I’ve been fed worrying news that the home credit trade body is taking my payday loan comments out of context in a report lobbying MPs against tighter regulation. Specifically, this is about the proposal being made by Stella Creasy MP (Lab) backed by Justin Tomlinson MP (Cons). I know MPs will be sent this link so as this is mainly for them, I’ve assumed a level of knowledge.
Why I’m writing this
I was rather disturbed today to receive an email from Stella telling me I was being used in the argument against her proposal by the Consumer Credit Association, and worse, it was having a negative impact on MP’s sentiment. That’s not good as I support her overarching proposals and the great campaigning work she’s doing on this.
This blog is a deliberate speedily written line in the sand to correct any misinformation as I know it will be circulated.
If you’re new to this, for background, please read the Don’t cap interest rates, cap loan costs, Time to ban 2,500% APR loans? and MPs to vote over payday loan curbs MSE articles.
I’m anti-interest rate caps – but pro total cost caps
The lobbyist document correctly reports that I’m not in favour of a cap on interest rates. Yet this isn’t because I think regulation and tighter controls of payday lending is bad. It’s because I think interest rates are a blunt tool for doing so (that bit is explained correctly in the report in the appendix below, but then used as an objection to total cost caps).
A total cost cap is much more sensible. Here, you limit the total cost of the borrowing (eg, a maximum £25 per £100 of loan rather than an APR limit), though I am still open to the level at which that should be set.
In fact, for me, the real danger of payday loans is less the APR, even though that can be 1,000%+, it’s the rollover effect. That’s where you borrow, but are then encouraged not to repay it or to borrow more to pay it back, which incurs further costs. Incorporating this within a long term total cost cap would be helpful.
Poor controls would lead people to loan sharks – but good regulation shouldn’t
Another quote of mine used was:
If we get rid of the high interest legal lenders who we can regulate and control, then some will move back into the arms of loan sharks."
In fact, the full quote from this October 2010 blog is:
If we get rid of the high interest legal lenders who we can regulate and control, then some will move back into the arms of loan sharks.
"As Paul Oginsky, adviser to Prime Minister David Cameron, says:
‘People will always find a way to borrow, if they need it, it’s like drugs.’
"In good conscience, I find it worrying to regulate and risk pushing people into the arms of those who threaten to ‘rape your children’ as a means of enforcing repayment (sadly, that’s no exaggeration)."
And again I stand by this – but this doesn’t mean I’m anti-regulation, just anti interest rate-based regulation.
I’ve spoken to credit unions (non-profit mutuals) on this to see what rate they could do payday loans at and the answer is always in the 100s of percents. That’s because to loan someone £100 is always going to have admin costs of say a fiver – and over a short time that’d be a huge APR.
My worry is that by capping APRs we’d kill the industry, yet a well imposed total cost cap rather than interest rate cap wouldn’t do that. It would just limit the danger these short term expensive loans have. It works overseas and it can work here – the plan needs to be done sensibly, though.
It’s a shame the industry doesn’t decide to work with these proposals and work on fairness, rather than just try to scupper them. If there are specific worries for the home credit section of the market (not something I have looked at in great detail) then it’s important to get them addressed within the proposals – and believe Stella is suggesting different caps for different sectors which should address that.
So if you’re still reading this MPs my view is simply "do support total cost caps and careful regulation of the industry".
Appendix! The note below is the document I’m responding to.
Price caps on credit – a good or bad idea?
Campaigners – led by the left wing pressure group Compass – are calling for price caps on unsecured credit. This short paper sets out what independent experts think about caps, and how they have the potential to harm those they are intended to help. It also explains one form of unsecured lending – home credit – including the unique role it plays in making credit available to people on lower incomes and how it differs from both mainstream and payday lending.
What the experts say
On the face of it caps might seem a simple and attractive way of reducing the cost of credit for consumers. But the experts who have studied price caps have expressed real concerns. Independent research shows that capping prices can mean:
– less transparency with greater back end penalty and ancillary charges;
– lenders withdrawing from the market; leading to
– increased exclusion for higher risk borrowers;
– higher levels of illegal lending;
– greater consumer detriment when in credit difficulties;
– greater chance of complete financial breakdown for consumers; and
– less product diversity and innovation in the market.
The regulatory, consumer and money advice experts who have looked at caps and expressed such concerns include:
The Competition Commission
The Office of Fair Trading
Money Advice Trust
Financial Inclusion Taskforce
Association of British Credit Unions
Institute of Public Policy Research
Professor Elaine Kempson CBE
This is what some of them have said:
"…there is quite a lot of evidence to suggest that it [a cap] may drive some consumers into the hands of the illegal or less good sector… we would be concerned about some of the unintended consequences of caps.”
Philip Cullum, Deputy Chief Executive Consumer Focus, in evidence to the Treasury Committee, November 2010
"If we get rid of the high interest legal lenders who we can regulate and control, then some will move back into the arms of loan sharks."
Martin Lewis, MoneySavingExpert.com, Weblog October 2010
"We agree with the view that an interest rate cap may have unintended consequences and not provide the protection such a cap would be intended to provide."
