The Ethics of PayDay Lending
Yesterday’s OFT report on the performance of “PayDay Loans” companies was, let’s be frank, damning. OFT Paper 1481 gives most of the lenders in this market a tiny window of twelve weeks to demonstrate compliance in five key areas. These are,
- Making sure borrowers are aware of the full costs of the loan, rather than simply advertising emphasising speed and accessibility of funds
- Conducting adequate affordability assessments of new customers and of customers who need to roll-over loans
- Acting with a greater degree of forbearance with customers who run into financial difficulties
- Restricting firms from using aggressive debt collection tactics
- Improving internal procedures, particularly in area of customer complaints
The OFT is already investigating some firms beyond these general requirements and the threat is to remove the banking licences of those firms that cannot demonstrate they meet the standards the OFT require of them. In theory, some firms could be shut down by the end of June, if not earlier.
It’s worth beginning a discussion of the ethics of this sector by making a case for PayDay lending. In principle, PayDay lenders can serve a useful purpose in providing small, short-term loans to help tide someone over an immediate financial difficulty. Take the example of someone who needs £100 to tide them over for a week or so, but who is right up to the limit on their bank overdraft. Going to a payday lender (let’s use FridayFriday as an example – they brand themselves as “ethical”) would incur a cost of £25 for borrowing the £100, plus an administration fee of £4.95 – that’s a little under £30. Now look at what one of the high street banks charges for unauthorised overdrafts – you’re looking at fees for multiple transactions taking your balance below the overdraft limit in the region of £40 / £50, and these fees may be taken from your account at a time not of your choosing leading to further solvency problems. In this scenario the PayDay Lender is a cheaper alternative, and as long as you pay back the loan on time has provided a useful financial service.
Of course, the key factor in this is paying on time. The OFT research indicates that the PayDay Lenders make a substantial portion of their profits from customers who fail to pay on time. When this happens they can incur late payment charges and extra interest costs as the loan is refinanced for another month. The other problem at this point is that it is very difficult for the borrower to now look elsewhere to move the loan – other PayDay Lenders are less likely to take over the debt and, like it or not, high street banks are averse to dealing with customers who are already in the sub-prime market. This means that defaulting customers often end up with debts that are many significantly higher then the original sums borrowed and have little opportunity to deal with the situation adequately.
So are PayDay Lenders caught between a rock and a hard-place? It’s not wrong to make money from providing a useful service, but it seems that far too often the big firms are landing themselves in trouble by the negative reputational effects of what happens to those who cannot service the debt they have run up. If that’s so, then does the OFT Report offer a window of opportunity for these firms to improve their working practices and in doing so their perception as ethical financial operators? While the Christian understanding of Usury has been transformed since the sixteenth century after Calvin (though Luther began the change of thinking in this area) began to argue that lending at interest was not in itself sinful, there is still a sense that charging for borrowing to those who need the money just to feed themselves is a practice of dubious moral practice. However, if the PayDay Loans Companies can be transformed to act as responsible lenders, might they then become agents of good rather than evil?
Thoughts?
At least part of the problem for the lenders is that the very nature of their business means that the level of defaults is greater, and the interest rate charged reflects this. The example you give is a horrendous yearly interest rate, but that’s not really the point, as the annual rate is not what’s important.
What’s really importatnt is that there is a fair and well regulated service available for those who need it that doesn’t involve men with baseball bats coming round to collect the interest.
Thanks Simon,
Yes, the simple fact is that the APR (though that is unrepresentative as these kinds of loans do not rack up compounded interest for a year – the legal framework for them simply won’t let that happen) is what the market will bear. The real issue, as you raise, is how to handle those who cannot (or will not) repay the outstanding finance, and the judgment as to whether someone should have had money lent to them in the first place.
I don’t think the example you give does make a case for payday lending. Someone at the limit of their bank overdraft is in no position to take on the £29.95 cost of the loan. Openwonga.com’s customer feedback page does one or two actual good examples of a useful service being provided. These revolve around convenience. For example there’s the chap who has filled his car with fuel in the middle of the night and suddenly learns that a due to a payment hiccough he can’t pay for the fuel until the business opens and he can sort out the error.
It seems to me that the convenience cases are edge cases and pander to a society which has become used to 24/7 access and instant gratification. This is not a sufficient “value add” to justify the downside of people borrowing when they actually cannot afford the terms of the loan.
The more common cases appear to be people borrowing because they will hit a brick wall if they don’t. Payday loans do not solve these problems. They simply move the brick wall whilst simultaneously increasing the eventual velocity of impact.
Is still think incurrring a £30 cost for credit as opposed to a £60 cost for the same credit is an improvement!
But your comment does raise the issue of affordability and this is one of the issues raised by the OFT. What they are demanding of lenders is much better assessment in this area, so the scenario of “backs against the wall” is valid, but if lenders can better calculate the likelihood of repayment then it’s not an invalid loan to make (if such affordability checks are made).
Standing back, it seems the problem is with banks having created systems that allow unauthorized overdrafts.
£30 is better than £60 in penalties but as others have commented, the issue is the Pay Day loans are mostly taken out by people who are least likely to be thinking about cost effoiciency – or they would probably have budgetted their spending, so not run out before pay day… and have some reserves for the unexpected empty petrol tank etc.
Credit Unions are better on both counts: My last church helped set up and run a credit union – which made it easy for people to learn to save – and once they had done that gave them cheap credit for small purchases of the kind the Pay Day-ers fund.
Finally, the problem with credit, in my view, is that *however exploitative the lender was in making the loan* the lender has a right to demand 100% repayment plus interest. This puts all the power in th hands of the lender. IF the lender and the borrower *shared* responsibility for the loan, iunterest and repayment, then lenders would suddenly get much more responsible about whether the borrower was likely to be able to repay
For instance, a pay day lender should check that the borrower will be able to repay on their next pay day and the loan should be frozen [at least] if it turns out they can’t..
In some sense your proposal in the last paragraph is exactly the kind of thing that the OFT is wanting lenders to do – make proper affordability assessments.
Yes, but my point is that the issue is more that the “assessments” the lenders make – the issue should be where the responsibiliy lies when the assessment was wrong and the borrower can’t (or just desn’t) repay.
I think that, ideally, for these high risk borrowers the lender should have to cancel the debt. The borrower was high risk and the *lender* took the risk!! OK, the lender might loose a couple of hundred quid and the borrower would never get another pay day loan, but that is better than roll-overs ’til the borrower is bankrupt!!
Thanks for this informative blog. Most of the time people won’t get secure loans from the lenders due to low income level and poor credit score. But people can get payday loan very easily without any hassles because the lenders don’t check the credit report of the consumers. It is true that payday loans help consumers to meet the emergency needs. Most people feel shy to borrow money from their friends and relatives because money issues can ruin their family relations. This is why people try to avoid borrowing money from their close relatives and friends. In these situations, payday loan plays a great role. The negative part of payday loan is that the interest rate is too high to afford. That’s why I feel people should aware about the payday loan laws before taking out a payday loan.
“the lenders don’t check the credit report of the consumers”
I’m not sure this is technically true. Whilst payday lenders may use different credit reference data, many do make the same default rate prediction assessments that mainstream lenders do. Of course, their business model is slightly different so they may be happy to accept a larger default rate because of the profitability of the loans that do pay back.