The issue with the case against ‘Reckless lending’

In operations I have two main roles, firstly is the obvious operational aspect of any company which has to do with logistics of loan suppliers and our distribution to clients as well as looking at the general business planning to ensure we are always at the best of our abilities. The other role is regulatory, I act as a compliance officer, while that is not a legal position, it is one in which the practical aspects of law surrounding financial services are to be found, how it works in real life.

On that basis I was surprised to see that there were several articles talking about the use of tort law to prove negligence in lending, and with that, a particular reference to the Consumer Protection Code (CPC) which has since been updated. While I admire the initiative being taken by New Beginning I have some doubts which I will express here.

One issue we have had with regulation is that it actually gives an asymmetrical advantage to the financial institution, (we probably shouldn’t complain because it offers protection to the industry we work in) the compliance officer in any financial institution is trained to specifically ensure that there is an audit paper trail proving the position of the firm every step of the way, in fact, it is on the times that this paper trail is lacking (not always when proof of wrong doing occurs) that many of the Financial Services Ombudsman complaints and Regulator sanctions hinge, so any compliance officer doing their job is on top of this all day every day.  It stands to reason though, because the regulated entity is the one being supervised, not the consumer they serve.

The use of the consumer protection code is also an interesting take, given that the code was implicit in its requirements, to prove a tort of negligence under the CPC with any firm in full compliance with the CPC is to say that in some respect the CPC actually didn’t protect the consumer, the practical application of the code is very black and white. We’ll see if a principles based system can stand the test of the courts, having said that, much of the CPC is not principled, it is prescriptive and very clear in the requirements.

You would also need to provide absolute examples, if you claim that a brick layer can’t service their loan and that a financial institution should know this at the point of sale then the fact that many brick layers are still servicing their loans would prove this argument to be false.

One topic worth consideration is that of regulation general, sub prime lenders were not regulated until the end of 2007, and they didn’t fall under the auspices of the Regulator the same as other banks, rather it was via the Markets in Financial Instruments & Miscellaneous provisions Act 2007 which was lead by Statutory Instrument 60 European Communities (Markets in Financial Instruments) Regulations 2007 – this is the main reference document we use in MiFID enquiries. This was achieved by a change in the Central Bank Act 1997 and the SI 60.

The point to note is that Sub Prime lenders – who are some of the most aggressive arrears collectors, were not regulated at a time when these loans were mainly being done, and the rules brought out since on protection do apply to them but a tort of negligence would be unfair because with a mortgage the advice is only given at the start – and that means the CPC didn’t’ apply in many cases unless you seek to retrospectively apply law which is generally never done.

Intermediaries (mortgage brokers specifically) will be front and centre with sub prime loans because they were primarily distributed by brokers and not the lenders themselves. While brokers represented over 50% of boom time high street residential lending, they were over 90% of sub prime residential lending.

If the Consumer Protection Code is to be used then you can work through every section starting with chapter 1: ‘General principles’ – this may be an area to consider, but to ‘prove’ a person didn’t act fairly or with due skill/care/diligence would fall down to a paper trail, which, as mentioned is designed to protect the consumer from the outset, but which in practice also offers an iron clad protection to the advisor and their firm.

The issue isn’t that people have suffered as a result of credit issuance, the issue is to prove negligence in that lending, with SubPrime lenders who would be the obvious offenders the regulation doesn’t apply for much of their history, and with the high street any credit issued which followed the CPC was acting in full faith of the rules of the land and in adherence with best practice as outlined by the ultimate authority of the Regulator.

A cynical part of the outside observer may think that New Beginning is an example of barristers harvesting people to present test cases for which (if successful) they may earn a fee, even if that is the case, one would have to reasonably support such cynicism in the name of the greater good, if opportunity exists to create profit while undoing wrong then it can reasonably be deemed ethical. However, it is the granular detail upon which any test cases will fall and in that respect I don’t believe that this initiative will help any significant number of borrowers in financial difficulty because (as Building Society Association and NBER) research has shown that unexpected economic developments on a macro level (which filter down to the micro level) have played a predominant role in individual finances.

On an equal note, the most culpable lenders were not subject to the very code upon which any test may stand until after the bubble had already burst, and even if successful it will only apply to those loans taken out after early 2008, a year in which most of the sub prime lenders closed down.

It will be interesting to see how this develops, but we remain agnostic on the possibilities until proven otherwise because our interpretation of this angle is that it will require undoing of  well established principles and actions which were in accordance with the law of the land and enacted in good faith, proof of contravention would have to rely upon individual cases and therefore it cannot have wide ranging scope. There is also the issue of estoppel between the borrower and lender, if the borrower presented facts in a certain manner and the lender took them in good faith then who is to blame?

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