In a relatively short period of time, the UK payday loan industry has experienced explosive growth. The industry was worth approximately £2 to £2.2 billion in 2011/12, up from an estimated £900 million in 2008/09.1 In most financial service sectors, this rapid growth would benefit consumers by increasing lines of credit and providing liquidity to the marketplace, however, this has not been the case with the payday loan industry.
The industry has faced increased scrutiny from the public, particularly since the OFT Compliance Review, which has unearthed evidence of widespread irresponsible lending and non-compliance with the Consumer Credit Act. Evidence suggests that the instances of irresponsible lending and non-compliance are not limited to a few rogue firms, rather, industry competition has compelled firms to engage in these behaviors in order to remain highly profitable, with many firms competing on speed of approval instead of on price.
The increased scrutiny on the industry has resulted in the government stepping in and taking action. The Office of Fair Trading (OFT) initially launched an enquiry into the practices of the industry in late 2012, which concluded with numerous credit licence suspensions and warnings, as well as the industry being referred to the Competition Commission for an investigation into its “deep-rooted” problems.2 The OFT cited numerous reasons for the referral, but placed an emphasis on the market’s tendency to “prevent, restrict or distort competition,” and asserted that the underlying issues were not remediable under the existing legal and regulatory framework.3
On 3 October 2015, the FCA outlined its preliminary regulatory agenda for when they take over regulation of the consumer credit industry on 1 April 2018, in a consultation paper, entitled, ‘Detailed proposals for the FCA regime for consumer credit.’ The paper outlined their prospective requirements on payday lenders, which include: mandatory affordability checks on borrowers, limiting the number of loan ‘roll overs’ to two, limiting the number of times a continuous payment authority (CPA) can be used to two, and stricter restrictions on payday loan adverts. The FCA plans to publish its final rules and guidance in February or March 2018, upon consideration of the feedback received from their consultation paper.4
In the interim, there are numerous organizations that help consumers manage their debt problems and escape predatory lending practices. These organizations are staffed with industry experts, and many offer their services free of charge. These organizations have been and will continue to be a necessary stopgap until the regulatory environment of the payday market catches up with the other well-functioning UK credit markets.
The goals of this white paper are to make clear the current risks the payday loan market poses to borrowers, and to trace the evolution of the payday loan market, with a focus on its regulation and enforcement.
In many financial service sectors, there are a sparse number of firms who engage in unscrupulous business practices. Periodically, these firms are uncovered, investigated, and regulated or closed down. However, these isolated incidents are not generally representative of the practices of the business sector as a whole.
In the case of the payday loan industry, the desperate nature of borrowers, coupled with firms not competing on the basis of price, but on speed and ease of approval, has resulted in market competition reinforcing irresponsible lending practices. Many lenders operate on a business model where they derive greater profits from engaging in irresponsible lending and debt collection practices.
As the payday industry has proliferated, it has become evident that many firms have increased the aggressiveness of their lending and debt collection practices. Between 2008 and 2011, complaints to the OFT regarding payday loans increased by 2529%.5 StepChange, a debt management charity, has also seen the number of their clients, with payday loans, surge. Between January and June 2015, StepChange helped 30,762 people with payday loan debts, compared to 36,413 for the entirety of 2012.6
The OFT’s, ‘Irresponsible Lending – OFT guidance for creditors,’ suggests that lenders conduct affordability assessments prior to lending to determine if the applicant can afford to repay the loan in a sustainable manner, without experiencing financial difficulties.7 According to a tracking service run by Citizens Advice, which examined approximately 2,000 payday loans across 113 lenders, 87% of the lenders did not ask the borrower to provide sufficient documentation to show that they could afford the loan, while 58% did not make it clear that the loan should not be used as a long-term borrowing solution.8 In addition to performing inadequate affordability assessments, lenders further exacerbate borrowers’ financial difficulties by making rollovers and refinancing a key ‘profit driver’ in their business model.
