Wonga, the UK payday loan industry poster, has entered the administration following an influx of customer compensation claims. Its demise is the result of government regulation aimed at reforming the payday lending industry in favor of the consumer.
A price cap introduced by the Regulator of the Financial Conduct Authority (FCA) in 2015 on high-cost short-term credit means that the history of irresponsible lending from Wonga and other payday lenders is catching up with them. Profits were reduced due to the cap, with Wonga having to foot the bill for a big number of claims for loans contracted before the introduction of the regulation. It is likely that as a result of the FCA’s ongoing reforms, other high-cost lenders will also collapse.
The experience of payday loan applicants gives an idea of the importance of this situation. On the one hand, these are people who are in desperate need of credit – often to pay bills. But, on the other hand, it makes them vulnerable to the payment of a poverty premium.
The rise of Wonga
The boom in payday loans came in the wake of the 2008 financial crash, which led many households into personal financial crises. Household budgets as a whole have been squeezed due to rising costs and wage freezes, many of whom are now worse off than before the great recession.
One way to close the gap between income and expenses is to use credit. For many, that means using traditional bank financing in the form of overdrafts, loans, or credit cards. But one growing number of households are unable to access traditional bank financing and are excluded from general options due to a low credit score or precarious employment.
High-cost credit in all its forms (payday loans, home loans, hire-purchase, daily loans) functions as an alternative credit market for those excluded from mainstream finance. Payday loans – and Wonga in particular – were extremely popular due to the anonymity and ease of applying online and the quick access to cash. But the huge interest rates have led many to pay dearly for this easy access to credit.
The new FCA regulations put an end to some of the worst excesses. But, to stay competitive with the new regulations, payday lenders have changed their operations and innovated new products. For example, some payday loan products have longer repayment terms. This does mean, however, that the loan is more expensive overall, even though the repayments are more affordable.
Alongside Carl Packmam (then at Toynbee Hall and now the Fair by Design campaign Against Poverty Premium), I undertook extensive research with former payday loan takers who then self-identified as “refused applicants” due to regulation. What we found was different from FCA 2017 report who said the majority of former payday loan users (63%) who have since become a “refused applicant” due to the regulations “feel they are better off as a result”. FCA research indicated that 60% of “refused applicants” do not borrow from other sources and have not turned to other forms of high cost credit or illegal money lenders.
Our interviews with 80 people who have been denied a payday loan since the introduction of the regulation suggest a more nuanced picture. In chatting with people face to face, we went deeper than the FCA consumer survey and found that people took a series of actions. They requested access to other loans after being refused, for example by going to another lender, friends and family. Some have tried to avoid borrowing, for example by going without credit or increasing their working hours.
The most common step people took after being refused was to access money from friends and family. The second was to apply for another type of formal credit product. Many of our interviewees were successful in obtaining a payday loan from another company after initially turning down one. This suggests that some lenders do not adhere to responsible lending or short-term, high-cost credit regulations, and that “denied applicant” status was temporary for some. Only four people borrowed from an ethical community finance lender (such as a credit union or community development finance institution) and one used a credit card.
This tells us that more borrowing options were better for refused applicants than managing otherwise. Or because the money was needed for essentials such as rent and utilities. This potentially strengthens the case for better and more affordable borrowing options for those who have now turned down a payday loan.
We know that credit is not always the solution to all borrower problems, but we also know that more affordable credit options would be a lifeline for many people today who feel that their only option is to ‘use very expensive credit products. While capping the cost of payday loans has largely had the effect of increasing the rules regarding what type of borrower (and in what type of situation) can handle the use of a payday loan with little risk. ‘lead to negative financial results, there is still a greater supply of alternative credit products available to meet this demand.