Will the payday loan cap really benefit consumers?

The payday loan rules confirmed by the Financial Conduct Authority yesterday for high-cost short-term credit will cause a major shake-up of the market. Whether that will be a good thing for consumers remains to be seen.

From 2 January a new price cap will affect any loan advertised at 100% APR unless it is provided by a home credit provider or a community finance organisation. The cap will limit interest charges to just 0.8% a day and ensure that nobody will repay more than twice what they borrowed, including fees. This means that a £100 loan for 10 days will cost £108, but if extended or defaulted it won’t cost more than £200. The FCA thinks it likely that many payday loan firms will leave the market unless they change their business models, leaving just thethree main online lenders and one high street provider – who currently represent about 60% of the lending market.

The cap will clearly have a massive impact on the market, but perhaps not in the way most people think. While the total cost of credit will be limited to 100%, it won’t reduce APRs, as these are an annualised representation of interest rates – so still expect to see interest rates of 2,000%-plus advertised online and on TV.

Furthermore, the FCA’s own analysis suggests that the four biggest lenders will not be affected by the cap as their charges are already below it, or they are in the process of adapting. The market leader is Wonga, so it seems the cap will affect neither its interest rate nor its profitability. However, since many of the small players may leave the payday-lending market, the sector will become a big-four monopoly led by Wonga. That can’t be good for consumers.

The FCA also estimates that 70,000 current borrowers would be denied finance under the new rules. Its modelling suggests that only about 2% of this group will potentially use a loan shark instead (though the numbers using loan sharks are notoriously difficult to estimate, and generally under-reported). The FCA’s research also suggests that many more borrowers will be offered less than they need, causing further problems.This new cap should be a great opportunity for alternatives to fill this gap – with suggestions that Community development finance institutions (CDFIs) or even credit unions could provide a responsible and affordable alternative. Sadly, few credit unions have an online presence, and fewer still offer any type of payday loan equivalent. CDFIs such as Fair Finance (where I work) and Moneyline offer an alternative, and with access to bank and private capital can meet some demand. While they have had more success in weaning people off high-cost providers, they are mainly branch-based and don’t match the convenience or speed of online payday providers. If these organisations want to be considered a serious alternative they require massive investment in people, know-how and finance to deliver the right products. Some of them are moving in that direction, but sadly most of them are not.

Interestingly, it is the home credit market – most disrupted by the payday lending industry – that offers a different perspective. It is exempt from the current price cap, and companies such as Provident Financial (the largest doorstep lender in the UK) have the national scale and resources to take advantage of the upcoming changes. It will be interesting to see if they will.