InvestmentsMar 19 2015

Taking a global view on payday loans

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When we paid for everything in cash, our wallet set a limit to our spending sprees. Point-of-sale finance and fast loans now come with a huge price tag.

Credit cards reward cash bonuses for using the plastic to purchase everything from a banana to a TV. Shops offer their own store cards to buy anything on installment, even a pair of trousers. The biggest volume of point-of-sale financing loans are taken during the festive season. Some deals, however, bring remorse once the party is over.

Wonga has come to symbolise the tough type of indebtedness in our consumer society. Against all the fame for the rates in the thousands, the temptation of a “loan in minutes” is its strong selling point.

Health warning

As payday loans usually end up being harmful to the borrower’s financial health, many suggested regulating their advertising by analogy with the tobacco industry, to make obligatory a warning similar to that on cigarette packs. The footnotes on Wonga’s or Quickquid’s websites have the standard text: “Warning: Late repayment can cause you serious money problems.” But this does not seem to make much impact. Payday lending in the UK is extreme.

An illustrative example would do a better job: if you borrow £600 to buy a smartphone, after one year you pay back £35,718, or maybe more, since the 5,853 per cent APR is representative only.

In the Netherlands, all credit advertising has to include the message: “Let Op! Geld lenen kost geld.” (“Borrowing money costs money.”)

Usury ... is affiliated to the image of illegal loan sharks collecting the debt with baseball bat

At the other extreme of interest rates is Sharia law, which forbids charging interest because Muslims must not benefit from lending money. On this religious ground, Newcastle United’s Senegalese striker objected to wearing the team’s shirt with Wonga as the sponsor on it. The Islamic law, however, did not stop Turks incurring credit card debts way over their heads.

The Turkish faced high inflation in the 1980s and 1990s, so they turned early from cash to credit cards. Later, when foreign capital was flowing into emerging markets such as Turkey, local banks gave spending limits many times customers’ monthly paycheques, oblivious to the risk they might not pay them back. Nothing like the sub-prime mortgage crisis of the US in size, but Turkey is facing its own credit crunch.

The number of problem loans is still obscure, since many debtors have several credit cards, juggling cash flows and borrowing from new cards to make payments on old ones. By now, Turkey’s 76m-strong population owns 54m credit cards, ranking as the second largest user nation in Europe after the UK’s 56m.

But where does the usurious rate start?

More and more European countries are capping the APR. In the Netherlands, the limit follows a formula – the ordinary interest plus 12 per cent – currently, that is 15 per cent, and 14 per cent from next year.

“It is a challenging environment, to earn some money, to find a solid business model with such an operating margin,” said Arlinde Vletter, a board member of the Dutch association of financing businesses (VFN) and former chief operating office of the consumer finance brands of the BNP and the Credit Agricole groups in the Netherlands.

To knock the British consumer credit industry into shape, the FCA has started its campaign of new regulations and set a cap in the form of a daily rate, which came into effect in January. European Coalition for Responsible Credit calculated that the daily 0.8 per cent equates to 1,270 annual percentage rate – on a typical 30-day payday loan. Not an overly restrictive annual rate cap, in itself.

Expressing rates in daily or monthly terms is a tactic of advertisements to make it sound small. It is not as simple as multiplying the monthly rate by 12 to work out the annual interest. Without repayments, compound interest accelerates the debt, transforming a 2 per cent monthly interest into 27 per cent APR.

Eastern Europe’s big payday brand, Provident, charges ‘only’ three-digit APR figures. The specialty there is home credit. The borrower does not need a bank account, since the nearest regional representative comes to your home with the cash. Provident’s Hungarian website states: “During the weekly visits, you can discuss with the regional representative any questions that occurred.” Meaning: when the weekly repayment is collected, you pay an extra 68 per cent as a home collection fee.

These practices earned the payday industry the reputation of being “legalised usury”.

The word ‘usury’ stems from ‘use’ of money and originally meant interest. In its current sense it stands for excessive and exploitative interest, and is affiliated to the image of illegal loan sharks collecting the debt with baseball bats. That ‘business’ activity is controlled by the criminal law and the police.

Payday lenders are, however, a legitimate source of credit. They rebuff qualifying their business as usury, reasoning the high charges by the high risk – as the loans are unsecured – and the fast service – credit scoring and placement within the day.

But the super-fast decision-making proved to be too hasty. In response to the irresponsible lending practices before the credit crisis, EU member states implemented the Consumer Credit Directive (2008/48/EC), which requires lenders to assess each borrower’s ability to meet repayments. In October, the FCA requested Wonga to write off the loans of several hundred thousand of its customers in arrears, due to the firm’s inadequate affordability assessments.

In Germany and Spain, the often regional banks dominate this segment. In the Netherlands, banks have a 60 per cent market share, and the rest of the consumer lending is done by specialist “finance houses”. The latter category contains automotive captives, but also some hybrid companies, such as the consumer finance subsidiaries of banks. LaSar, for example, is the specialist consumer credit brand of the French BNP Paribas group. Similarly, Sofinco is the consumer finance subsidiary of the French Credit Agricole banking group, and it is the pan-European market leader.

Typically, the British consumer credit market is dominated by non-bank Wonga-like consumer finance specialist companies, and 40 per cent of online payday loans are taken out via a lead generator – such as Cash Lady or Bee Loans – with borrowers not even realising they are using such a site.

The new FCA rules are expected to wipe out all but the biggest payday lenders in the UK. The British high street banks, however, cannot attract the clientele of the disappearing lenders, as they are typically sub-prime borrowers. Chasing them, by loosening the banks’ credit standards, would be reminiscent of pre-credit crunch behaviour.

The consumer finance firms of the Netherlands have a different approach. “With our capped interest rates, you attract a different type of customer, near prime customers,” said Arlinde Vletter.

What the British banks could do is to make their weeks-long loan processing times shorter, to make personal loans easier to take out.

The overdraft facility, which banks provide as immediate credit, can also fund the purchase of that big gift. Being in the red on the current account, however, is a more expensive form of credit.

In the Netherlands, overdraft costs 15 per cent – the maximum APR is charged – while the very popular personal revolving credit starts at around 5 per cent, if you have a good credit profile, explains Vletter.

Maria Sovago is a freelance journalist

Key facts

Wonga has come to symbolise the tough type of indebtedness in our consumer society

The number of problem loans is still obscure, since many debtors have several credit cards

The new FCA rules are expected to wipe out all but the biggest payday lenders in the UK