George Osborne’s plan to cap the cost of payday loans is a welcome but overdue recognition of the fact that intervention can help correct a dysfunctional market. A regulatory reset can ensure payday lenders serves consumers more effectively and fairly. However, even with a new cap in place, this is only the start when it comes to ensuring that credit is affordable and sustainable for all. With over a million people set to use pay day loans to pay for Christmas, this can’t come soon enough.
Payday lending has exploded in the wake of the financial crash: in the last few years, the industry has more than doubled to be worth £2.2 billion. Moreover, with wages squeezed and prices rising, the demand for short term credit is unlikely to disappear anytime soon, but UK citizens are poorly served by the market. As the OFT recently concluded, there are significant factors in the market preventing or distorting price competition. As a consequence, those using pay day loans, the majority of whom have an income of less than £25,000, pay a poverty premium often simply to get by.
A cap on the total cost of credit should bring down the cost of a loan. Until today the UK was an outlier in refusing to put an upper limit on how much payday lenders could charge. However, as George Osborne mentioned, Australia, amongst many others, limits the total cost of credit. We must learn from international best practice in how the legislation is designed: it is vital that the cap is based on the total cost of credit, not just interest rates, to stop the lender recouping costs in higher fees or hidden charges. Combined with stronger rules coming into force in April regarding rollovers and the aggressive use of debt collection, these reforms can begin to build a fairer, more responsible payday lending market.
However, regulation can only go so far. Reform must place the payday lending sector in the wider context of the £180 billion consumer credit market and the failure of mainstream banking to effectively serve low income households. That means bearing down on high and uncompetitive costs, such as overdraft charges. It means doing more to promote credit unions as one long-term alternative whilst driving innovation in other affordable alternatives such as peer to peer lending linked to housing associations or councils. It should include efforts to dampen demand in the first place. For example, Australian energy companies by law must give far greater flexibility to low income households on their payment schedules. Given energy costs is a key cause of taking out a loan, could we not consider an equivalent here? It also means considering a ‘public option’ for short term loans at affordable, sustainable rates, modelled on the drastically diminished Social Fund scheme. We need to be bolder in both reforming the market but also promoting better alternatives.
Mathew Lawrence is a Research Fellow at IPPR. He tweets as @dantonshead