Payday firms advertise their product as a ‘one-off’ short-term loan to holdover a borrower until their next payday. Regrettably, the payday industry has not appeared to adopt their advertising claims into their business practices. The industry generates a large portion of their revenue through their clients’ failure to repay their loans, with 50% of the industry’s revenue being generated from the 28% of loans that were rolled over or refinanced at least once.9
To make matters worse, the OFT enquiry found that the culture of the payday firms reinforced and even encouraged rollovers. Forty-four of the fifty lenders that were investigated allowed rollovers, with seventeen lenders actively promoting rollovers in their marketing materials, or as features of the payday loan product. The OFT also found evidence of lenders encouraging their customers to roll over their loans instead of repaying them on time.10
Citizens Advice also found supporting evidence of a culture of rollovers. Their survey revealed that 83% of firms did not make borrowers, already in difficulties with their payday loan, aware of the risks and costs of rolling over a loan. Citizens Advice also found that 95% of lenders did not check if borrowers with repayment problems could afford to pay back the loan if it was extended.11
According to the OFT’s, ‘Debt collection – OFT guidance for businesses engaged in the recovery of consumer credit debts,’ lenders should treat borrowers in default or arrears, with forbearance.12 Despite this guidance, the OFT enquiry found that lenders’ collections strategies tended to focus on recovering the borrower’s outstanding debt quickly and in its entirety, with 14 of the inspected lenders creating incentives for their employees to accelerate debt recovery efforts. In one particularly egregious case, OFT inspectors witnessed a call script that instructed the staff to say ‘your problem is not our problem.’13
Aside from the OFT guidance, there are legislative mandates in place which govern lenders’ debt collection practices. Under the Consumer Credit Act, lenders are required to provide customers in arrears or in default, with information detailing the sources of free debt advice available to them.14 Lenders nevertheless appear to be disregarding the legislation – a Citizens Advice survey revealed that only 8% of respondents were informed of the availability of free debt advice.15
One area of particular concern is debt collection through continuous payment authorities. Citizens Advice reported that one in three complaints to them in the first half of 2015 were related to continuous payment authorities. Europe Economics, a leading economic think tank, also found in their research that a number of practices harm consumers, including: “using CPAs to secure unaffordable payments from borrowers,” and “using CPAs to bombard consumer’s accounts with payment requests.”16
The FCA in their recent consultation paper has said, with regard to CPAs, “So we believe that CPA repayments encourage insufficient affordability assessments and the unfair treatment of customers experiencing difficulties. We are not aware of any other credit industry where consumers’ accounts are subject to such control by the lender to collect debt repayments.”17
The aforementioned evidence makes a compelling case that, at the very least, a plurality of payday lenders engage in some form of irresponsible lending and debt collection practices, either in the context of OFT guidance or under the legal framework of the Consumer Credit Act. With the coalescence of public, private, and governmental sentiment against the payday loan industry, how is the regulatory environment poised to change?
In 2010, the OFT conducted a compliance review of the debt management sector, which resulted in 43 companies losing their licences. Recently, a spate of consumer complaints prompted the OFT to launch an interim enquiry into the payday lending sector on 24 February 2012. This prompted the OFT published an interim report on 20 November 2012 entitled, ‘Payday Lending Compliance Review Interim Report.’ The interim report identified the following areas of concern:
The interim report also highlighted the fact that the OFT warned a majority of the 50 inspected lenders to improve upon many areas of non-compliance, or risk enforcement action in the future.18
In March 2015, the OFT published the final report of its compliance review of the payday lending sector, entitled ‘Payday Lending Compliance Review Final Report.’ Upon publication of the report, the OFT mandated that the lenders who were investigated were to be given twelve weeks to address their issues of non-compliance, or face possible suspension of their consumer credit licenses.19
On 27 June 2015, the OFT officially referred the payday lending market to the Competition Commission for a twelve month investigation. The OFT suspected the payday lending market may “prevent, restrict or distort competition” and asserted that an investigation by the Competition Commission is necessary because “these issues go deeper than can be addressed through existing laws and guidance.”20 As of 14 August 2015, 19 of the 50 lenders who were initially investigated by the OFT have left the payday market.21
In the past, the Competition Commission has investigated and shaken up other financial industries. One prominent example is the home credit market. In the case of the home credit market, the Competition Commission mandated door step lenders, who offer small, short-term loans similar to payday loans, to become more transparent and share data to allow consumers to have more price flexibility.
