The Financial Conduct Authority’s new controls on payday lenders are geared toward protecting borrowers from excessive charges, which is welcome news. From January of next year, the regulator will impose an initial 0.8% cap per day on interest charges, a cap of £15 for defaulting on payday and a total cap cost of 100% of the loan, preventing borrowers from needing to pay back more than twice the amount they borrowed.
While this is definitely an improvement from a borrower’s perspective, there are a number of remaining issues. In particular, it has been speculated that many payday lenders will leave the market to set up elsewhere or change their business model. If legitimate payday lenders leave the industry, this will leave less choice to borrowers, with the possibility of loan sharks strengthening their positions in local communities.
The FCA argues that their new regulations will deter many prospective borrowers from resisting a loan or turning to their families for financial help. I have some reservations about this from research I’ve done into why people take out payday loans. This research has comprised of several in depth interviews with third sector organisations, attendance of seminars arranged by related organisations, and focus groups with borrowers over the last year.
A person in financial desperation, as many of these people are, cannot simply resist a loan. The FCA may have dismissed the financial desperation that significant borrowers of payday loans become accustomed to, especially in economically deprived areas like the North East.
In the interviews we have conducted within this region, we found that borrowers, through no fault of their own, are sometimes plagued by unexpected events (such as bereavements, divorce, disablement) that savage any minimal savings they have, and find themselves in circumstances in which they have no foreseeable option but to take out a loan.
I also have reservations about these borrowers turning to families and employers for help, as suggested by FCA chief executive, Martin Wheatley. Borrowers tend to be ashamed or feel guilty about getting their families involved. People with debt problems tend to delay the seeking of advice from families or third party organisations when their options become even more restricted.
What is woefully needed is a mechanism for identifying and targeting these people at much earlier points, before the pain of irreversible debt mounts up. Sometimes pride takes precedent and borrowers are reluctant to come forward when they start to get into difficulty. Free advisory charities must encourage these people to come forward sooner.
For those who do consult their families, we have found that financial problems can escalate from one member of a family to an entire generation with severe repercussions. Since asking for family help does not resolve the cause of the problem it will not usually lead to a quick fix.
The appeal of the loan sharks
To reiterate, the new regulations are welcome as they signal a need for transparency in the business. But they will not help all borrowers. Some will return to loan sharks for several reasons.
Loan sharks have built up strong social connections and networks within local communities that make them more culturally acceptable than lenders such as credit unions. Reflecting from our depth interviews, the bonding loan sharks cultivate with local communities has a very strong impact on what borrowers feel they should do.
The outwardly friendly projection of loan sharks lock borrowers into relationships with providers that they struggle to extricate themselves from. Credit unions are generally less familiar to potential borrowers than payday lenders since they do not enjoy the large advertising budgets of the latter.
Importantly, would-be borrowers sometimes feel intimidated in approaching a credit union or other traditional sources of credit in case they are knocked back and refused credit. Credit unions can be perceived as stuffy in imposing strict criteria on lenders about their financial positions. Borrowers may not appreciate discussing the dos and don'ts of personal finance, as they simply do not wish to be reminded of their own financial shortcomings.
The appeal of payday lenders was their perception of being hassle-free. The opportunity to sign up online with payday lenders has made them particularly attractive to low income groups suffering financial problems. Hence payday lenders are legitimised by their accessibility and familiarity that most credit unions cannot currently compete with.
Attempts have been made to make credit unions more accessible. There’s an initiative, for example, for several smaller ones to pool their assets together under the auspices of the Association of British Credit Unions in the hope of capturing greater market share by offering loans at more favourable rates. But credit unions can only offer these rates to people who have a lower risk of defaulting so they tend to work to different business models to loan sharks, which appeal to the desperate.
The caps to be introduced in January 2015 could be greater, or protection further improved by learning from other countries. In many parts of the world, payday lenders have been more strictly regulated. But, in order to give borrowers more choice, alternatives must be seen to be both credible and accessible, for example by exploring the marketing used to attract customers in the past to high risk payday lenders.