Book credit

crackdown was vital, but credit unions must expand after coronavirus to fill void

The cost of accessing small personal loans can be extremely high for those who need them the most. Take the UK, where a £ 200 13-week Provident Personal Credit loan costs £ 86 in interest. That’s an equivalent APR of a whopping 1,557.7%.

These offers are available even after the cap on payday loans that the UK introduced five years ago. In the months following the reforms, the Financial Conduct Authority (FCA) reported that the number of loans and the overall amount borrowed fell by 35%. From there the decline continued: there were 5.4 million high cost loans totaling £ 1.3 billion in 2018 with a total repayable amount of £ 2.1 billion; five years earlier there had been 10.3 million loans worth £ 2.5 billion.

Yet it is clear that high cost credit has not completely disappeared and looks set to rise again. Provident, the largest provider of home loans in the UK and Ireland, expects demand to increase when unemployment rises as the UK leave scheme ends. The lender is said to have set aside £ 240million for an increase in defaults.

So what have we learned since the rules changed, and will those who need credit be able to access it in the wake of the pandemic?

To cap or not to cap?

High interest rates are usually justified by the argument that borrowers are more likely to default, having often been turned down elsewhere. Higher rates compensate the lender for a higher risk.

Either way, payday loan companies have gained a reputation for predatory lending, especially after the last financial crisis. UK restrictions set a cap on interest and charges at 0.8% of the principal outstanding per day, and a maximum total cost of 100% of the amount borrowed.

It reflected a global trend. In Germany, for example, the maximum authorized APR is double the market rate as calculated by their financial regulator, [BaFin]. In France, it is 1.33 times the market rate.

The primary intention was to make credit more affordable for vulnerable consumers. This follows clear evidence that most high cost credit clients fall into a low income category, with poor credit history and low financial resilience, which means they may struggle to do well. in the face of financial setbacks.

They often borrow on the basis of convenience and their ability to repay, rather than the cost of the loan. This can lead to financial stress, repeated borrowing and defaults. After all, credit is debt.

High cost credit is tied to low income consumers.
Thin glass

Nonetheless, the debate continues among political experts around the world as to whether caps are the best answer. Proponents say the restrictions have lowered the cost of credit for low-income borrowers, fought over-indebtedness and helped prevent people from being exploited.

Some consumers may no longer have access to credit because suppliers change their business models or exit the market, but many of these people would likely not pass rigorous affordability checks and may already be over-indebted.

Opponents point to the possible unintended consequences. In addition to reduced access to credit, they worry about the potential for more illegal pawn shops and loan companies to introduce fees that circumvent the restrictions.

Influenced by these arguments, Ireland is part of a minority of European countries that favor stronger regulation and supervision rather than caps. For example, high cost warnings in loan advertising became a requirement effective September 1. Although the government is revising its general approach, fears that the restrictions will reduce the supply of credit still seem to be prevailing.

What the evidence says

A 2019 OECD report found that interest rate caps reduced exploitation and over-indebtedness, made short-term loans cheaper, and reduced defaults. However, the OECD cautioned against excluding riskier consumers from formal credit, as they could borrow from lenders in countries with more flexible rules. This happened in the Netherlands, for example.

Likewise, the 2017 FCA review found that UK restrictions had led to cheaper loans and fewer debt problems. And he saw little evidence that consumers were turning to illegal pawn shops. Our own research in 2017 agreed on cheaper loans, but warned that they must be accompanied by measures to make more affordable alternatives available and to help consumers make good credit decisions.

Credit unions are one of the few alternatives, as the FCA has recognized. They aim to build consumers’ financial resilience by lending at affordable rates, encouraging regular savings, and providing education and financial information. This helps to improve the credit records of the borrowers.

There are around 440 credit unions in the UK, with 2 million members and growing. Loans to members topped £ 1.5bn in 2018, surpassing that of high-cost loans.

Currently UK credit unions are allowed to charge up to 42.6% APR, a far cry from the rates allowed for high cost providers. Yet penetration is low relative to the total population, at only around 3.5%. We need to expand the reach of credit unions and enable a greater online presence to support much faster lending decisions.

Fair4All Finance, a government funded organization from dormant accounts, has started helping credit unions build their capacity, but funding is limited and mostly only available in England. An expansion would be valuable.

Woman choosing between different credit cards.
Many people live on endless refinancing.

Scaling up affordable alternatives has certainly never been more urgent. Provident reports that the number of its customers declined in 2020 after tightening its lending practices, but this could be due to lower consumer spending, as well as increased savings and government support in response. to the COVID-19 pandemic. The picture could be very different a year from now.

Boosting credit unions would also challenge the new generation of digital lenders, who are armed with people’s personal data to entice them to borrow more. This new form of loan will be more prevalent in all socio-economic groups, rather than just a poor person’s problem, and will likely be more difficult to regulate as it will cross international borders. Government support for the pandemic has been essential, but they need to think about the increased demand for loans that is on the way.

Tags : interest rates
Margarita W. Wilson

The author Margarita W. Wilson