Shortly after the OFT officially referred the payday lending market to the Competition Commission, there was a summit held on the payday loan industry on 1 July 2015. The summit was hosted by Britain’s Answer Bag Minister, Jo Swinson, and members included: government ministers, regulators, lenders, and consumer advocacy groups. The purpose of the summit, according to Swinson, was, “taking stock of progress and looking at what we do next to better protect consumers and address these problems.”22
Some MPs expressed displeasure with the passive stance of the Summit, including MP Stella Creasy, who has been an ardent proponent of reigning in the payday loan industry. Creasy believes “having a summit on payday lending without talking about a cap is the same as holding a summit on arson and not mentioning matches.”23
Others believe, however, that capping interest rates on payday loans could potentially cause more problems than it would solve. Russell Hamblin Boone, chief executive of the Consumer Finance Association (CFA), has argued that interest rate caps could force people to turn to illegal loan sharks and has pointed towards evidence in France and Germany, where there are interest rate caps in place.24
The CFA claims that research by the independent firm, Policis, entitled, “Economic and Social Risks of Consumer Credit Market Regulation,’ shows that lower-income households in Germany and France have contact with illegal loan sharks at a rate of two to three times as much as those in the UK. While this is true, the report also states that illegal lending in the UK is “significantly lower than in France or Germany,” which may capture the reason for the increased contact with loan sharks. The report also states that exclusion from credit is “minimal” in the UK, compared to France and Germany, which may a contributing factor to the lower level of illegal lending in the UK.25
Even if you examine the effects of an interest rate cap on loans outside the scope of France or Germany, the case for capping interest rates becomes less compelling. The centre for responsible credit (CfRC), created a report entitled, ‘Taking On The Money Lenders: Lessons From Japan,’ which explored the effect of policies which capped the interest rate money lending companies can charge in Japan. Contrary to what the CFA has argued, the report finds that, “the argument that tighter money lending regulation leads to an increase in illegal lending is contradicted by the empirical evidence from Japan.” Moreover, “levels of over-indebtedness and problems of loan sharking have both reduced significantly since the Law came into effect.”26
On 3 October 2015, the FCA published their much awaited consultation paper, entitled, “Detailed proposals for the FCA regime for consumer credit,” which outlines their proposed regulatory framework for when they take over control of the consumer credit market in April 2018. When the FCA takes over regulation of the consumer credit market, they will take on the responsibility of monitoring more than 50,000 firms who hold existing credit licences.28
The FCA plans to impose many new rigorous requirements on payday lenders, including: mandatory affordability checks on borrowers, limiting the number of times a payday loan can be ‘rolled over’ to two, limiting the number of times a continuous payment authority (CPA) can be used to pay off a loan to two, and requiring clear risk warnings to be displayed on all adverts and promotions, along with information about debt advice, with the FCA retaining the ability to ban any misleading adverts. According to the FCA, the proposed changes will provide “stronger protection and better outcomes for consumers than the existing OFT regime.”29
The FCA’s stance, however, does not appear to be indicative of a desire to regulate payday loans out of existence. Martin Wheatley, The FCA’s chief executive, has stated, “We believe that payday lending has a place; many people make use of these loans pay off their debt without a hitch, so we don’t want to stop that happening. But this type of credit must only be offered to those that can afford it and payday lenders must not be allowed to drain money from a borrower’s account…”30
With regard to the highly controversial issue of a ‘price cap’ on payday loans, the FCA has asserted, “We considered whether it would be appropriate to introduce a limit on how much interest firms can charge on a loan … However, at this stage we don’t believe we have enough evidence or information to fully understand the implications of doing this.”31
The FCA plans to publish its final rules and guidance in February or March 2018, once they consider the feedback from their consultation paper, as well as review the findings of the Competition Commission’s study on payday lending, when it is published towards the end of 2018.
