At the beginning of the year there was a major victory for consumer advocates who wanted to see increased regulation over the payday loans industry, including the implementation of a price cap to stop lenders ripping off hard-up consumers.
We might have known that that wouldn’t be the last we heard of the industry. We have just seen the publication of an investigation by the Competition and Markets Authority (formerly the Competition Commission), the outcome of which found that many consumers were not shopping around for their loans before entering into a payday loan contract.
When it comes to ‘shopping around’, behavioural economists are all too aware that sometimes it is rational for a consumer not to want to spend hours of their busy lives looking at what the options are – it might be worth more of their time to just choose what feels cheapest and easiest and leave the comparison sites to those who can afford more leisure time.
When trying to explain why someone would wish to visit a payday loan for credit there are many different reasons: desperation for credit comes up rather high; the assumption that there are no other options follows closely behind; and taking on a small sum loan to keep the bank manager happy (replacing a payday loan with going into an overdraft for example) might be another reason.
But as to why someone takes out credit that is fairly obviously expensive, like a payday loan, has kept people debating for years – particularly while I’ve been looking into the issue.
What the Competition and Markets Authority has decided, from its investigation, is that one of the reasons people aren’t shopping around before taking on a payday loan is because payday lenders are not particularly good at putting their services on price comparison websites and, in any case, they are not particularly transparent with their prices.
We are not expecting perfect information from payday lenders because we do not expect miracles, but it is obvious that for consumers to begin to make informed decisions about the credit they take out, a mechanism that compares payday loan prices might be a good idea.
Except there is one small problem: payday lenders rarely compete on price anyway. While, as I previously mentioned, the victory at the start of the year was very big, it will surprise very few people to find that on 2 January, when payday lenders were enforced by a cap on the price at which they sold credit, all of the lenders remaining in the market charged the maximum amount, which roughly works out, for a loan of £200 for two weeks, at £24. The total paid back would be £224.
The price cap was a reaction by the regulator that oversaw a broken market – static prices were not benefitting the consumer, the volume of lenders in the market was not bringing down prices, typical market rules were not working, so the state stepped in – as it should.
This is rather typical of the industry. A US study by Robert DeYoung and Ronnie J. Phillips at the Federal Reserve Bank of Kansas City back in 2009 found in Colorado that, after a cap was implemented on the price for short-term credit, loan prices gravitated towards the rate ceiling – if not initially then over time.
What does this mean? It means that even with increased regulation of the industry there seems to be an inherent problem for payday lenders to compete on price, which in turn means that the only mechanism that will benefit consumers in this market will be constant assessments and modifications of the price cap.
No entrance into a price comparison website, as the CMA wants, will spur on price competition – it won’t happen.
What we do need, however, is more competition to payday lending from ethical providers. It wasn’t so long ago that the Archbishop of Canterbury made a call to ‘outcompete Wonga’ with church-backed credit unions. Where are we with that?
Recently Citizens UK published a proposal paper spelling out exactly how they would like to see community finance start to outcompete the payday lenders and provide a real alternative, so consumers are no longer reliant on them.
Not for profit organisations like credit unions and CDFIs (Community Development Finance Institutions) would be supported by a new organisation, a charitable trust with the working name of the Community Finance Foundation.
The foundation would allocate grants to initiatives that sought to reduce the burden of high cost credit, bringing research and other resources, and also a strategic investment fund that would help ethical financial institutions meet their capital requirements.
This would be funded through £200m worth of fines levied over the next parliament by the Financial Conduct Authority – who are having to fine many financial institutions lately – Wonga.com most notably last year.
It’s very encouraging to see the payday loans sector come under increased scrutiny – it was a long time coming. But now we need to step up our game on seeking alternatives. The creation of a Community Finance Foundation would be a good start – and deserves your support.
First published on the Left Foot Forward blog on 24 February, 2015.