The payday lending industry is in total disgrace. After a survey and report carried out by Citizens Advice, who called the industry “out of control”, it has been shown that lenders have sold loans to young people aged below 18, people with mental health difficulties and people who are drunk. This is contrary to any responsible lending criteria and should therefore be dealt with rigorously by the authorities.
To make matters worse it has emerged that complaints to the Financial Ombudsman Service (FOS) about payday lending shot up 83 per cent last year, the third highest rise of any sector with the exception of the home credit industry (139 per cent) and payment protection insurance (PPI – 140 per cent).
The Office for Fair Trading officially began their investigation of the industry in March 2013, but since the CAB's results run up until 13 May 2013 (when their in-depth analysis of 780 cases stopped) it's safe to say that bad practice carried on regardless of OFT oversight.
Even the payday lending trade association, the Consumer Finance Association, has its own Code of Practice which its members (making up 70 per cent of the payday lending market in the UK) pledge to commit to, including rules of affordability assessments, debt collection procedures and grace periods for troubled debtors.
The trouble is irresponsible lending is woven so firmly into the business model of payday lending it is hard to erase it. When we consider for example that 28 per cent of loans are either rolled over (where one loan is taken out to service the interest on an existing loan) or refinanced, which provides 50 per cent of a lenders' revenue, it's a very big ask to expect the industry to voluntarily give up a big part of its profit maximisation.
What's more is that payday lenders do not compete on price, but rather speed of service. Therefore if a high street is littered with lenders this will not have too much effect on the price at which a loan will cost (which ranges from around £25-35 per £100 loan, per month) but drives lenders to make faster decisions, incentivising the accepting of loan applications irresponsibly.
As Stella Creasy MP said on Tuesday “this industry continues to fall out of the grip of regulators”. Indeed it looks like its getting worse before it gets better.
However we are still at a point where we are merely finding faults with the industry and not seeking solutions.
Gillian Guy, the chief executive of Citizens Advice, in her FT editorial on Tuesday, pointed out that banks need to take some part in the blame for the rise of payday lending.
In so doing they should also do the following: a) accept responsibility and offer a product to challenge payday lending; b) provide basic “jam-jar” accounts for individuals which also offer budgeting support; c) offer face-face financial support; and d) reopen their offer of current accounts to undischarged bankrupts.
This would be a fantastic start in the consumer credit industry, but alongside this government should also acknowledge the ways in which other countries tackle predatory lenders.
The Financial Conduct Authority will have the power to cap the cost of credit when they take over from the Financial Services Authority on payday lenders in April 2014. They should use it, looking to the rest of the world for guidance.
For example in France and Germany there are restictions on where credit is available from. In Germany interest rates are capped at twice the market rate and in France the limit is reviewed every three months. There is no evidence to suggest illegal lending is any more a problem in those countries than in the UK where there is no cap on the price at which a lender can sell credit.
Furthermore, in the UK, there are 7.7 million bank accounts without credit facilities, nearly four times the number of Germany (2 million at the end of 2006) and France (2.1 million in 2008),while 9 million people cannot access credit from mainstream banks in the UK, as opposed to around 2.5 million in Germanyand between 2.5 million and 4.1 million in France.
Looking further afield to Canada, unless changed through provincial legislation concerning the provisioning of payday loans, usury laws prevent lenders to charge interest above 60 per cent per year. In case this squeezed supply without addressing the demand for this type of finance, Canada has made a big push on credit unions as an alternative to high cost, short term credit.
According to the World Council of Credit Unions Canada has the highest per-capita membership in credit unions in North America. More than a third of the population is a member of at least one credit union.
Also in Japan there has been a total cost of credit cap from 40 per cent to 29.2 per cent between 1986 and 2000. While illegal lending has not risen (in fact it rose with the loosening of restrictions on the amounts credit sellers could lend at) neither has lending from mainstream banks or Shinkin (the equivalent of credit unions).
According to Damon Gibbons of the Centre for Responsible Credit, this has been “part of a more general trend amongst Japanese households to reduce their use of credit over this period.”
There are many more examples like this that the government could and should consider but instead it runs scared of firmer regulation. We've seen the damage and irresponsibility done by payday lending, now we need to do something about it.
If Gillian Guy's recommendations about what the banks could do to incorporate more people into mainstream finance were taken up, government could really start to crack down on the legal loan sharks, bringing some crucial changes to responsible credit and financial inclusion.