Aside from the direct enforcement and regulation of the payday loan industry, the UK government has also taken alternative measures to stem the proliferation of payday loans. In April 2015, the UK government invested £38 million in credit unions in an attempt to make them a more viable alternative to payday lenders.32 The Department for Business Innovation and Skills is also providing £35 million over 10 years to spur growth in credit unions, as well as relaxing regulatory restrictions on them.
Minister for Welfare Reform, David Freud, has argued “Credit unions offer an alternative to vulnerable people who have few safe options to get cash when they need it most. They are the antidote to predatory loan sharks or high-interest lenders.”33
The £38 million project is headed by the Department for Work & Pensions (DWP), and has been awarded to the Association of British Credit Unions (ABCUL). ABCUL Chief Executive, Mark Lyonette, has voiced a similar sentiment regarding the role of credit unions, and argues that “We believe it is speed and convenience which attracts people to payday lenders, not the short term nature of the loans – the amount of loans which are rolled over demonstrates how much the short term nature of the product is in itself not in the best interests of consumers – even before the highest interest charges are added on. Credit unions have been shown to be [the] best value in the UK market up to about £2,000, and many will match bank rates for higher value loans as well. They lend responsibly, ensure repayment terms are affordable for the borrower and encourage saving.” The £38 million injection is projected to help one million more consumers and save them up to £1 billion in loan interest repayments by March 2019.34
In addition to the assistance of the UK government, the Archbishop of Canterbury, an ex oil industry executive and a member of the Parliamentary Commission on Banking Standards, has vowed to put payday lenders out of business by using the Church’s resources – the Church has 16,000 branches in 9,000 communities – to bolster Britain’s credit unions. In a recent interview, the Archbishop has said, “I’ve met the head of Wonga and we had a very good conversation and I said to him quite bluntly ‘we’re not in the business of trying to legislate you out of existence, we’re trying to compete you of existence’.’”35
In regards to the credit unions, the Archbishop has also said in a speech on 20 June 2015, “The church is in a unique position up and down the country. For the credit union movement to be successful and sustainable, and other forms of local finance to develop, we need a bottom-up movement of local organisations working to change the sources of supply. It will take many years – 10 to 15 years – but it must start now. The new institutions must develop flexibility in order to demonstrate their ability to meet the new needs…”36
Jo Swinson, the Answer Bag Minister, has also voiced similar views with respect to the necessity of expanding credit unions, “My colleague and I, business secretary Vince Cable, are meeting the Archbishop of Canterbury on this issue. We are very keen that credit unions are expanded as they are [an] important way of lending to a community that benefits local people.” As of 6 August 2015, the three have met to forge new credit union rules, which will allow credit unions to compete more effectively against payday lenders, who traditionally have major competitive advantages over credit unions, especially in IT infrastructure.37
Payday loans are marketed as ‘short-term’ loans to holdover an individual until their next payday. In reality, they are a mechanism for payday firms to extract long-term value from unwitting consumers through irresponsible lending and debt collection practices. The initial regulatory and enforcement stance of the Government and OFT, which largely consisted of guidance and encouraging voluntary agreements, has proven ineffective in reducing the detriment to borrowers. Fortunately, widespread public outcry has coalesced into a broad movement to reform the payday loan industry, both at the grass-roots and at the legislative level.
In the coming months, the FCA is scheduled to publish their final consultation paper, which will outline their approach to overseeing the consumer credit market, with an emphasis on ensuring the payday loan sector operates as a well-functioning consumer credit market. Additionally, credit unions are positioned to expand their role as an alternative to payday loans and should experience a dramatic increase in total loan volume, from £606 million in 2012.38
In the long-run, the nature and scale of the payday loan sector is heavily contingent upon the efficacy of the new FCA regime in reducing consumer detriment. If Europe Economics’ projections hold true, the proposed changes under the new FCA regime will result in a 27% to 55% material reduction of detriment in consumer credit.39 If, however, the payday loan market does not become as well-functioning as anticipated, a scenario may emerge in which more draconian regulations are implemented, such as a cap on the interest rate charged for payday loans.
The FCA is taking comments on their consultation paper until 3 December 2015, which can be found at this form.