Consultation Response Office of Fair Trading: Proposals Payday Lending, Consultation on a Market Investigation Reference March 2013 Who we are Toynbee Hall has worked on the frontline in the struggle against poverty for 130 years. Based in the East End of London we give some of the UK s most deprived communities a voice, providing access to free advice and support and working together to tackle social injustice. Toynbee Hall helps over 13,000 people a year. Our years of experience in providing people with the skills to improve their financial health, means that we are in an ideal position to help others improve their financial health policies and practice. We have used this understanding to create the Financial Health Exchange. The Financial Health Exchange is committed to creating a fairer, more financially healthy society and our aim is to improve financial health in the UK. We help policy-makers and practitioners stay up to date on the latest financial health thinking and ensure that financial health good practice is followed in all of their work with clients and service users. We are at the forefront of shaping the future of financial health in the UK. Our publications, research, good practice examples and expert opinion pieces are accessible to all those who want to improve the financial health of others. To date, many commentators have been extremely critical of a market which they view as misleading vulnerable consumers and charging them extortionate rates for loans they would be better off without. Despite these widespread negative views, we believe that there is a positive role for some of the products found in the short-term credit market and that, properly regulated, they have the potential to be valuable components of UK financial markets. Our acceptance of the value of the service the market provides to some notwithstanding, we do believe that there are severe and deeply rooted issues with the way in which it functions which are leading to the exploitation of some consumers. It is important that any future regulation has the necessary nuance to protect vulnerable consumers from exploitation whilst at the same time
minimising the extent to which services are withdrawn from those for whom payday loans provide a valuable resource. It is our opinion that some of the problems in the market derive from factors which limit competition and are accordingly strongly supportive of the OFT s decision to refer the market to the Competition Commission. Although we feel the OFT is right to think that incentives present in the market encourage noncompliance with various standards, we believe that it is possible that even with full compliance with existing standards, many of the issues in the market would still remain and thus that further regulation may be necessary. We hope that the referral to the Competition Commission will result in a detailed look at the effect of the various options on the table for that further regulation. In what follows, we highlight some areas which we feel should be of particular concern to the Commission. Roll-overs, Affordability Checks and the Concept of the Product One of our concerns with the market is the frequency with which loans are rolled-over and the ways in which firms are marketing the option to do so to consumers. OFT figures show that one in three loans is refinanced or rolled-over, and these loans count for almost 50 per cent of revenue. Roll-overs are an important option for some borrowers; an unexpected large outgoing or a late pay cheque can mean that an extra month to pay back a loan gives people a flexible option. Nevertheless, we believe that these cases account for only a very small percentage of actual rollovers and that the majority are cases of consumers simply being unable to afford to pay back loans and therefore should be treated as defaults and consumers should be put on a repayment plan rather than having their loan extended. On top of this we are particularly concerned by the OFT s finding that at least a third of lenders are actively promoting roll-overs at the point of sale. The OFT Compliance Review found that 50 per cent of profits are made from loans which are rolledover once, and 19 per cent from loans which are rolled-over four times. Coupling this with the findings in the report recently published by the Personal Finance Centre at Bristol University (the Bristol Report), that only 10 per cent of online borrowers (and 14 per cent of retail borrowers) roll-over their loans, we think it shows a worrying indictment of how affordability checks are not working. This draws a picture of a business model in which payday lenders have a strong incentive to carry out inadequate affordability checks and to encourage people to roll-over. The relationship between the incentives rollovers provide to firms, their excessive use of them and the inadequacy of the affordability checks they undertake is something we believe the Commission should look into. The justification for the high-cost of credit in this market has always been that products within it pose high risks for firms and are costly to provide. We do not wish to dispute either of these claims. Rather, we believe that both costs must be reflected in the initial price of loans. It is grossly unethical for firms to attempt to save money by undertaking insufficient affordability checks and then covering the costs of the increased risk this entails by extracting funds through rollover charges from the most vulnerable of consumers. If it is not possible for the true costs to be reflected in the initial price of loans in this manner then we would argue that the product is simply unviable in its current form. As we have already made clear, we believe that the products do provide a valuable resource for many consumers, and thus we hope that this is not the case. Whether it is or not should be a central concern of the Commission. When considering these issues, it is important to keep in mind the distinction between affordability and payability. An individual can pay for a loan simply if they possess the money in order to do so; they can only afford to pay for a loan if they possess enough money in order to do so whilst maintaining their ability to pay for essentials and to avoid falling into further hardship. In this context we welcome the Commission looking at the use of Continuous Payment Authorities (CPAs) in the market. CPAs enable lenders to take payments from customers accounts without express permission. They are widely used for loans, and payments are being taken regardless of whether this leaves borrowers with money for 1
