South African entrepreneurs Errol Damelin and Jonty Hurwitz could not have foreseen the impact they would have when they set out to disrupt the 120-year-old payday loan market in 2006.
Wonga’s founders set up the company to serve cash-strapped borrowers as the UK headed for economic collapse during the 2008 financial crisis. But the now-disgraced lender – who charged some customers vulnerable to interest rates above 5,000% – became a lightning rod for controversy before it collapsed in 2018 and sparked a regulatory crackdown on the unscrupulous UK payday loan market.
Since then, the market that Wonga once dominated has nearly halved. More than 50 businesses collapsed or voluntarily closed. No new payday loan provider has been cleared by regulators to operate since, leaving less than 40 high-cost short-term lenders in operation.
As consumer advocates applauded their steady demise, questions have been raised about where the country’s most vulnerable households will go next to make ends meet. Amid the cost of living crisis, some industry figures say a more tightly regulated payday lending industry could have a role to play.
Regulators at the Financial Conduct Authority (FCA), the city’s watchdog, raised concerns earlier this year about the relatively small number of high-cost lenders left in the market for borrowers who fail to meet not the lending criteria of traditional banks.
At its May meeting, FCA board members said the reduction in high-cost lenders, “along with rising inflation…was likely to cause a number of pinch points where consumers will need quick access to cash and options would be limited”.
With the decline of the payday loan market, hopes have been raised that more socially responsible options such as credit unions and non-profit community development finance institutions could fill the gap. However, there are fears that they may struggle to expand fast enough to help anyone in need of financial support over the next few months.
Fears have been expressed that more people may turn to illegal loan sharks to make ends meet. According to the Center for Social Justice, the think tank co-founded by former Tory leader Iain Duncan Smith, more than a million people are now turning to illegal moneylenders in England.
Others are turning to unregulated but legal forms of lending such as buy-it-now, pay-later (BNPL) programs run by companies such as Klarna, Clearpay and Laybuy. Although borrowers often do not pay interest on their purchases, buyers are still at risk of becoming over-indebted. Companies are not required to offer forbearance or compensation when things go wrong.
“This cost of living crisis is potentially the most worrying I can remember in over 25 years as an activist,” says Mick McAteer, former FCA board member and co-founder of the organization. Financial Inclusion Center research. “So the risk of people turning to loan sharks may well increase.
“[And] Although BNPL does not have the kind of excessive and abusive terms and fees like payday loans and other subprime loans, the product encourages over-borrowing. It’s bad for long-term consumers.
A study published by Barclays Bank and the charity Stepchange in June found that almost a third of BNPL borrowers said their loans had become unmanageable and had pushed them into debt. Shoppers using BNPL refunded an average of 4.8 purchases, nearly double February’s 2.6 purchases, according to the research.
With growing concerns over illegal and unregulated lending, some high-cost lenders say they are offering safer choices for borrowers, despite years of alleged loan mis-selling to vulnerable borrowers.
Jason Wassell, the head of high-cost credit lobby group the Consumer Credit Trade Association, says there is still a place in the market for private lenders. “At this stage already, the demand far exceeds the supply,” he says.
“What we have seen over the last few years is a number of lenders leaving. This has led to reduced access to alternative credit, and this poses a problem for families in the UK, especially those who have been underserved or not very well served by banks in the past.
Executives at surety lender Amigo – which allows friends and family to stand surety and agree to cover any outstanding loan for cash-strapped borrowers – say they learned their lesson after a deluge of affordability claims nearly pushed Amigo toward collapse, forcing it to suspend lending at the onset of the coronavirus pandemic.
Jake Ranson, Chief Client Officer of Amigo, said his team “does not condone any past Amigo practices or products,” which included selling unaffordable loans to customers, which were typically priced at around $49, 9% interest.
He now hopes the FCA will give them the green light to restart lending under a new brand, RewardRate, from September, offering new features such as lower interest rates if borrowers make their payments on time.
“We’ll do military-grade accessibility testing, using things like open banking, and making sure customers are talking to a human…and that they understand the responsibility that comes with being have the product,” Ranson says. “It’s a very different proposition.”
However, consumer activists are worried. Sara Williams of the Debt Camel blog is skeptical that the wider high-cost credit industry is safer or more suitable for vulnerable consumers, even after regulatory crackdowns. “Debt is rarely helpful in this situation,” she says.
Rather than a restart of the payday loan market, more government support for struggling families is vital, she says. In the meantime, consumers had better consider debt management plans on any existing loan.
Last year, 4.4million people across the UK borrowed money to make ends meet, according to figures from StepChange. About 71% said using credit had a negative impact on their health, relationships or ability to work, while two-thirds said they were only able to meet their payments skipping housing or utility bills, or reducing them to the point of difficulty, putting them at risk of further financial harm.
StepChange said the risks vulnerable borrowers faced were not due to a lack of high-cost lenders in the market. Instead, he pointed to the lack of other options available when consumers were hit with unaffordable bills or unexpected costs.
“Going to subprime lenders should be a last resort,” says McAteer, adding that it is problematic that the UK has failed to create a “wider non-profit lending sector” to make in the face of the current crisis.
Not-for-profit social enterprises lend just £25m a year and serve only 35,000 clients on average. Despite their dwindling presence in recent years, payday lenders still managed to lend out around £60.4m in the first quarter of 2022 alone, according to the FCA, while door-to-door creditors lent around £95million in the last three months of 2021.
“We are seeing a welcome increase in the number of people using credit unions and other non-profit lenders. Membership in credit unions has now exceeded 2.1 million. But that’s not enough,” says McAteer. “Nonprofits are likely to be financially overwhelmed by subprime commercial lenders backed by private financial institutions.
“We need emergency measures to help households survive the crisis, and then medium and long-term measures to help people build their financial resilience against future shocks, which will occur. We have made almost no progress in building financial resilience since the 2008 crisis. Will we learn the lessons?