How the upcoming Consumer Duty is paving the way for Value-Based Finance
By Sho Sugihara, Co-Founder and CEO, Pave/Fuse
The cost of living crisis drags on, with rising interest rates putting pressure on the finances of millions across the UK. This mounting pressure isn’t a new thing. It goes further back than the past year, and can be traced all the way to the 1979 oil crisis.
Since then, growth in wealth (GDP) has outpaced the growth in distribution of this wealth (median real income), and consumer finances have stagnated. In the UK, real income still remains below 2008 levels, with real wages falling by 2.4%[i] in the most recent ONS census, continuing on this trend.
Improving consumer finances must be more of a focal point for key players in our financial system. In the aftermath of the 2008 Global Financial Crisis, we focused on capital solvency and preventing irresponsible sales of products like subprime mortgages. This was a start, but only the first step towards solving deep rooted issues in our financial system.
Amidst the current crisis we are talking much more about how to prevent lenders from failing than how to make people wealthier. As we emerge from 2023, we must focus on improving consumer finances, and invest in the necessary steps to make this happen.
Learnings from healthcare
Why have we failed to improve consumer finances? I believe this is because the industry hasn’t been held accountable to do so. Having previously worked in the healthcare sector before moving into fintech, I’m reminded of the US healthcare system which had a similar dynamic a decade ago. Care was expensive, often unattainable and poorly quality controlled. This started to change when insurance firms and regulators pressured healthcare providers to deliver more affordable and effective treatments to consumers.
What emerged was the idea of Value-Based Care (VBC); a delivery model where providers, including hospitals and physicians, are paid based on patient health outcomes i.e., only when the patient’s health improves. This is a model that other sectors can learn from, especially finance, where embedding similar incentives within existing systems would unlock huge value for consumers.
If lenders only made money when customers improved their financial situation, we’d see investment in financial health monitoring solutions that predict and prevent ill financial health, and reduce arrears. If consumer financial outcomes were something lenders were held accountable for, we’d naturally see improvements in consumer financial wealth.
Providing the building blocks
To help reverse the long-term impact of the cost of living crisis for consumers, it is crucial that financial institutions start thinking in a more outcomes-based way. Emerging datasets like Open Banking provide solid foundations for the concept of Value-Based Finance, opening up a wealth of data that can be used to better support borrowers by monitoring their ongoing financial health, while assessing the impact of financial products they use.
The growing range of datasets like Open Banking and analytics services now available, including Fuse by Pave, give lenders richer data-driven insights about a prospective borrower’s financial health. This empowers lenders to improve decision making, reduce the number of defaulted loans, boost profitability, and ensure borrowers aren’t taking out more than they can afford to repay – ultimately ensuring borrowers only receive products that improve their financial standing and financial health outcomes.
It’s an exciting time for the industry. The latest developments in artificial intelligence are enabling more holistic and robust credit risk and financial health assessments, which can help lenders to increase acceptances, reduce losses, and monitor vulnerability to ensure good outcomes for customers. This is a tectonic shift with the power to reinvent finance as we know it, and it’s a change that’s long overdue.
The Consumer Duty – a regulatory catalyst
So why isn’t Value-Based Finance more widely adopted already? Banks are generally in better health compared to earlier in the millennium, and alternative datasets like Open Banking are gradually being adopted to support lenders to be more inclusive. To really enable systemic change, stronger incentives are still required. This will take regulatory pressure – just like in healthcare – to ensure it happens at pace.
This is the reason that we believe the Consumer Duty, a regulation being implemented by 31 July this year, could be a powerful catalyst for change. The new regulation requires providers to proactively monitor customer vulnerability, and ensure good financial outcomes are attained by consumers. It outlines an approach to product design that changed healthcare forever, and if we seize the opportunity, it could do the same for finance too.