the month. We would particularly encourage the Commission to look at action on the use of CPAs in the context of the recent introduction of Universal Credit. When Universal Credit is rolled out nationally later this year people will receive all of their monthly benefit in one lump sum. This change will provide unscrupulous lenders the ability to take larger debt repayments, whilst greatly increasing the potential hardship vulnerable borrowers could face, including, for the first time, rent arrears or eviction. The use of CPAs is enabling lenders to recoup debts from customers who may not be able to afford to pay back, shielding them from the repercussions of bad lending. In addition to this, customers are being kept in the dark about their rights to cancel: the OFT recently found that 70 per cent of lenders are failing to explain properly to customers how a CPA works and that they have the right to cancel at any point. By enforcing the provision of clear, concise and correct information about CPAs, when they should be used, how they work and how to cancel them, borrowers would benefit greatly, and lenders would have less incentive to write loans that borrowers cannot afford. Clearly, if there was a direct link between risk for borrowers and risk for lenders, a key property of a well functioning financial market, then there would be a natural incentive for firms to undertake proper affordability checks. The erosion of the relationship between risks faced by different agents in the market is worrying and similar to the notorious situation which existed in some sub-prime markets in the lead up to the financial crisis. Factors such as the use of CPAs, which lead to the erosion of this relationship are thus an issue which the Commission should take very seriously. Transparency Another aspect of the current market that is of particular concern is the lack of price transparency. There are legal obligations on all lenders which aim to ensure that customers are able to weigh up the full cost of credit and to enable them to shop around for the best price. There is evidence that these obligations are not being fully complied with by all firms but, more importantly, we also feel that the information that lenders are required to provide to customers is unsuitable for the payday lending market. Currently payday lenders are legally obliged to display the APR when advertising a loan. When the OFT looked at 50 payday lending websites over half of them showed no APR, or did not display the APR with sufficient prominence. Firms are emphasising the speed and ease with which a loan can be taken out, and neglecting to show the true price of a loan. On top of this there is evidence of the practice of drip pricing, whereby lenders at first advertise only part of the price, which then goes up as the customer goes through the buying process. In the majority of cases the OFT evidence shows that lenders are not supplying customers with full information about costs, and conditions, until after the loan has been approved. We worry that this lack of transparency is leading to vulnerable customers being denied the full facts, meaning they are taking out loans that are not within their means, worsening their financial situation. One possible measure we feel could increase transparency is for the Commission to encourage, or force, lenders to display the total cost of credit (TCC) alongside APR. Whilst APR is an easy way of comprehending cost of a long term loan, it is relatively meaningless in relation to short term, high interest loans. APRs of 2,500 per cent or more do not easily convey the true cost of a loan to borrowers, as loans are taken out for a matter of days or weeks and not a year. The Bristol Report shows that customers are more likely to base their decisions upon TCC (the pounds and pence that they are going to pay back). 80 per cent of retail payday borrowers and 89 per cent of online borrowers consider the total amount borrowed, plus interest, whereas less than half of each group considered the APR as an important factor. Current lack of transparency means that customers are making their decision based on what they think the total cost of their borrowing will be, but in many cases these costs escalate or have not been fully explained. Customers are being sold a loan with the image that is a one off, with one fixed cost, but this is not the case for many customers, who are encouraged to take out rollovers. We appreciate that as not all customers will extend a loan or receive 2
a late payment charge it can be difficult to calculate a true representation of TCC. Nevertheless it seems that, as customers are already using this as their main means of assessing affordability of a loan the Commission should look into policies which encourage or enforce more transparency about TCC. We feel a fair representation of what a customer can expect to pay if they pay back on time, alongside the currently required APR, would go a long way to increasing transparency of costs, help to prevent consumers from taking out loans they cannot afford and encourage price competition. Price Insensitivity and Barriers to Entry We further support the referral to the Competition Commission due to evidence of price-insensitivity throughout the market. Looking at the OFT s figures, there has been significant entry into the market in the last few years (190 firms operating in 2011/2012, up from 136 in 2010/11 and 96 in 2009/10) and yet this has not resulted in a reduction in prices. The Commission should take note of evidence which suggests that, for those customers for whom there are no other options for credit, borrowing decisions are being based on the speed and ease of taking out a loan and not upon which firm is offering the lowest price for credit. As a result there is currently no incentive for firms to compete on price. Lenders are advertising the speed at which they are able to offer a loan and deposit the funds into a borrower s account and in some cases even advertising the lack of credit and affordability checks, in clear violation of the OFT Irresponsible Lending Guidelines. The Bristol Report found evidence that borrowers are not choosing lenders on the basis of who will offer them the cheapest loan: 56 per cent of retail payday borrowers and 44 per cent of online payday borrowers would still take out their loan if