The collapse of payday loans company Wonga was met with numerous calls for better responsible lending, including by MP Stella Creasy and the charity StepChange. They focus on the need for responsible lenders that ensure potential borrowers are able to pay off their loans prior to entering into a contract.
New, responsible lending regulation has had a positive effect on the unsecured short-term lending market, resulting in the demise of Wonga and others offering similar products in the short-term credit market. But it is clear that this policy has not addressed the heart of the problem. Many millions of UK citizens are in need of short-term credit to supplement the poor and exploitative pay regimes that they are experiencing in the work place. The way that many businesses operate needs to change.
Both shadow chancellor, John McDonnell, and Archbishop of Canterbury, Justin Welby, spoke recently of the fact that too many people are stuck in insecure employment, which forces them into “debt slavery”. This is supported by all the research, which clearly shows the growing problem of income inequality through employment contracts that are exploitative.
An estimated 4.5m workers are on temporary or zero hours contracts. Most of these jobs are in the service sector and reflect society’s needs and demands. The need for care of the elderly, the demand for fast food and direct selling from warehouses, for example, all rely on the gig economy.
Employers emphasise the need to control costs, matching worker hours to meet the changing nature of demand. The result is temporary or zero hours contracts, which tend to be low paid. These jobs represent a large part of Britain’s record low unemployment levels and the expansion of the job market in future years may well rest with the expansion of these service sector jobs.
It is these relatively unskilled, low paid workers who are the target of payday lending companies and other providers of short-term credit – not the unemployed. It is these workers who can be in a position to pay back at least the original loan and interest. But it is these workers who often fall into the lending trap.
Initially, they can meet the loan repayments but will then find themselves in further debt because of some unplanned mishap, such as a need to replace or repair household equipment like a washing machine. This situation often results in a default on a loan and the need to take on another loan – all of which involves costs and extra interest payments on the rollover of existing loans. Subsequently, many borrowers find themselves in so much debt that they are unable to repay. This still remains an attractive proposition for greedy lending companies.
Nature of the lenders
In this debate, it is important to appreciate the nature of the companies that operate in the short-term loan market to understand their motives and how they interact with their customers. The pie chart below shows the various costs and profit as a percentage of total revenue for Cash America one of the prominent payday lending companies in the UK, which featured in the report Payday lending: fixing a broken market commissioned by the Association of Chartered Certified Accountants.
Similar patterns can be expected and seen for other payday lenders. Losses are incurred due to non-repayment of loans (often categorised as bad debts). But, as the chart shows, despite a significant number of people struggling to meet repayments, the company is still able to generate a reasonable profit. Such business models in today’s struggling economy can only be described as toxic.
Another feature of these companies is the sophistication and the extent of their advertising and marketing. Through television, sponsoring of popular football teams and the use of social media, they are able to target and capture their clients. They also have quick and sophisticated systems to sign up customers in as little as ten minutes. Simply type “quick loans” into a search engine and you’ll get multiple offers of cash in minutes, with no credit history.
It is a highly competitive market with companies paying for high profile advertising slots. The question is: should companies that target vulnerable people exist in a modern society?
I would argue that investors have a big role to play in shaping the behaviour of the companies they invest in. Investors should intervene by lobbying for better behaviour or withdrawing their investment. This would bring an end to the toxic companies that have business models targeting vulnerable borrowers and also those others that pursue poor employment practices.
The United Nations-supported Principles of Responsible Investment is an international network that promotes responsible investment. It has a rapidly growing community, which has signed up to its six guiding principles and work towards incorporating these principles into their own investment and ownership decisions. Signatories of the principles have estimated investments of US$73 trillion worldwide.
The principles are primarily driven by environmental, social and governance (ESG) issues, which are seen as the three central factors in measuring the sustainability and ethical impact of an investment. There is growing evidence that these ESG factors, when integrated into investment analysis and portfolio construction, may offer investors long-term performance advantages.
It gives further reason to stop investing in companies with poor employment practices and payday lenders. Meanwhile, regulators must also promote investor action to address the intolerable personal over-indebtedness in society.