As has been widely reported and commented on across the financial press and popular media, the FCA’s new payday loan rate cap came into effect from the 2nd January 2015.
The introduction of a rate cap had been the source of much debate over the last few years – the free market approach arguing that a rate cap a) interferes with the market mechanisms for setting prices and b) introducing a cap would simply push the higher rate borrowers into the illegal loan-shark market. Supporters of the rate cap argued that a) not all markets can be left purely to market forces as the Government has a responsibility to provide some protection to consumers (for example Healthcare where drug companies face rigorous controls over the drugs they can offer the public) and b) there are numerous state agencies in place to deal with illegal activities – the Police, Customs & Excise, HMRC etc.
Common sense prevailed and the Government instructed the FCA to introduce a payday rate cap, following consultation, by January 2nd 2015.
However, since its introduction, the rate cap has attracted some criticism from both the financial and popular press – suggesting, in essence, that; firstly, the introduced ceiling on interest rates was not low enough, and secondly that the cap was not applied broadly enough across the market.
I would like to take a moment to consider those criticisms and present the counter arguments.
The first criticism picks up on the fact that the maximum interest rate able to be charged is 0.8% per day which equates to £24 per £100 borrowed over a 30 day month, which isn’t greatly different from the average previously available to consumers, hence the criticism. However, this criticism fails to take into account the other 2 elements introduced as part of the rate cap. Firstly, that payday lenders can no longer charge more than £15 in default fees, and secondly that the total cost of borrowing (interest, fees and charges) must never exceed 100% of the original loan amount. The combination of all 3 factors have had a big impact on the payday lending model, which previously used term extensions (or ‘rollovers’) and fees and charges to supplement the profitability of each loan.
You will probably have noticed that I’ve referenced the Payday Loans market quite a lot so far, which brings us to the second criticism, that the cap was not applied broadly enough across the loan market. The primary reason for this, in the FCA’s defence, is that the Government legislation (which directed the FCA to introduce the cap) is very specific in its instruction;
“the Government has legislated in the Financial Services (Banking Reform) Act 2013 to require the FCA to introduce a cap on the cost of payday loans” (http://www.publications.parliament.uk/pa/cm201314/cmselect/cmbis/1136/113604.htm)
The rate cap regulations apply to the payday market (or the ‘High Cost Short Term Credit’ market, if you prefer the FCA’s somewhat wordier definition) as per the direction of the legislation that required it.
However, leaving the legislative requirements to one side for a moment, some commentators have called for the scope of the cap to be widened and have even condemned other forms of lending, in particular Guarantor Loans. In an article this week, The Daily Express, points out that the regulations discussed above do not apply to Guarantor Loans and suggests these products “are targeted at those with poor credit ratings”. (http://www.express.co.uk/news/uk/550071/Consumers-warned-against-guarantor-loans-trap-not-regulated-payday-loan)
Whilst the article is quite right that the new rate cap does not apply to Guarantor Loans, it also doesn’t apply to any loans outside of the FCA’s definition of High Cost Short Term Credit – in essence a loan that has an APR greater than or equal to 100% and is fully (or substantially) repaid within 12 months. Meaning all sorts of loans and credit are intentionally excluded, such as, Overdrafts, Logbook Loans, Credit Cards or any instalment loan with an APR lower than 100%.
The article states that many Guarantor Loans are offered “at APRs as high as 54.9%” but fails to point out that many other products are still available at APRs well in excess of 200%. Given that Guarantor Loans tend to fall at the lower end of this spectrum I’m unsure why they were singled for criticism in this manner.
I would also like to pick up on the article’s assertion that Guarantor Loans target consumers with poor credit ratings, a point of view echoed in another article this week on Bitter Wallet (http://www.bitterwallet.com/debt/new-payday-loan-regulations-pushing-people-into-unregulated-credit-82370). Firstly I would refer to the debate outlined at the top of this article which reflects that interest rates are the pricing mechanism of the loan market. There are many factors that lenders use to assess which price they will offer each customer and credit history is undeniably one of them. A less than perfect credit history will indicate to a lender there is a greater risk that the borrower will not repay the loan.
We may find this objectionable but the lenders have to have mechanisms for pricing their products and I would suspect that anybody falling on the ‘wrong’ side of one of their criteria points would be critical. For example, Homeowners generally are ‘scored’ more highly then Tenants and yet I can think of several friends and colleagues who are well paid, responsible potential customers who make the choice to rent rather than buy their home, for a myriad of non credit-related reasons.
Secondly, the inference in both of these articles is that higher rate products offered to people who are unable to access the low, high street rates, that many of us take for granted, is wrong. That argument can be interpreted in two ways. Firstly that higher prices for higher risk customers is wrong in principle. I disagree with that assertion for 2 main reasons; firstly for the pricing argument outlined above and secondly, that would effectively mean that everybody with any credit impairment at all would be excluded from the credit market because providers would be unable to price them accordingly. Often the only way to improve your credit rating is to show that you can successfully manage credit. Further, what about those unfortunate people whose credit ratings are damaged through no fault of their own, for example if a spouse causes default on a mortgage or credit card?
So if the argument isn’t the principle of higher rates for higher risk then it may be the practical outcome that interest rates for non-High Street products are simply too high. This argument I have some sympathy with, for exactly the same reasons that the rate cap was introduced into the payday sector – market mechanisms are fine but consumers do need some protection. Even given this, I still can’t fathom why Guarantor Loans should be targeted in this manner, given many other products are available at much greater APRs.
Finally, it should be remembered that a rate cap is just one tool available to the regulators to protect consumers. The FCA have made great strides in tightening up the regulation and control over the lender’s decision to lend – for example, loan providers now have a much greater responsibility to evidence and assess income, demonstrate affordability and cross reference against 3rd party data (such as credit bureau), to name but a few.
The rate cap in the payday market was welcomed by many, both inside the industry and outside it, and there may well be a case for extending it, however the key to finding the right level will be through well balanced discussions rather than looking for the next headline-making scapegoat.