence by achieving small successes, such as paying the agreed – achievable – periodic amount.
Self-control. The amount of self-control people have determines whether they can resist short-term temptations in exchange for long-term goals – such as getting out of debt or staying out of debt (Hoch & Loewenstein, 1991). A consumer with a low degree of self-control is vulnerable and susceptible to impulsive purchases, whether or not financed with credit. It also costs them more effort to stick to agreements on repayments (Barboza, 2018).
Self-binding mechanisms can offer a solution in such a case (Thaler & Benartzi, 2004). These are ways to ensure that people stick to an agreement with themselves, for example, by signing a contract.
Financial scarcity. Scarcity can cause a reduced ability to think clearly. The focus is temporarily shifted to finding short-term solutions (for example, paying a bill), causing the consequences of chosen 'solutions' (for example, the obligations associated with the concluded credit) to be overshadowed and the long-term perspective to be lost (Mani et al., 2013).

Employees are capable of providing a good solution
Executing thorough arrears management demands a lot from employees. Employees must be able to have difficult conversations in an empathetic manner, penetrate a financial situation, and have subject matter knowledge. An important requirement for these employees is that they are 'good at human contact'. It is therefore important that they are well supported by the provider in this. This means that various training programs are available, which monitor both knowledge and skills. This is important not only for new employees but also for employees with more experience. It is also important that employees are guided well. In performance agreements, for example, customer interest is evidently central.