FCA regulations: A savior for customers against usurious payday lenders

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Payday lending industry has been popular in UK for a long time. They are said to be the main villains during the financial recession in Britain. Constant public anger was building against them for the past couple of years. However this dam of anger finally burst open in 2014 when a huge number of cases were published in mainstream and social media showcasing how the payday lenders end up extracting huge repayments for minuscule loan amounts. The Financial Conduct Authority (FCA) finally launched a crackdown on major lenders who had to pay heavy fines for their activities.

A major piece of regulation was announced in the last quarter of 2014. As a result of this regulation new price caps will be required on all payday loans from January 2nd 2015. The major points within this regulation are:

  • Interest Caps: Interest rate charged per day will be capped at 0.8%.
  • Default charges: If a customer makes late payment then the maximum default rate charged can be £15.
  • Maximum repayment amount: The final repayment amount cannot exceed double the borrowed principal.

These three caps will have a long term effect on the industry and will make sure that the lenders charge justifiable amount from their borrowers. One of the biggest grudge against payday lenders was the exponential escalation in the cost of borrowing. Many cases were published where the borrower took £200 and this amount rose to over £1,000 within a few of months due to non repayment.

By limiting the final amount to be repaid the borrower is protected against spiraling costs and default charges. A major part of the revenues of payday lenders is through late charges and default interest. By adding the late charges to the original sum the overall amount due escalates rapidly. When the upper limit of the cost of borrowing is set this escalation of amount payable is prevented. Many payday lenders, who are reliant on these late charges for sustaining their operations, will face a rude shock when these caps are enforced. According to Martin Wheatley, chief executive of FCA, these caps will make sure that a right balance between customers and firms exists within the market. According to him, it will allow a viable market and at the same time provide requisite protection to borrowers.

These caps were long overdue and were almost inevitable as the country heads into the next general election in 2015. With the increase in political temperature the payday industry was demonized for charging interest rates which are unheard of in the developed world. The overall result of these caps is that most of the payday firms will revisit their strategy on how they provide loans. The final effort will be two pronged. On one hand these payday companies will try to actively reduce risks in their lending and make sure that the default rate is at rock bottom and on the other hand they will try to reduce their operational costs.

The past few years saw an exponential growth of payday companies as they expanded their market through massive marketing campaigns. The basic selling point for these payday lenders was ease of processing. You can register on their platform and within ten minutes the money can be in your account if the application is accepted. This ability to get loan with a few clicks gave the impression of easy money to a large section of borrowers. The damage was done when these payday lenders gave loans to borrowers who could not afford them. Although this increased their market reach and expanded the customer base, the net result was that many borrowers were sucked into a never ending spiral of financial debt.

Every borrowing must be carefully thought over from the borrower’s side and adequately vetted from the lender’s side. When ease of processing is the ultimate goal on both sides many imprudent decisions are taken. These decisions can affect the long term financial planning for the individual and also the long term viability of the lending firm. These regulations have come at an opportune time as the total industry size in monetary terms is still not that huge. The payday lending industry is about £2.2 Billion which is much smaller than the mortgage lending industry or other banking sectors. However the impact of this sector on the general population is enormous. A total of 1.8 million people availed payday loans in 2013 which is a huge percentage of the total working population. Many people used these loans multiple times to tide over their financial troubles.

This shows the usefulness of these regulations. They will help to regulate a sector which affects a large portion of the working population, most of whom are at the lower rung of the earnings pyramid. By giving the protection of these regulations many payday lenders will be reined in from using high interest and processing charges from their customers.

Another major reason for the expansion of the payday industry has been due to the lower prevalence of financial planning among its customer base. If the level of savings done by an individual or a household is near zero it is obvious that sooner or later a requirement to take outside financial help will arise. Even during this time the payday loans rarely helps. The main reason is that by taking a single repayment payday loan the problem of this month is only pushed to the next month instead of looking at resolving it prudently. When the payment is due in the next month the budget gets squeezed again and causes many individuals to fall in a continuous debt trap. On the other hand there are other alternatives like short term  instalment loans. These loans do not require full repayment at the next payday. Repayment of loan can be broken into smaller installments of say the 3, 5 or 6 months offered by True blue Loans which would give the customer greater flexibility to adjust their expenses and meet the repayment schedule. Yes, these longer term loans will cost more overall, but the lower monthly repayment amount has to come at a cost.

By moving more customers towards short term lending of three to six months it should be possible to look at these loans as a helpful part of the financial system instead of a mere stop gap approach of meeting ones expenses in a month.