Where will struggling households turn after the UK cracked down on payday lenders? | payday loan

South African-born entrepreneurs Errol Damelin and Jonty Hurwitz could not have foreseen the impact they would have when they set out to disrupt the 120-year-old payday loan market in 2006.

Wonga’s founders set up the company to help defaulting borrowers as Britain headed towards economic collapse during the 2008 financial crisis. But the now-disgraced lender – which charged some vulnerable customers interest rates in excess of 5,000% – became a lightning rod for controversy before its collapse in 2018, sparking a regulatory crackdown on the UK’s ruthless payday loan market.

Since then, the market that Wonga once dominated has almost halved. More than 50 companies have collapsed or been closed voluntarily. Since then, no new payday loan providers have received regulatory approvals to operate, leaving fewer than 40 expensive, short-term lenders in operation.

As consumer advocates hailed its steady decline, questions have been raised about where the country’s most vulnerable households might turn next to make ends meet. Amid the cost-of-living crisis, some industry insiders say a more tightly regulated payday loan sector could play a role.

Regulators at the Financial Conduct Authority (FCA), the city’s regulator, earlier this year raised concerns about the relatively small number of expensive lenders left in the market for borrowers who don’t meet mainstream bank lending criteria.

At their May meeting, FCA board members said that cutting back on expensive lenders “as inflation rises…is likely to result in a series of chokepoints where consumers need access to money quickly and options are limited.”

As the payday loan market declined, hopes were raised that more socially responsible options like credit unions and nonprofit financial institutions could fill the gap for community development. However, there are concerns that they will struggle to scale fast enough to help anyone who needs financial assistance in the coming months.

Fears have been raised that more people may be turning to illegal loan sharks to make ends meet. According to the Center for Social Justice, the think tank co-founded by former Conservative leader Iain Duncan Smith, more than 1 million people are now using illegal lenders in England.

Others are turning to unregulated but legal forms of lending, such as Although borrowers are often not charged interest on their purchases, buyers still run the risk of overburdening themselves with debt. Companies are under no obligation to offer leniency or compensation if things go wrong.

“This cost-of-living crisis is the most potentially worrying I recall in my 25+ years as an activist,” said Mick McAteer, former FCA board member and co-founder of the research organization Financial Inclusion Center. “So the risk of people turning to loan sharks could increase.

Wonga collapsed in 2018. Photo: Dominic Lipinski/PA

“[And] While BNPL may not have the kind of excessive, exploitative terms and fees that payday and other subprime loans do, the product encourages overconsumption of credit. This is bad for consumers in the long run.”

A study released in June by Barclays Bank and debt relief organization Stepchange found that nearly a third of BNPL borrowers said their loans had become unmanageable, pushing them into problem debt. Shoppers using BNPL paid an average of 4.8 purchases — almost double the 2.6 purchases in February, the research found.

Amid rising concerns about illegal and unregulated lending, some expensive lenders are claiming they are offering safer options for borrowers, despite years of alleged misselling of loans to vulnerable borrowers.

Jason Wassell, who heads the consumer credit trade association’s high-priced credit lobbying group, says there’s still a place in the market for private lenders. “Demand already far exceeds supply,” he says.

“What we have seen in recent years is a number of lenders exit. This has led to limited access to alternative credit and this is causing a problem for families across the UK, particularly those who have historically been underserved or not very well served by banks.”

Executives at guarantee lender Amigo – which gets friends and family to vouch for and approve unpaid loans for defaulting borrowers – say they learned their lesson after a spate of affordability claims almost pushed Amigo into collapse and forced it to halt lending Beginning of the corona pandemic.

Jake Ranson, Amigo’s chief customer officer, says his team “makes no apologies for Amigo’s past practices or products,” which included selling prohibitive loans to customers who were typically charged around 49.9% interest.

He now hopes the FCA will give them the green light to resume lending under a new brand, RewardRate, as early as September and offer new features like lower interest rates if borrowers pay on time.

“We’re going to do weapon-level affordability testing, use things like open banking, and make sure customers are talking to a human… and that they understand the responsibility that comes with owning the product,” says Ranson. “That’s a completely different suggestion.”

banknotes and pound coins
With concerns growing about illegal and unregulated lending, some expensive lenders claim they offer safer options for borrowers. Photo: Dominic Lipinski/PA

However, consumer advocates are concerned. Debt Camel blog’s Sara Williams is skeptical that the broader high-cost lending industry is safer or more suitable for vulnerable consumers, even after regulators crack down. “Debt is rarely helpful in this situation,” she says.

Rather than restarting the payday loan market, more government support for struggling families is crucial, she says. In the meantime, consumers would be better off looking at debt management plans for existing loans.

According to figures from StepChange, 4.4 million people across the UK borrowed money last year to make ends meet. About 71% said using credit had negatively impacted their health, relationships, or ability to work, while two-thirds said they were only able to keep up with payments by skipping home or utility bills, or getting them to the point reduced by the need, there is a risk of further financial damage.

StepChange said the risks faced by vulnerable borrowers are not due to a lack of expensive lenders in the market. Instead, it pointed to the lack of other options available when consumers were hit with prohibitive bills or unexpected expenses.

“Turning to subprime lenders should be the last resort,” says McAteer, adding that it is problematic that the UK has failed to build a “major non-profit lending sector” to deal with the current crisis.

Not-for-profit social enterprises lend just £25m a year and serve just 35,000 clients on average. Despite their declining presence in recent years, payday lenders were still able to raise around $60.4 million in the first quarter of 2022 alone, according to the FCA.

“We’re seeing a welcome increase in the number of people using credit unions and other nonprofit lenders. Credit union membership has now grown to over 2.1 million. But that’s not enough,” says McAteer. “There is a real chance that nonprofit organizations will be financially outperformed by commercial subprime lenders backed by private financial institutions.

“We need immediate action to help households weather the crisis and then medium-term action to help people build financial resilience to future shocks. We’ve made almost no progress on building financial resilience since the 2008 crisis. Will we learn the lessons?”

About Bradley J. Bridges

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