Money Advice Trust submission to BIS, December 2010
"The Taskforce believes that there is no case for introducing an interest rate cap on unsecured credit until there is an adequate alternative supply of affordable credit. Attention and resources would therefore be better focussed on improving the supply of affordable credit rather than introducing further restrictions to supply."
Financial Inclusion Taskforce, March 2010
"The OFT is concerned that such [price] controls may further reduce supply and considers there to be practical problems with their implementation and effectiveness."
Office of Fair Trading press release on publication of review of high-cost credit, June 2010
"…at this point in time, if the Government were to legislate now and put in a cap of any percentage rate for the people who were paying 700%, you would actually put a lot of those people, two or three million people who are using even just home credit for example, in a position where they would not have access to any kind of affordable credit at all."
Mark Lyonette, Chief Executive Officer, Association of British Credit Unions Limited, in evidence to Scottish Affairs Committee, July 2009
"It would appear likely that credit exclusion will result from the imposition of a ceiling and that the consequences will include significant hardship for excluded households who will no longer be able to access small sum cash credit to manage cash emergencies or peaks of expenditure or to enable them to spread the cost of major purchases."
Policis, ‘The impact of interest rate ceilings’, 2008
"We consider that price caps would have significant disadvantages in this market… We further noted that there would be considerable practical problems with the implementation of price caps."
Competition Commission, Home Credit Market Investigation, November 2006
Why some APRs and Total Cost of Credit appear very high compared to ‘mainstream’ loans
APR is an annualised percentage rate. This means that the formula set down in legislation has the effect of creating ever higher APRs the shorter the term of the loan. Experts agree that APR isn’t a good indicator of value for shorter term, small loans. As Martin Lewis put it to the Treasury Committee recently:
"I did a pet calculation the other day which showed that if I lent you £20 and said, ’Pay me back a pint of beer next week; buy me a pint for it,’ and the pint cost £3, that’s 141,000% interest, if you compound it. Yet most people would say, ‘Buy me a pint and £20, is a pretty reasonable deal.’"
Whether you provide a loan of £100 or £10,000 the administrative and regulatory costs are the same. For short term small sum credit the Total Cost of Credit (the cost per £100 lent) therefore also inevitably appears significantly higher than for larger, longer term loans.
Independent research commissioned by the Joseph Rowntree Foundation demonstrated that, even with favourable assumptions and costs of funding excluded, providing home credit on a not-for-profit basis would need an APR of 123%.
Capping the Total Cost of Credit is not a more forensic measure than capping APR. It would specifically discriminate against home credit providers compared to other forms of credit, because of the higher costs of home collection.
As a result it would distort the market. Crucially it would have exactly the same other negative effects as a cap on APR, ie, exclude more people on lower incomes from accessing credit, reduce the availability of small sum lending, thereby reducing competition and increase illegal lending (with the social harm that follows).
What home credit is and how it works
Home credit has the following key characteristics:
– Uniquely – and different to other forms of lending including payday lending – there are no penalty fees or extra interest for late or missed payments. Interest and the total amount payable is fixed. Each pound repaid by the customer brings down the total amount owed by a pound. The amount owed by a customer cannot ‘spiral’ out of control. This control and certainty is hugely important for, and valued by, people on lower fixed or variable incomes.
– Loans offered are small – typically in the range of £200 to £500. Lower income borrowers typically want to borrow relatively small amounts.
– They are short term and unsecured, usually for a year or less.
– All would-be borrowers are assessed in person, unlike with both mainstream and payday lending.
– Also uniquely, loans are granted and repayments collected from customers at home. Both customers and home credit agents are predominantly women.
– Unlike other lenders, repayments are collected on a weekly basis, making the amounts collected small and manageable, while also matching lower income household budgeting cycles.
– Agents are paid for the repayments they collect, not what they lend. This encourages responsible lending.
– Home-based service is key to this form of lending. Customers value it as it offers access and penalty-free tolerance of missed payments. Attempts at remote repayment models have been shown to be unviable.
– The home credit sector has been providing its bespoke form of small, short term lending for more than 200 years.
– Home credit is not a source of consumer complaints. Figures from the Consumer Credit Counselling Service show home credit accounted for 0.3% of problem debt they saw in 2009.
– Home credit accounts for just under 1% of unsecured lending in the UK. Bank of England data shows that total unsecured lending has been falling since 2004.
Dame Deirdre Hutton, when Chair of the National Consumer Council, had this to say of the home credit product and service:
"Home credit offers a unique service – there’s nothing else quite like it. Small, short-term unsecured cash loans, perhaps for as little as £100, are a lifeline to people on long-term low incomes who are excluded from the mainstream credit market. When they need extra cash for household bills, their child’s school uniform, or to cope with the financial demands of relationship breakdown, a new baby or sickness in the family they turn to the friendly agent who calls every week. The deal is done quickly, informally and face-to-face with local collectors who may have been known to the family for generations. Trust, flexibility and fixed weekly payments – with no penalties for missed payments – are the hallmark of a service that fits the needs of this vulnerable group like a glove."
The Consumer Credit Association represents almost 500 businesses, the majority of which are SMEs. Members have to comply with the Association’s Code of Practice and undertake regular compliance training.