Last month the regulatory body for consumer finance in the UK, the Financial Conduct Authority, published their proposals for a rate cap for the short-term, high-cost credit market. The proposal was a response to a directive from the Government which requested them to implement such a cap by January 2015. Here I take a look at those proposals and what they could mean for the market.
Firstly it’s important to understand that the FCA proposal is only (currently) aimed at the short-term, high-cost credit market – that is any loan with an Annual Percentage Rate greater than 100% and which is substantially repaid in 12 months or less. The definition is a bit of a mouthful but it’s an important distinction to note that they’re not just talking about Payday Loans. Whilst this may well be the loan type the Government predominantly had in mind, the FCA definition of the market is broader to include instalment loans with APRs over 100% and shorter terms.
The proposal from the FCA actually has 3 central tenets to it;
- Firstly, no lender would be able to charge an interest rate of more than 0.8% per day – that equates to 24% for a 30 day month, or £24 for every £100 borrowed.
- Secondly, the amount lenders can charge in Default Fees will be limited to a maximum of £15. Lenders would be allowed to continue to charge interest post-default but not above the rate set out above.
- Thirdly, the total cost of borrowing, including all fees and charges, must never exceed 100%. In other words if you borrow £100 then the most you can pay back in total is £200.
The Impact On The Lenders
Firstly let’s look at that rate cap of 0.8% per day. Without doing the maths it’s tempting to think this will be a massive reduction in the rates being charged by payday lenders as we’re so used to the media highlighting the APRs of over 3,000%. But that’s the problem with an APR – they force lenders to place an annualised rate on a product that’s designed to be repaid in just 30 days. A quick look just now at the payday lenders advertising on page 1 of Google showed that they charge between £25 and £30 per £100 borrowed over 30 days. An actual interest rate that’s not much above the limit proposed by the FCA.
The second part of the cap focuses on the level of default charges that can be levied by the lenders if the loan goes into default. Every lender has a different scale of charges for fees for scenarios involving missed repayments and defaulted loans. The charges can vary however most of the lenders’ default fees will be around the £15 to £30 mark.
Whilst some sections of the media have pointed to default fees as a ‘sneaky’ way for lenders to increase their revenue, for most lenders that’s actually not true. Whilst fees can soon rack up and make up a hefty chunk of the total amount outstanding, they do not usually represent a big income stream because of the simple fact that once a loan has been defaulted the lender is far less likely to get anything back at all.
However, it’s the 3rd part of the cap, the limit on the total amount repayable, that may have the lenders running for the hills – or at least reviewing their business models. This has the effect of pulling together several strands of FCA policy into one over-arching principle. Currently lenders have been used to creating an overall margin by charging high rates, adding fees and charging for multiple rollovers – the FCA have cleverly side-stepped having to set detailed and complicated rules for each income strand by limiting the overall amount lenders can charge, regardless of its component parts.
The Impact On Products
Without the ability to create unlimited revenue streams around a payday loan you can draw 2 probable outcomes from the latest proposals.
Firstly, whilst the payday lenders undoubtedly charge high interest rates and supplement that with fees and charges, the high returns (in part at least) subsidise the relatively high default rates caused by borrowers not repaying their loans.
Let’s leave for another day the argument of whether the high costs are a self-fulfilling mechanism in that respect – the fact is the lenders will be forced to work much harder to find the customers who both can and will repay the loans. With limits on the total cost of credit the lenders will not be able to carry high default rates and still hope to make a profit.
Secondly, because of the overall cap of 100% the amount a lender can charge (in total) is now effectively capped by the loan amount itself. Answer? Increase the average loan size and you’ll increase the profit potential on any given deal.
Of course with higher loan amounts the potential losses when any given loan is not repaid also increases. Answer? The lenders will need to focus on customers who repay (as above) but will probably become much more aggressive about pursuing outstanding loans from those customers who have not repaid. At the moment the payday lenders tend not to do much, other than register the defaults with the Credit Reference Agencies – which has in itself encouraged a somewhat relaxed attitude amongst some borrowers. With less of an ability to offset bad loans against higher charging repaid ones, defaulting customers could find themselves much more likely to be pursued through the courts for their debts.
Whilst the idea of a rate cap was primarily to regulate the lenders a side effect could well be a change in attitude amongst borrowers regarding how seriously they take unrepaid debt.