Payday lenders’ unclean profits

Let me declare a prejudice from the outset: I don’t like payday lenders. I admit they are better than the traditional loan shark, who pushes money into the hands of someone who can’t make ends meet – and then comes around with a heavy a few days later, demanding repayment and a substantial interest charge on top.  That is extortion, but some of the behaviour of the payday lenders is also disreputable.


Wonga is the largest of the payday lenders operating in the UK. It presents a friendly image, with puppets of a nice old granny and granddad borrowing money for a few days and then repaying it.  The reality is a bit different.


In return for easy cash, Wonga charges very high rates of interest. Its website quotes as a representative example a £150 loan, due for repayment after 18 days, which would be subject to an interest charge of £27.99 and a transmission fee of £5.50.  This represents a 5,853% Annual Percentage Rate.  (The calculation is quoted by Wonga.)  If a borrower misses the due date, the amount to be repaid escalates.


And while Wonga does not send round heavies to collect outstanding debts, some of the tactics it does use are unacceptable. It has just been told by the financial regulator, the Financial Conduct Authority, to pay £2.6m in compensation to about 45,000 customers for sending letters requesting repayment that appear to be from firms of solicitors – but are not.  The Law Society suggests this might be a breach of criminal law.


According to campaigning anti-payday loan Labour/Co-operative MP Stella Creasy, the payday lending sector is costing vulnerable people £45m a year. “People are overpaying for this kind of credit because prices are distorted,” she said, following the publication of research by the Competition and Markets Authority.


A new report reveals additional information about the business model of Wonga and its competitors. ‘Payday lending: fixing a broken market’ has been published by the Association of Chartered Certified Accountants (ACCA).  (Here I should declare an interest, ACCA is my largest client – though I was not involved in producing the report.)


ACCA’s report blows the lid off the claims by payday lenders about how they operate. These lenders like to imply that typical borrowers take-out a one-off loan, repay it after a few days and get on with their lives.  In truth, many borrowers pay astronomic rates of interest on a small loan, which then multiplies in size, leads to dependence on repeat borrowings, with the borrower becoming trapped in a cycle of debt.


The report explains: “the OFT [Office of Fair Trading] found evidence of a borrower who had been so poorly served by that sector that they had rolled the same loan over 36 times. That borrower is not alone. In 2012 borrowers spent over £900m on payday loans, with £450m spent on loans which were subsequently ‘rolled over’.”


It continues: “The evidence presented in this report suggests that existing online payday lending business models are reliant on repeat borrowing for their profitability. Consumer detriment, in the forms of default, repeat borrowing and the taking of multiple loans from different lenders, appears to play a highly profitable role in existing business models. It seems that many payday loans serve only to increase the likelihood of future indebtedness.”


The payday lending sector has expanded rapidly in recent years. As recently as 2006, the sector hardly existed – it loaned a total of £330m in the UK.  By 2012, total payday lending in the UK had rocketed to £3.7bn.  It is not difficult to imagine the level of suffering that has gone along with this.


The appeal of payday lenders is easy to understand. Loans can take less than an hour to process.  (Wonga says it can turn round an application in just five minutes)  People in financial need who have been turned down by more responsible lenders such as building societies and banks can walk into a high street shop with an empty wallet and walk out with £270 to be repaid in a month (the average size and duration of a payday loan).


It is no surprise that demand for payday lending is on the rise – welfare payments are being cut, food and energy costs have risen over recent years, while real wages have not kept pace. A survey conducted by Christians Against Poverty found that 78% of borrowers used payday loans to buy food, 52% to pay energy bills and 27% to meet the costs of Christmas.


Whether the irony is intended or not, the symbolism of payday lending is through Kerry Katona. The one-time pop star, winner of reality TV show ‘I’m a celebrity, get me out of here’, who has twice been declared bankrupt, is the best known face promoting payday lending.  That should be a warning in itself.


ACCA’s report argues that the Financial Conduct Authority should take firmer action to clean-up the payday lending industry. This is clearly right, though not in itself enough.  The Church of England has called for Wonga to be “competed out of existence”, in the words of the Archbishop of Canterbury, Justin Welby, with credit unions supported instead – though his moral authority was lost when the Church of England was found to be an investor in Accel Partners, which are part owners of Wonga.


Credit unions have been put under a lot of pressure to provide lending facilities that offer an alternative to payday loans. In part to deal with that, credit unions were permitted from April this year to raise their interest rates to 3% per month.  The Department for Work and Pensions explains: “The extra income will allow credit unions to use the extra income to consider lending to members with a higher risk profile, which they currently turn away…”.  I have real concerns about this approach.


I support the concept of credit unions moving beyond their core functions of being savings and loans institutions, for example by offering current accounts and debit cards. But I am concerned when this goes too far. Part of the problem for the Irish credit union movement was when it moved into higher risk lending to commercial institutions – exactly the same problem that afflicted the former Britannia Building Society and some other building societies in Britain.


I have spoken to credit unions that are already worried by the increased level of non-repayment of debt – which I agree provides a justification for raising interest rates in some instances. Asking credit unions to take on even higher risk lending, on a higher interest rate basis, is expecting them to move too far from their core purpose, in my view.


It would be better, surely, to allow different types of niche mutual financial institutions to operate alongside each other and to co-operate. We have building societies, whose core purpose is to provide home loans.  Credit unions, which service a reliable and financially solvent membership.  Micro-credit institutions, which provide small loans to kick-start economic activity.  Friendly societies such as Benendon, Engage and Liverpool Victoria continue to provide financial products that supplement the role of the welfare state.


A new type of financial mutual might then be created to provide an alternative to payday lenders. These new mutuals might offer short term loans to borrowers whose conditions do not meet the normal terms of a credit union loan.  Indeed, most of these borrowers will not be members of credit unions.  The terms of the loan will be higher interest than a normal commercial loan, but substantially below the rates offered by the payday lenders.


Borrowers would be helped to avoid needing repeat loans – the opposite situation with a for-profit lender, which financially gains from borrower dependence and repeat loans. This new type of mutual might assist the borrower with budgeting, dealing with existing unaffordable loans and helped, perhaps, to benefit from collecting bulk-buying of some products and services, such as energy supply.


Such a service may not be commercially viable. Some mutuals may be in a position to help subsidise the service, as may some banks.  (Barclays has agreed to support credit unions as alternatives to payday lenders.)


But it is reasonable to expect national and devolved governments to provide financial assistance as well. At a time of continued state austerity, it is right to ask what we expect the role of government to encompass.  Assisting the poorest in society to avoid suffocating debt seems to me a proper role of government – especially in the time of austerity.

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