Be careful what you wish for

The Financial Conduct Authority has finally announced what action it will take to curb the costs of high cost credit.

It is considering restricting fees on unauthorised overdrafts, will consult on extending the price cap on rent-to-own credit and placing new requirements on store card and catalogue providers to explain their products, and help customers avoid persistent debt. They do not seem to be considering extending the price cap to home credit and have announced a welcome intention to work with partners to explore and develop reasonably priced alternatives.

Nonetheless the price cap remains the favoured option of many in the debt advice sector. However, arguing for this could be a case of ‘be careful what you wish for.’

Taken in isolation such a measure would significantly reduce the cost of these loans ostensibly benefiting consumers. However, this analysis ignores the effect that such a move would have on the providers of home credit and rent to own and thus on the availability of this type of credit to many consumers whose ability to access credit is already severely limited.

For many years now debt advisers at CASNS and other agencies have seen more and more people whose debt problems have not been caused by a fiscal shock or life changing event (such as losing a job, relationship breakdown, accident or illness) but simply because their income is insufficient to meet their basic day to day living expenses. To make up the shortfall they borrow. Such borrowing is especially commonplace at times of additional expense such as when the kids go back to school, Christmas and birthdays.

For many years home credit providers met this demand through their network of local agents. Yes the loans appear to be expensive when expressed in terms of the APR, but in reality given the relatively small amounts and short terms of the loan, the actual cost of credit is less exorbitant than it first appears.

The arrival of pay day loans changed the market dramatically principally through their ease of access. A simple phone call or click on a website and cash could be in your bank account in a matter of seconds. The problems associated with this type of credit are well known and I won’t rehearse them here.

Why did people use this type of credit if it was such a poor deal? Easy access, low levels of checking and speed were the primary attractions. When asked in 2016 what the money was spent on, consumers listed: day to day spending, household bills and emergencies/paying off debts as the top three reasons. This research from the Social Market Foundation reinforces our impression that much short term credit is to plug the gap in weekly budgets.
It came as no surprise when the FCA began to intervene in the market in 2013, exercising its newly acquired regulatory muscle, culminating in the imposition of a price cap in 2015 which limited the amount that could be repaid in interest and costs at 100% of the amount borrowed.

What happened next? In 2013, according to the FCA, 1.7 million people took out 10.3 million pay day loans worth £2.5 billion. By 2016 the figures were 760,000 people, taking out 3.6 million loans worth £1 billion. A significant contraction in the market that was reflected in and caused the fall in Citizens Advice clients reporting problems with pay day loans from 16,000 in 2013-14 to 9,000 in 2016-17.

Interestingly the FCA figures show that the average annual income of someone accepted for a pay day loan in 2016 was £20,400, compared to the average annual income of someone declined (£15,900) and the average annual income of someone accepted for a loan in 2014 of £15,600.

Clearly those pay day lenders  who remain active (and many have left the market since 2013) are moving ‘up-market’ and targeting better off customers, while dropping the poorest. This makes business sense as it reduces the risk of non-payment, but requires them to identify a pretty tightly defined niche market between those who present a bad risk and those able to access ‘mainstream’ credit. But it begs the question what happened to those million customers now excluded from pay day loans?

The FCA found little evidence that customers declined for pay day loans suddenly switched to other forms of sub-prime credit in any significant numbers, nor much “robust” evidence that they were turning to illegal moneylenders (not that such evidence is ever readily available for obvious reasons). However, they did find that 40% of declined customers turned to informal sources of credit such as family and friends: essentially poor people borrowing from other poor people.

The evidence here is a little inconclusive and contradictory, given that loans were not taken out for fun and frolics but to cover essential spending. What is clear though is that the impact of the cap on pay day loans and on those excluded from them is more nuanced than has been suggested (e.g. Citizens Advice’s simplistic reference to the fall in debt issues reported) and does not contradict the assertion that a significant tranche of the poorest will become further excluded if the cap is extended.

This then puts the extension of the price cap to home credit and rent to own in an altogether more worrying light. Home credit customers typically have the same average annual income as their pay day loan counterparts did in 2014 (£15,500) and a similar number (700,000) took out home credit loans with a similar value in 2016. However, this comes at a time when the largest provider of home credit has shed nearly a million customers in four years as it tries to target more affluent customers.

Rent-to-own ostensibly offers very poor value for money with the total price (including interest, insurance and delivery etc) of an item often being two or three times the shelf price of the same or a comparable item if bought outright. However, the majority of rent to own customers cannot afford to buy outright and the price factor that determines their choice is not the total cost but the weekly payment: if that’s affordable then the deal is good enough.
Neither of these types of credit are ideal or even desirable but given how the consumer credit market operates in the UK and the lack of realistic alternatives, they are often the only options open to many people, in other words the best of a bad lot.

Is extending the price cap the answer? Maybe, time will tell; but equally it could prompt a further contraction or possible collapse in some sections of the market, especially for rent to own, leaving vulnerable and financially excluded consumers with nowhere to turn.

If the home credit market goes the same way as the pay day loan market (which it is showing signs of without a price cap) borrowing from family and friends will increase, in so far as it can and people will increasingly ‘borrow’ from local authority council tax accounts, social landlords and utility companies by running up arrears on those accounts and spending the money on food and other essentials.

We are already seeing arrears on these accounts growing and without the safety valve of home credit they are likely to increase further. The patience shown by these creditors thus far is not limitless.
Add into the mix the impact Universal Credit will have on family budgets and the consequences could be even more dire because there are currently few alternatives.

Credit Unions are only part of the answer as their restrictions mean small loans over a short term are simply not viable for them. Community Development Finance Initiatives are few and far between, small and often unpopular amongst those who do not understand their interest rates, and there are few realistic alternatives to the effective duopoly in the rent- to-own market. I hope the FCA's commitment to exploring alternatives will see greater investment in responsible lenders such as CDFIs and a significant expansion in their availability and reach.

We would hope the FCA will think long and hard before extending the price cap until there are realistic, affordable and accessible alternatives in place. A price cap may protect consumers from predatory credit companies, but if it leads to further market contractions the poorest and most financially excluded will become excluded even more and the problems of their poverty will be exacerbated. That is in no one’s interests.