South African-born entrepreneurs Errol Damelin and Jonty Hurwitz could not have predicted the impact they would have when they set out to disrupt the 120-year payday loan market in 2006.
Wonga’s founders created the company to serve cash-strapped borrowers just as the UK headed into economic crisis in the 2008 financial crisis. But the now-disgraced lender, which charged some vulnerable customers higher interest rates at 5,000%, it became a lightning rod of controversy before its collapse in 2018, sparking a regulatory crackdown on the rogue UK payday lending market.
Since then, the market that Wonga once dominated has shrunk by almost half. More than 50 companies have collapsed or voluntarily closed. No new payday loan providers have been cleared by regulators since then, leaving fewer than 40 high-cost, short-term lenders in operation.
While consumer advocates have applauded their steady demise, questions have been raised about where the country’s most vulnerable households might turn to make ends meet. Amid the cost-of-living crisis, some industry figures say a more tightly regulated payday loan sector could play a role.
Regulators from the Financial Conduct Authority (FCA), the city’s watchdog, raised concerns earlier this year about the relatively small number of high-cost lenders left in the market for defaulting borrowers. the lending criteria of major banks.
In its may meeting, FCA board members said the shrinking of high-cost lenders, “with rising inflation … would likely cause a number of tipping points where consumers would need access to money quickly and options would be limited.” “.
With the decline of the payday loan market, hopes have been raised that more socially responsible options, such as credit unions and nonprofit community development financial institutions, could fill the void. However, there are concerns that they will struggle to grow fast enough to help everyone who needs financial support in the coming months.
Fears have been raised that more people are turning to illegal loan sharks to make ends meet. According to the Center for Social Justice, the think tank co-founded by former Conservative leader Iain Duncan Smith, more than 1 million people now use illegal moneylenders in England.
Others are turning to unregulated but legal forms of lending, such as buy now pay later (BNPL) run by firms such as Klarna, Clearpay and Laybuy. Although borrowers are often not charged interest on their purchases, buyers are still at risk of taking on too much debt. Companies are not required to offer leniency or compensation when things go wrong.
“This cost-of-living crisis is potentially the most worrying I can remember in my 25-plus years as an activist,” says Mick McAteer, a former FCA board member and co-founder of the Financial Inclusion Center research organization. “So the risk of people turning to loan sharks could increase.
“[And] While BNPL may not have the kind of excessive and exploitative terms and fees as payday loans and other subprime loans, the product encourages excessive borrowing. This is bad for consumers in the long run.”
Research published by Barclays Bank and debt charity Stepchange in June found almost a third of BNPL borrowers said their loans had become unmanageable and led to debt problems. Buyers using BNPL paid an average of 4.8 purchases, nearly double the 2.6 purchases in February, the research found.
With concerns about illegal and unregulated lending on the rise, some high-cost lenders say they offer safer options for borrowers, despite years of allegedly misleading loan sales to vulnerable borrowers.
Jason Wassell, the head of the Consumer Credit Trade Association’s high-cost credit lobbying group, says there’s still a place in the market for private lenders. “Already at this point, demand far outstrips supply,” he says.
“What we have seen in recent years is the exit of several lenders. That has led to a reduction in access to alternative credit, and that is causing a problem for families across the UK, particularly those who have been underserved or not very well served by banks in the past.
Executives at guarantor lender Amigo, which allows friends and family to vouch for and agree to cover any unpaid loans for cash-strapped borrowers, say they have learned their lesson after a spate of affordability claims nearly pushed Amigo into collapse, forcing it to pause loans. at the beginning of the coronavirus pandemic.
Jake Ranson, Amigo’s director of customer service, says his team “makes no apologies for Amigo’s past practices or products,” which included selling unaffordable loans to customers, who were typically charged interest from the 49.9%.
It now hopes the FCA will give them the green light to restart lending under a new brand, RewardRate, from September, offering new features such as lower interest rates if borrowers make payments on time.
“We’ll do weapons-grade affordability testing, use things like open banking, and make sure customers are talking to a human…and that they understand the responsibility that comes with owning the product,” says Ranson. “It’s a very different proposition.”
However, consumer advocates are concerned. Sara Williams of the Debt Camel blog is skeptical that the high-cost credit industry in general is safer or more suitable for vulnerable consumers, even after a regulatory crackdown. “Debt is rarely helpful in this situation,” she says.
Instead of restarting the payday loan market, more government support for struggling families is vital, she says. In the meantime, consumers would be better off looking for debt management plans on any existing loans.
Last year, 4.4 million people across the UK borrowed money to make ends meet, according to figures from StepChange. Some 71% said that using credit had negatively affected their health, relationships or ability to work, while two-thirds said they could only keep up with payments by skipping or reducing housing or utility bills. point of difficulty, putting them at risk of further financial damage.
StepChange said the risks vulnerable borrowers face are not due to a lack of high-cost lenders in the market. Instead, he pointed to the lack of other options available when consumers were hit with unaffordable bills or unexpected costs.
“Going to subprime lenders should be a last resort,” says McAteer, adding that it is problematic that the UK has failed to build a “larger not-for-profit lending sector” to deal with the current crisis. .
Not-for-profit social enterprises lend just £25m a year and serve as few as 35,000 clients on average. Despite their declining presence in recent years, payday lenders managed to lend around £60.4m in the first quarter of 2022 alone, according to the FCA, while doorstep lenders lent around £95m in the last three months of 2021.
“We are seeing a welcome increase in the number of people using credit unions and other non-profit lenders. Credit union membership has now risen above 2.1 million. But it’s not enough,” says McAteer. “There is a real possibility that nonprofits will be financially outperformed by subprime commercial lenders backed by private financial institutions.
“We need emergency measures to help households survive the crisis, and then medium- and long-term measures to help people build financial resilience against future shocks, to come. We have made almost no progress in building financial resilience since the 2008 crisis. Will we learn the lessons?