Ban payday lenders and the vulnerable will be forced to use loan sharks
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The government yesterday announced major plans to clamp down on the practices of payday loan companies like Wonga. Although sensibly deciding against a cap on interest rates, restrictions on advertising will be introduced, and firms will be asked to draw up a code of practice. In a separate announcement, the Office of Fair Trading threatened to take away the licenses of payday lenders if they fail to change the way they operate.
But even if you don’t agree that consenting adults may rationally enter a voluntary transaction to tide them over hard times, tightly regulating an undesirable action isn’t necessarily the best way of solving it. In fact, it could make the situation for vulnerable people much worse.
Restricting payday lending will likely harm the very people it intends to help – the poor. Most attacks on payday loans, for instance, cite truly eye-watering rates of interest. But these figures are misleading. They are annualised percentage rates (APR), which are only useful means of comparison if a loan is repaid over a longer period.
Indeed, payday loan rates aren’t really interest rates at all. The administration costs of these tiny loans are included in the quoted rate. A £100 loan for two weeks, for example, with a set-up cost of £5, would have a quoted APR of 256 per cent, even if the interest charge were zero. In any case, loans from payday lenders are almost always paid off over a short period (typically one to two weeks), so the actual amount of interest paid is in most cases nothing like that suggested.
Crucially, loans of this kind are intended to provide cash over the very short term – they are a mechanism for letting people without access to other finance get liquidity. And this is done on the basis of the only kind of security many poor people have – future income from employment or personal possessions.
And restricting access has been found to have devastating effects. The Department for Business, Innovation and Skills undertook research of restrictions to payday lending back in 2004. It found that Germany and France, which both have interest rate caps, had around five times the level of complete financial breakdown (like bankruptcy) among people who had trouble with debts.
The same study showed that an absence of high interest payday lenders would make short-term cash flow problems more serious and harmful than they otherwise needed to be. The use of illegal loans was found to be much greater in France and Germany, at nearly three times the UK figure. If cash is needed in the short term to meet a utility bill, for example, it’s far better that liquidity is provided by a payday lender than by a truly unsavoury loan shark.
All the evidence suggests that, by restricting legitimate payday lenders like Wonga and its competitors, you are not helping the poor and vulnerable. You are creating troubles that could make the poor’s difficult financial position even worse.
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Very good piece. Niall Ferguson recalls the case of a Glaswegian loan shark in his “Ascent of Money” who charged 25% interest per week, or roughly 100,000% APR. Pay day lenders provide an incomparable bargain. And you get to keep your health, of course.
I feel there is a crucial point being missed here with regards to payday lenders, yes the loan is over a very short period of time, and the administration fee levied could be described as proportionate to the loan amount, however the real underlying problem is if the loan is not paid infull by the avreed tlme frame then another loan is taking out to stop them defaulting on the previous one. This process could and does go on taking people in to an ever downward spiraling debt cycle. The lender will continue to give these short term loans out knowing that the customer has no choice but to, to avoid default this cycle contin ues breeding debt because its in the lenders interest to continue with the debt cycle. This is where those hidious apr’s come in to there own for the lenders and should be capped. Lets not forget we do have a banking industry that refuses to lend to many people and businesses which has let the payday lending business grow and indebted many thousands.
I am sorry but there is no justification in payday loans. They do trap you. The only people who have a real interest in them (excuse the pun) are the greedy lenders who see the opportunity to exploit the vulnerable. I admit I didn’t understand the consequences of taking such a loan and they weren’t clearly made by the fluffy advertising of the company I first used (nor the second or third companies I ultimately had to use to pay the first). If I had approached my standard creditors in the first place I would now have paid all debt. As it is with interest from payday loans and always struggling to pay off the fees and rates I now have two years of debt more than I would have had had I just contacted my original creditors and agreed a payment plan. Shame on you payday lenders. You should be banned.