TPayday loan rules confirmed yesterday by the Financial Conduct Authority for high-cost short-term credit will cause a major upheaval in the market. Whether this will be a good thing for consumers remains to be seen.
From January 2, a new price cap will affect any loan advertised at 100% TAP, unless it is provided by a mortgage provider or community finance organization. The cap will limit interest charges to just 0.8% per day and ensure that no one pays back twice what they borrowed, including fees. This means that a £ 100 loan for 10 days will cost £ 108, but if extended or in default it won’t cost more than £ 200. The FCA believes that it is likely that many payday loan companies will exit the market unless they change their business models, leaving only the top three online lenders and one leading provider – who currently represent around 60% of the loan market.
The cap will clearly have a huge impact on the market, but maybe not in the way most people think. While the total cost of credit is capped at 100%, it will not reduce APRs because it is an annualized representation of interest rates. So always expect to see interest rates of over 2,000% advertised online and on television.
In addition, FCA’s own analysis suggests that the four largest lenders will not be affected by the cap because their fees are already below it, or they are adjusting. The market leader is Wonga, so it looks like the cap will not affect its interest rate or profitability. However, as many smaller players may exit the payday loan market, the industry will become a Big Four monopoly led by Wonga. It cannot be good for consumers.
The FCA also estimates that 70,000 current borrowers would be denied financing under the new rules. Its modeling suggests that only about 2% of this group will potentially use a loan shark instead (although the number of loan sharks is notoriously difficult to estimate and generally underreported). FCA research also suggests that many more borrowers will be offered less than they need, which will cause further problems.
The cap will clearly limit the damage faced by those with spiraling payday loan debt, but other measures could have a bigger impact, such as cracking down on the abuse of continuous payment power (the device that allows lender to empty your bank account at will) and measures to make loans more accessible – an issue that recently forced Wonga to write off £ 220million in loans.
This new cap should be a great opportunity for alternatives to fill this gap – with suggestions that community development finance institutions (CDFIs) or even credit unions could provide a responsible and affordable alternative. Unfortunately, few credit unions have an online presence and even fewer offer any type of equivalent payday loan. CDFIs such as Fair Finance (where I work) and Moneyline offer an alternative, and with access to bank and private capital, can meet some demand. While they have been successful in weaning people off of high cost providers, they are mostly branch based and do not match the convenience or speed of online help service providers. If these organizations are to be seen as a serious alternative, they need massive investments in people, know-how, and finances to deliver the right products. Some of them are going in this direction, but unfortunately most of them are not.
Interestingly, it’s the mortgage market – the one most disrupted by the payday lending industry – that offers a different perspective. It is exempt from the current price cap, and companies such as Provident Financial (the UK’s largest home-based lender) have the national scale and resources to take advantage of the changes to come. It will be interesting to see if they do.