it were more expensive. Vulnerable customers who have no access to mainstream credit are more likely to be price-insensitive, as they have no other borrowing option and are thus likely to make economically irrational choices, thereby distorting market forces. Vulnerable customers with the least financial capability are the very ones which would benefit most from increased price competition between firms. We hope that the Commission uses this opportunity to tackle price insensitivity by simultaneously tackling the problems of price transparency, which we feel is in no doubt exacerbating the problem. Lack of transparency has a distorting effect on competition in the market, as customers who are kept in the dark about true costs will make decisions based on speed and ease and firms therefore have no incentives to compete on price. We are in agreement with the opinion of the OFT that failure to compete on price is not down to a few individual lenders, but an entrenched problem with the market as a whole, and this is a further reason why we agree with the referral of the payday lending sector to the Competition Commission. We feel that price insensitivity further poses a problem by creating a barrier-to-entry for new firms; as customers are price-insensitive then smaller firms can t compete on price. OFT numbers show that the three biggest firms collectively have a 57 per cent market share, leaving 187 smaller firms to fight over the remaining 43 per cent. Those three firms have the advantage of now being household names thanks to nationwide publicity campaign. In addition to this, the three largest firms have built up a database of which borrowers repay loans, bringing down their operating costs. This leaves the smaller firms and new entrants to lend to the riskier borrowers, who are more likely to go into arrears or default on a loan, thus pushing up the cost of their business. These aspects mean that, while the payday lending market is relatively cheap and easy to enter, we feel there are significant barriers stopping smaller firms from competing at the top of the market, to the detriment of borrowers. We hope that the Commission will be able to act to correct market irregularities that are purely to the detriment of the consumer, such as lack of price-competition. At the same time we understand that many regulatory options, such as a price cap, or stricter affordability checks, push up operating costs for lenders, distorting competition and acting as a barrier to entry. In spite of this, we hope that those negative effects on competition can be balanced against affording vulnerable consumers the protection they deserve. The Limits of Competition 3
Notwithstanding what we have said above about the centrality of competition to the various ways in which consumers interest are being adversely affected by markets, we do feel that it is important for the Commission and other regulators to bear in mind that not all of the problems in the market are due to lack of competition. Indeed, many potential options for regulation currently being tabled place new obligations on firms and thus risk increasing their costs, creating barriers to entry and thereby negatively affecting competition. In relation to this point, we particularly have in mind the imposition of a cap on interest rates or the total cost of credit, about which we feel much more research needs to be done, at least some of which we hope the Commission can contribute. Though the Bristol Report did provide some useful original research and data, we feel there remain some significant gaps in what is currently available. Much of the research on a cap was of a general, qualitative nature. We feel, firstly, that much more specific, quantitative data is required and, secondly, that it is important to identify more accurately consumers and how they will be impacted by a cap, in terms of, for example, what they are using payday loans for and thus in terms of how negatively affected they will be by any changes bought about by a cap, or by other regulations for that matter. Finally, a question that the Bristol Report did not make any attempt to answer was how much and which of a firm s costs such as advertising costs for example were necessary costs. It is crucial to be in possession of such information to judge adequately what effects the imposition of a cap would have on the market. We are pleased that the Government and regulators have chosen to not rule out such a cap, and that the FCA will have the powers to impose it. Nevertheless, we do regard it as a significant step that should not be taken, or for that matter ruled out, without an extensive evidential base. We feel that the Competition Commission may be well placed to undertake or commission some of this research, and should certainly look further into how a cap would affect competition in the market and how any negative effects on competition could be balanced against positive effects of the policy. A final word of caution concerns the ways in which competition can be increased. Research undertaken by Jason Allen, a principal researcher at the Bank of Canada, and reported in the Canadian Globe and Mail on January 4 th 2013, showed that neighbourhoods with more bank branches and payday lenders per capita (i.e. more competition) have looser lending standards (higher leveraged households) and experience greater bankruptcies (i.e. instability). This research could potentially show that some increases in competition in the UK market could in fact negatively affect consumers. Evidently, such a possibility should be of central concern to the Commission. One way of dealing with this issue which has been broached would be to require all lenders to share real-time data in order to reduce repeat lending to the same borrowers and assist in the making of good affordability assessments. We would like to stress that we are very supportive of the approach regulators are taking to the market and hope that this referral to the Competition Commission signals a continued commitment to an in depth appraisal of the many complex issues in the market and of all the possible regulatory responses to them. 4
Toynbee Hall 28 Commercial Street London E1 6LS Tel: +44 (0) 20 7247 6943 Email:info@financialhealthexchange.org.uk Website: financialhealthexchange.org.uk Registered Charity No. 211850. A company limited by guarantee. Registered office as shown. Registered number. 20080 England Copyright Toynbee Hall. All rights reserved. 5