Between debt and financial exclusion – Payday loans: the lesser of two evils

23^rd September 2013

ResPublica’s Lorena Papamanci argues that payday lending is a vital lifeline for those on low pay

At the Liberal Democrat party conference last weekend, ResPublica changed the debate on payday loans, exploring both the drawbacks and advantages of short term credit. The verdict: not that guilty after all.

Since the financial crisis, lenders have become more stringent in their activities, and now largely exclude two categories of consumers: small businesses and those on very low incomes. This not only tightens financial exclusion, it excludes those who need access to credit most. And while regulators have since alleviated access to finance for small businesses – the recognised motor behind economic recovery – individuals on low pay are still left with limited alternatives.

A ResPublica roundtable fringe event at the Liberal Democrat Party Conference explored whether payday loans ever have the best interest of the consumer at heart or whether they are just another financial trap concocted by a new breed of legal loan sharks. Participating in the discussion were Jo Swinson MP, Minister for Employment Relations and Consumer Affairs; Rebecca Taylor MEP; Joanna Elson OBE, Chief Executive of Money Advice Trust; and Russell Hamblin-Boone, Chief Executive of the CFA.

The media has been circulating incredible figures of people borrowing a few hundred pounds for emergency expenditures and having to pay back thousands of pounds for missing the deadline – as well as the fine print indicating enormous Annual Percentage Rates (APR) of up to 4000%. Another example of supposedly nefarious activity describes certain individuals approaching several payday lenders in a single day and accumulating debt that they would be unable to repay. All this has turned payday lenders into modern day pariahs of the financial industry, and has both regulators and customers seriously questioning their supposedly Machiavellian mission.

However, this approach fails on two grounds. Firstly, the featured cases, although very dramatic for those involved, represent an exception to the norm rather than everyday occurrences. The CFA reports that only 5% of successful loan applicants default on their loans, with a study by YouGov revealing that more than 92% of customers understand the total cost of the loan and complete proper affordability checks before taking it out. Secondly, without payday lenders offering these services for an growing market (demand has more than doubled over the last four years) the UK will be faced with a “wider social malaise”, as Stephen Knight AM put it – that of financial exclusion of the low-paid. Without payday loans available on the financial market, the only other alternative would be loan sharks or other forms of potentially dangerous or illegal credit.

Indeed, ResPublica agrees with Jo Swinson that “people need to get debt advice instead of more debt”. However, there will always be those who refuse to read the warning signs or those who have exhausted all other avenues – and will opt for a payday loan as an alternative to foodbanks when money is tight.
Furthermore, it is not just payday loans that increase the debt of the low-paid. According to the UK Cards Association, there was £55.3bn in outstanding credit card debt as of February 2013, with 54.5m credit cards issued in the UK. Additionally, the market has seen a marked increase in overdraft debt in the past five years, with the average client now owing £2,082 in overdraft debt, up from £1,748 in 2007. In total, outstanding overdraft debt was £43.2bn as of December 2012. Yet these forms of credit are neither abolished nor questioned, since, as Joanna Elson very well put it, “For most people, credit is a tool that straightens the temporary pits and falls in life.”

Public debate should, therefore, look at all these aspects in order to avoid a simplistic discussion of how unscrupulous payday lenders are. Jo Swinson MP agreed with Russell Hamblin-Boone of the CFA in this regard, arguing that this type of short-term loans represents a viable financial solution for 2-3 weeks when the consumer is faced with a temporary cashflow imbalance that can be righted once they are paid.

With regulators and professional associations such as the CFA looking into issues such as rollovers, continuous payment authority, affordability assessments and access to proper information, payday lending should soon become as safe and transparent form of credit. Additional regulation would not be desirable as Rebecca Taylor MEP pointed out from examples in other EU member-states, because it would mean risking market exit from legitimate and professional lenders who would no longer see this as a profitable business and leaving a great deal of market demand uncovered by any legal lending options.

The debate hosted by ResPublica at the Liberal Democrat conference last week showed that when properly regulated and monitored, payday loans represent viable credit solutions for the low-paid. As bad as accumulating debt would seem, financial exclusion is far worse. Thus, when giving the verdict on payday loans, one has to choose the lesser of two evils.