Coalition partner Damon Gibbons from the CfRC has produced a report on payday lending in the UK which has attracted media attention from the BBC. This report alongside the one produced by the UK consumer body Consumer Focus last August ( ‘Keeping the plates spinning’ by Marie Burto) will hopefully feed into the BIS call for evidence on consumer credit issued in October. In addition, a summary of research on payday lending has just been published by John P. Caskey of Swarthmore College and visiting scholar at the Federal Reserve Bank of Philadelphia (Payday Lending: New Research and the Big Question, by John P. Caskey, Swarthmore College, October 2010)

Payday lending in the UK: a review of the debate and policy options

We are pleased to attach a new report on payday lending in the UK, which calls for improvements in consumer protections to help prevent people in financial difficulties from becoming trapped in a cycle of repeat, high cost, borrowing.

The report comprises a review of current UK evidence on the impacts of payday lending, and includes a comparison of payday loan prices with bank and credit card charges. It also reviews the regulatory responses of the US and Canada, where payday lending has been established for longer, and looks at current lender practice in the UK.

Finding that payday loans are both an expensive form of borrowing and also risk creating long term debt problems, particularly for lower income customers, the report calls for:

• The Office of Fair Trading and Advertising Standards Authority to ensure payday lenders are not misleading customers about the relative costs of their loans compared to bank charges and other forms of borrowing
• The Office of Fair Trading to review payday lender compliance with its Irresponsible Lending Guidance and take enforcement action against firms which fail to limit roll over lending.
• The Financial Services Authority and Office of Fair Trading to encourage banks and credit card companies to provide greater assistance to customers who have exhausted their credit limits by helping households to reschedule existing commitments and by providing financial education and access to simple savings products
• Payday lenders to develop a code of practice that limits maximum loan values to one quarter of monthly income as is the case in some US states; commits them to avoiding multiple, repeat, and 'roll over lending'; and ensures borrowers in financial difficulties are provided with assistance to reduce their level of debt without incurring additional charges.
• Government to expand the scope of its proposed price capping powers for credit and store cards to all areas of the consumer credit market. BIS should now publish the draft criteria to be considered by regulators when deciding whether, and how, to implement such a power for consultation.

----

Extract from CfRC’s Responsible Lending Journal (Oct 2010)

Regulating Payday Lending: are we being ambitious enough, are we asking the right questions?

Recent Consumer Focus research has identified the need for stronger payday lending regulation. Gavin Hayes, General Secretary of Compass, and the CfRC’s Damon Gibbons argue that regulatory practices in US and Canada should form the basis for future action and call on Government to investigate the ties between major banks and payday lenders.

In August, Consumer Focus published research into the use of payday lending which estimates the market to be worth over £1.2 billion per year, and which indicates this form of borrowing was used by some 1.2 million people in 2009. The report also goes on to forecast a significant growth in payday lending in the coming years, and examines criticism of the industry that loans are expensive and trap people in a pattern of repeat borrowing.

The report finds that although some groups of borrowers use payday loans as a short term solution to temporary cash flow difficulties and do not get into difficulties, others, particularly lower income borrowers do often find themselves ‘rolling over’ loans or taking out multiple loans from a number of different lenders, resulting in ‘significant financial problems and emotional stress’.

The Consumer Focus research, which follows an examination of the payday lending industry as part of the Office of Fair Trading High Cost Credit Review published earlier this year, makes a number of policy recommendations, notably:

- The number of rollovers or loans per year should be restricted to a maximum of five per household.

- Households reaching this level of usage should be referred by lenders for advice and support with their financial problems.

- That the OFT should place controls on the amount of money that can be borrowed by ensuring lenders conduct thorough affordability assessments prior to granting a loan.

- That lenders should share information concerning payday borrowers to prevent consumers from taking out multiple loans from different lenders at the same time.

Consumer Focus also calls for the industry to respond to the recommendations of the OFT’s High Cost Credit Review, which included the development of an approved industry code of practice covering these issues. However, regulatory action in many areas of the US, where the payday lending industry originated, and Canada, which has also experienced a significant growth in payday lending in recent years, go much further than the measures proposed by Consumer Focus.

----

Payday Lending: New Research and the Big Question (John P. Caskey, Swarthmore College, October 2010)

Payday lending is controversial with US cash loans of less than $500 facing finance charges of usually 15-20 percent of the amount advanced (or 400% APR for a typical two-week loan). Payday lenders however, do not direct their services to the very poor, but rather to moderate-income households who have little financial savings and who lack access to lower-cost credit. In many cases, their customers have severely impaired credit histories or they have reached their limit on lower-cost sources of credit, such as credit cards.

This article briefly describes the payday lending business and explains why it presents challenging public policy issues. It surveys recent research that attempts to answer the "big question”: Do payday lenders, on net, exacerbate or relieve customers’ financial difficulties?

Payday lending should be beneficial (terms of loan are easy to understand, must be best alternative instead of either 1) $30 non-sufficient funds fee for a bounced check and a $15 returned check fee; 2) delay paying the utility bills and incur late payment charges and perhaps utility service disconnection (disruption cost) BUT they can also prey on people who are tempted by easy access to cash (they focus on the immediate benefits only, underestimate the repayment cost. Such myopic individuals (hyperbolic discounters) might be better off if they did not have access to payday loans. The problem of rolling over the loan and entrapment of people who heavily discount the future cost of repaying the loans can be seen from the perspective of the first-time loan as nearly a free one-time grant.

This article includes examples of quasi-experimental research techniques as well as simulation studies which may help researchers. It also suggest how researchers should try and obtain the cooperation of a payday lender to conduct an experiment, carry out ethnographic studies that carefully follow the budgeting decisions and thought processes of payday loan customers and their households over time, and monitor the effects that consumer financial education can have on the demand for payday loans.