Legalized loan sharks get their fins cut off

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The payday lenders have long been considered as legal loan sharks who prey on the most vulnerable sections of the society and profit from their financial difficulties. This fact was accentuated after the financial crisis when a lot of households had to seek outside help to manage their financial difficulties. This time saw the most rapid growth of the payday industries where the likes of Wonga were able to get exponential growth. At this time the checks performed by many lenders were less than comprehensive. 

Finally in 2014 there was a huge amount of debate on how these payday lenders work. They were pilloried for the excruciating interest rate charged by them and the heavy default fees. In many cases like Wonga the interest rates would rise to above 5,000% which led many people to give them the name of legalized loan sharks. On back of the massive profit margins these lenders could plough bigger sums of money in their advertisement campaigns which led to a vicious cycle of ever increasing demand and profits.

The biggest loser out of this was obviously the general borrowers. Many borrowers were fooled into believing that this was a frivolous exercise because the actual charges were often small in comparison. However the actual earnings for the industry was not on the back of the first month’s interest but due to the default charges and the late payment interest charges which would make the final repayable amount grow to astronomical amounts. Over the past year there have been negative comments by the Church and the politicians on the payday lenders. Labor MP Stella Creasy led a major campaign asking for regulating the payday industry.

Although the industry is puny when compared to other credit sectors like mortgage or commercial lending, clocking about £2 billion pounds a year, it still has a huge impact on the lives of many borrowers. According to FCA over 10 million loans were taken by 1.6 million borrowers in 2013. This shows the extent to which the payday industry had made inroads within the society. In most of the industries low regulation allows new players to enter the market which over a period of time benefits the final customers by lowering the costs. However the payday industry didn’t compete on interest rate but tried to expand the market by showcasing the ease of processing loans with them. This allowed Wonga, charging over 5,000%, to increase its market share to over a third of the total market.

Under such circumstances it was required by the government and the regulator to step in before further damage was done. In mid-2014, Wonga was slapped with a penalty of £2.6m for sending fake legal letters to its borrowers. It had to take a higher penalty in October when it was asked by FCA to write off £220m of loans given to the borrowers as they were made without due affordability checks. Finally the price caps dictated by FCA was the final straw for some lender who either shut their shops and others are contemplating downsizing their operations or chaning their market or product. The new price caps have ensured that the borrowers will have their loans capped so that teh daily interest, default charges and overall cost cannot be added wihout limit.

The regulator has stuck a reasonable balance by not making the price caps too stringent as it would eliminate the viability of many firms and push the borrowers towards illegal lenders. The next step is to make the customers realize the importance of each loan. If a loan is taken for unnecessary spending it would affect the borrower’s financial health adversely. Many borrowers of payday lending industry are young and a good amount of effort will be needed to educate them about the problems which can come by taking such loans for frivolous reasons. The first step would be taken by the payday lenders themselves to make sure the loans are suitable. Hence they will scrutinize the applications closely and the rejection rate should increase considerably.

Instead of only computer aided application assessment, showcased by Wonga, there would be a greater need for human involvement in ascertaining whether to lend to a given borrower. The payday loans should also give way to longer term lending which allow greater flexibility of payment and lower monthly repayment installments. Currently the market is waiting for a new beginning in this space where more experienced lenders will have a greater benefit. Instead of expanding the market on the back of huge advertising campaigns all the firms will focus on meeting borrower requirements. This should be a positive change in the lending sector and be a good example of how reasonable regulation can aid in bringing discipline in the market.

Short term lending will be required by the borrowers because one cannot always plan for every unforeseen expense. Nor is it possible to keep a buffer for every expense. However we can be sure that responsible loan lending has as truly arrived and now the future of short term lending lies with firms who can bring greater value to their customers and maintain their loyalty.