The short-term loans industry has come under increasing pressure: but it needs protecting, in order to give 600,000 borrowers the protection they need.
High-interest, short-term credit solutions – often called ‘payday loans’ – have always been good news for the headline writers:
Loan sharks charge 4,000% interest
Payday lenders use fake solicitor’s letters
Yet in the majority of cases, these loans met a legitimate need, with defaults and late payment penalties the exception rather than the rule. However, that did not stop short-term loans being the subject of widespread condemnation, from both parliament and the pulpit.
Initially, this had little impact on the profits of the companies offering the loans. Perhaps the best known of these was Wonga, famous for its TV ads, controversy over the fake solicitor’s letters and – latterly – having their name plastered across the front of the Newcastle United kit.
However, in 2015 the Financial Conduct Authority took action against payday loans companies – to the resounding cheers of the campaigners – by setting a cap on the interest rates which could be charged and encouraging more stringent underwriting requirements.
Perhaps even more significantly, Google decided to act in the summer of 2016, refusing to accept adverts for loans with a term of less than 61 days – which resulted in many leading players in the market moving to longer term instalment loans – often with a 6-month term.
In a fine example of the law of unintended consequences, this meant that the borrower had less control over the loan product, and often ended up paying more interest as it was accrued over longer periods.
HCSTC – The position now
Two years on from the action taken by the FCA there are real fears that they may have done more harm than good, with early evidence from debt charities and the industry indicating that a growing number of people (one estimate puts the figure at 600,000) are now completely locked out of credit markets – pushing them into the arms of backstreet moneylenders and loan sharks.
As Jane Tully of Money Advice Trust said, “You can regulate away the supply but you cannot regulate away the demand,” and she went on to express concern that problems have ‘simply been moved elsewhere.’
Why do people need short-term loans?
People lose their jobs, they get ill – and think back to your class at school: some people were good at art, some were good at maths and some were really good at football. Money is no different: some people can manage their money well, others just seem to have a blind spot. For whatever reason, people find themselves needing short-term loans – tiding over for a few months, or until the next pay cheque arrives.
Why are interest rates on short-term loans so high?
As with any financial transaction, there is risk and reward to take into account. If I am lending to a 40-year-old chartered accountant with a regular income who has never missed a payment in his life then my risk as the lender is small, and I can accept a very low rate of interest.
If I’m lending to someone who needs a loan for two weeks, lives in rented accommodation and has a chequered credit history, then clearly the risk is commensurately greater – and I am justified in charging a higher rate of interest to cover that risk.
Short-term borrowing is and always meant to be just that – short-term.
What do people use short-term loans for?
It is important to note that people are not using short-term loans for frivolities or luxuries. Laura Rodrigues, policy adviser to the debt charity StepChange said,
“People are being forced to make impossible choices: they have to choose between feeding their children or travelling to work. It is no wonder that they miss bill payments or resort to short-term loans.”
There was more evidence of this sort of ‘impossible choice’ recently when it was revealed that girls from low-income families have been missing school because the families cannot afford sanitary protection.
The rise of rent-to-buy
As short-term loans have come under pressure, so we have seen the rise of the rent-to-buy retailers like Brighthouse, where interest rate charges and the cost of add-ons such as service cover can see products cost two to three times what they would if bought for cash. In reality, rent-to-buy sees those households that can least afford it paying the highest possible price for cookers, TVs and fridges.
What’s the real answer?
Russell Hamblin-Boone, CEO of the Consumer Finance Association, summed the present situation up like this:
Important questions remain about the impact of regulatory intervention [and] the availability of credit. The CFA estimate that around 600,000 people no longer have access to credit, more than double the number expected. In order for the demand to be met by responsible lenders we need fair and equitable regulation across all credit services.”
Jane Tully’s simple statement encapsulates this entire debate: ‘you can regulate supply; you cannot regulate demand.’ You cannot regulate human nature either. There will always be those who need to borrow, there will always be those prepared to lend. The advice Polonius famously gave to his son – “neither a borrower nor a lender be” – is fine in theory: in practice, in the harsh realities of today’s real world, it can never apply.
So there is a need for a short-term credit industry – and as the paragraph on risk makes clear – such loans will always attract a higher rate of interest because of the inherent risks involved. And besides, the high street banks – seemingly untouched by the FCA – seem quite prepared to accept the risk of a short-term lending. If your local branch charges you £40 for an unauthorised overdraft of £100 for two days, it is an effective rate of interest which would make even the meanest back street loan shark green with envy.
Yes, of course, the short-term loans industry needs to be regulated – but the industry does not need to be driven out of existence. To do that would mean people who need a short-term loan have recourse only to loan sharks and money lenders who will stop at nothing to be repaid.
Illegal money lenders are not beholden to FCA price caps, nor are they averse to taking matters of debt collection beyond a threatening letter.
It cannot be the intention of the FCA to create an ‘industry’ where the only security customers can offer is their own physical safety.