Are FCA proposals to cap payday loan charges in the best interests of borrowers?
This guest post is brought to you by Jeremy King who is a freelance writer and blogger specializing in consumer affairs and finance issues. When he’s not busy writing for some of the UK’s most authoritative websites, Jeremy likes to settle down in front of a mountainous stage of the Tour de France.
The latest in a long line of payday loan news stories featured in the mainstream press is the recent announcement of the Financial Conduct Authority’s proposed cap on charges. If you are yet to read the proposals, there are a number of elements the City regulator intends to introduce.
Firstly, the FCA proposes capping the total fees and rates that can be applied to a payday loan at just 0.8 percent per day. In addition to this cap on charges, the interest and fees on a loan would not be allowed to exceed the original value of the loan. In practice, that means that an original loan amount of £100 could never cost more than £200 to repay. The final proposed change is to limit the amount a lender can charge when a borrower defaults to just £15.
However, until November of this year when it was ordered to do so by the Treasury, the FCA had opted not to impose a cap on the cost of loans. The regulator believed that such caps would render many payday loan providers unprofitable, and could leave 160,000 prospective borrowers without access to short-term credit.
What are the reservations about the proposed caps on charges?
On the face of it sounds counterintuitive that plans to reduce the charges applied to payday loans might not be in the best interests of borrowers. However, there are five hidden costs that might cause detriment consumers.
- A reduction in competition and access to loans It is estimated the proposed changes will result in a 43 percent reduction in revenue for the payday lenders, which could drive smaller operators out of business. FCA research suggests that only cash loan provider Wonga, the UK’s biggest payday and a tiny contingent of its closest competitors could afford to remain in the industry.As a result of the caps, lenders are unlikely to compete on price. However, the level of competition in terms of speed of delivery, access to funds and customer service would be drastically reduced.
- Fewer people will have access to loans The lower the charges applied to loans, the more selective payday lenders have to be when making their lending decisions. Due to the reduction in their margins, payday lenders will not be able to afford to risk bad debts by lending to people with poor credit ratings. The Financial Conduct Authority estimates that payday lenders will no longer be willing to lend to 160,000 people, equating to 11 percent of the total customer base. Another 210,000 would not be able to borrow as much as they currently access. This could leave many to struggle to make ends meet, potentially forcing them into the arms of criminal loan sharks.
- Increased use of illegal lenders As a result of stricter lending criteria, those in real need of short-term credit will have to go elsewhere to access the money they need. Unfortunately, credit unions, which have stricter lending criteria than payday lenders, are unlikely to lend to these customers, leaving many with little option other than illegal loan sharks. According to FCA research, 4.7 percent of those who were rejected for payday loans considered borrowing from criminal loan sharks. Alternatively, an increasing number of people might choose to rely on bank overdrafts, which in many cases prove to be more expensive than payday loans.
- Short-term borrowing becomes more widespread Currently payday loans are viewed as a last resort and are commonly used to pay for essential expenses such as food, living costs and utility bills. The risk is that as they become cheaper, those with access to payday loans will use them more frivolously by borrowing larger amounts for inessential expenses. The result could be a debt problem equal or greater to that which exists today.
- Has the crackdown come too late? As the UK emerges from the debt crisis and more and more people are becoming financially stable, the number of payday loans is naturally declining. The value of loans granted in 2012 and 2013 fell from £2,151million to £2,145million respectively. Although this a small decline, the early signs show this trend is set to continue in 2014.
Do you think the proposed caps will be a positive move for consumers? With the proposals not likely to come into force until January 2015, is the FCA closing the stable door after the horse has bolted? We’d love to hear your thoughts on this issue, so please leave your comments below.