crackdown was vital, but credit unions need to grow after coronavirus to fill the void

The cost of accessing small personal loans can be extremely high for those who need them most. Take the UK, where a £200 loan from Provident Personal Credit over 13 weeks costs £86 in interest. That’s an equivalent APR of a whopping 1,557.7%.

These offers are available even after caps on payday loans introduced by the UK five years ago. In the months following the reforms, the Financial Conduct Authority (FCA) reported that the number of loans and the total amount borrowed fell by 35%. From there, the decline continued: there were 5.4 million high-cost loans totaling £1.3 billion in 2018, with the total amount repayable being £2.1 billion; five years earlier there had been 10.3m loans worth £2.5bn.

Yet, it is clear that high-cost credit has not completely disappeared and looks set to pick up again. Provident, the UK and Ireland’s largest high-cost home loan provider, expects demand to rise as unemployment rises as the UK furlough scheme ends. The lender is said to have set aside £240million for an increase in defaults.

So what have we learned since the rules changed, and will those who need credit be able to access it in the wake of the pandemic?

To cap or not to cap?

High interest rates are usually justified by the argument that borrowers are more likely to default, often having been turned down elsewhere. Higher rates compensate the lender for higher risk.

Either way, payday loan companies have gained a reputation for predatory lending, especially after the last financial crisis. UK restrictions set a cap on interest and charges at 0.8% of the principal outstanding per day, and a maximum total cost of 100% of the amount borrowed.

This reflected a global trend. In Germany, for example, the maximum allowed APR is double the market rate as calculated by their financial regulator, [BaFin]. In France, it is 1.33 times the market rate.

The primary intent was to make credit more affordable for vulnerable consumers. This follows clear evidence that most high-cost credit customers are in a low-income category, with poor credit histories and low financial resilience, which means they may struggle to do well. in the face of financial setbacks.

They often borrow based on convenience and ability to repay, rather than the cost of the loan. This can lead to financial stress, repeated borrowing and defaults. After all, credit is debt.

High-cost credit is tied to low-income consumers.
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Nonetheless, debate continues among policy experts around the world over whether caps are the best answer. Proponents point out that the restrictions have lowered the cost of credit for low-income borrowers, tackled over-indebtedness and helped prevent people from being exploited.

Some consumers may no longer have access to credit because providers have changed their business model or exited the market, but many of these people would likely not pass rigorous affordability screening and may already be over-indebted.

Opponents point to possible unintended consequences. In addition to reduced access to credit, they worry about the possibility of more illegal lenders and loan companies introducing fees that circumvent restrictions.

Driven by these arguments, Ireland is one of a minority of European countries to favor the strengthening of regulation and monitoring at the ceilings. For example, high cost warnings in loan advertising became a requirement from September 1. Although the government is reviewing its general approach, the fear that the restrictions will reduce the supply of credit still seems to have the upper hand.

What the evidence says

A 2019 OECD report found that interest rate caps reduced exploitation and over-indebtedness, made short-term loans cheaper, and reduced defaults. However, the OECD has warned against excluding riskier consumers from formal credit, as they may borrow from lenders in countries with looser rules. This happened in the Netherlands, for example.

Similarly, the 2017 FCA review found that UK restrictions had led to cheaper loans and fewer debt problems. And he’s seen little evidence that consumers are turning to illegal lenders. Our own research in 2017 agreed with cheaper loans, but warned that they must be accompanied by measures to provide more affordable alternatives and help consumers make good credit decisions.

Credit unions are one of the few alternatives, as recognized by the FCA. They aim to build consumer financial resilience by lending at affordable rates, encouraging regular savings, and providing financial education and information. This helps to improve borrowers’ credit records.

There are around 440 credit unions in the UK, with 2 million members and growing. Loans to members topped £1.5bn in 2018, outpacing that of high-cost loans.

Currently, UK credit unions are allowed to charge up to 42.6% APR, a far cry from the rates allowed for high-cost providers. Still, penetration is low relative to the total population, at around 3.5%. We need to expand the reach of credit unions and enable a greater online presence to make much faster lending decisions.

Fair4All Finance, a government-funded organization from dormant accounts, has started supporting credit unions to build their capacity, but funding is limited and mostly offered only in England. An enlargement would be invaluable.

Woman choosing between different credit cards.
Many people live on endless refinancing.

Scaling up affordable alternatives has certainly never been more urgent. Provident reports that its customer numbers fell in 2020 after it tightened its lending practices, but that could be due to falling consumer spending, as well as an increase in savings and government support. in response to the COVID-19 pandemic. The picture could look very different a year from now.

Boosting credit unions would also challenge the next generation of digital lenders, who are armed with people’s personal data to entice them to borrow more. This new form of lending will be more prevalent among socio-economic groups, rather than just a poor person’s problem, and will likely be more difficult to regulate as it will cross international borders. Government support for the pandemic has been essential, but they need to think about the surge in loan demand that is brewing.

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