How the credit industry works

Canary Wharf skylineMillions of us have mortgages, loans and credit cards. But how many of us really understand how the industry behind them works?

Here, we look at the different types of lenders and explain how they operate, are regulated and interact with other companies within the industry such as credit reference agencies.

Different types of lenders and how they operate
Banks, like all other businesses, exist to make money. And one of the main ways they fill their coffers is by lending out money paid in by savers and current account holders to borrowers at higher rates of interest.

With the best easy-access savings accounts on the market currently paying about 3% and the average credit card having a standard APR in excess of 16%, it's easy to see how they can make big profits - even in a recession.

They are not the only lenders out there, though. You can also borrow through a building society.

These too exist to make a profit, but are slightly different to banks in that they have members, rather than shareholders.

Then there are credit unions, which are member-owned financial cooperatives that can range from volunteer operations with a handful of members to institutions with millions of pounds worth of assets and many thousands of members.

Those keen to avoid traditional lenders can also borrow through the Zopa lending exchange. Its loans are financed by consumers willing to risk lending to individuals to beat the returns currently on offer from savings accounts.

The company has arranged loans worth more than £160 million since its launch in March 2005. Giles Andrews, the cofounder and chief executive of Zopa, said: "Cutting out the banks is not only satisfying, these people are also enjoying much better rates on loans and on their savings by doing so.

"There is vast scope for growth in this new and exciting arena, and we have every intention of taking much bigger bites out of the banks' monopoly on personal loans and savings."

Credit reference agencies and what they do
There are three credit reference agencies in the UK: Experian, Equifax and Callcredit. They make money by holding files that lenders, landlords and sometimes retailers pay to look at when deciding whether or not to accept you as a customer.

Information gathered by the credit reference agencies include your address and repayment history for everything from your gas bill to your mortgage.

Based on this information, they then award you a credit score, which is the main figure that interests the banks and the credit providers.

If it is low, your chances of getting approved for credit are slim, while even if it is mediocre, the best deals are likely to be out of reach.

You can view your file for a small fee if you want to know more or are concerned about your score. Just contact the agencies directly.

Industry regulation and how it is changing
The Office of Fair Trading (OFT) is currently the organisation charged with ensuring that companies in the credit industry treat their customers fairly.

However, consumer credit regulation will be transferred from the OFT to the Financial Conduct Authority (FCA) once the Financial Services Bill - introduced to Parliament last week - becomes law.

Under the new regime, the Financial Ombudsman Service will continue dealing with individual consumer complaints, but consumer groups will make super-complaints about serious issues to the FCA instead of the OFT.

It is hoped that this with improve the regulatory framework protecting consumers who take on credit. Financial Services Authority (FSA) chief executive Hector Sands said: "The FCA will build upon the FSA's proactive consumer protection strategy, launched in March 2010."

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