In some quarters, there is some jollity and satisfaction with the woes Wonga now faces, with administration and the break-up of its loan book. Perhaps Wonga has indeed mis-sold its products to large numbers of consumers and deserves what has come its way. But more broadly we should be careful before being too joyous about the demise of high-cost short-term lending such as payday loans. It could have bad implications for the consumers affected.
A few years ago, Friends Provident Foundation, Liverpool JMU and Policis jointly sponsored a survey entitled “Credit and low-income consumers — A demand-side perspective on the issues for consumer protection”. It found that getting on for half of payday loans are taken out in order to cover an emergency or urgent bill, a mortgage, rent or utility payment.
That means that, setting aside the “background noise” of 20 per cent or so of loans being for cash liquidity purposes — common across most forms of credit, some two thirds of payday loans serve the role of paying other bills. This strongly suggests that avoiding defaulting on other debts is a significant motivation (probably the single largest motivation) for taking out payday loans. (By contrast, mainstream loans, home credit and revolving credit loans are overwhelmingly used to fund planned borrowing.)
That has a number of implications. First, it can be seen as a measure of the riskiness of payday lending — a large proportion of payday borrowers are in sufficient financial distress that they are taking out high-interest rate emergency loans to avoid defaulting on other obligations. That is one reason payday loan interest rates are very high.
But another implication is that, because they enable borrowers to avoid defaulting on other obligations, those borrowers will find them enormously valuable and be prepared to pay extraordinary interest rates to secure them. In 2015 my colleagues at Europe Economics and I estimated that, for someone on the minimum wage the ability to borrow short-term to avoid defaulting on another £500 debt might be expected to be worth 12 to 24 times the value of the loan. For someone on median full-time income the value of avoiding defaulting on a £1,000 debt might be worth more than 150 times the value of a short-term loan provided for that purpose. The psychological costs of becoming someone that “gives up” could be even higher.
One aspect of payday loans being so extraordinarily valuable to borrowers is that they are vulnerable to exploitation. There are a number of important classical policy concerns regarding high-cost short-term lending, which Europe Economics’ previous work for the FCA had sought to address.
These included the problem that making a loan one expects the borrower to default upon is inducing the breaking of a promise — unethical under just about every moral system, a failing of which a number of firms appear to have been guilty.
They also included the problem that lending at high interest to a borrower that is already insolvent is a way of profiting at the expense of other creditors with whom one notionally ranks equally. Payday loan companies tended to do this through their use of “continuous payment authorities”, whereby payday borrowers gave the lender the right to extra money from their bank accounts instantly whenever they felt they were owed money. Payday borrowers can also be in denial, and become trapped in a cycle of increasing indebtedness.
Each of these is a genuine issue, and regulation (which has been introduced) was needed to address them. But restrictions that go too far, such as an interest rate cap (which was introduced by George Osborne against the FCA’s advice), risk the consequence that those unable to borrow any more face the huge losses associated with default.
In my view, it is far too commonly and cheaply claimed that managed bankruptcy is an obviously better path for such people. It is plausible that, in some cases, that is true in a narrowly financial sense. And it is also undoubtedly true that some people become highly psychologically and behaviourally distressed when they are highly indebted and that accepting defeat and help is an important part of their returning to personal as well as financial health.
But for others, giving up will have huge personal behavioural consequences. Once they cross that threshold by defaulting on their loans, they may find giving up very rapidly becomes a habit in many other ways as well — giving up on their marriages, giving up on their dreams, giving up on their battles against addiction. To pretend to people that giving up on paying loans is an easy way out is wrong. And if you could get through, and someone is willing to lend you money to do that (for the right price), and those willing to lend have appropriately controlled their own behaviour, we should let people make their own choices, take their own risks, and try to muddle through in their own way.
Payday lenders undoubtedly did some bad things, which regulation was rightly introduced to address. Wonga in particular may have done some especially bad things, and deserve its demise. But we should be careful what we wish for regarding the demise of payday lending more generally. Stopping people from finding their own way to navigate short-term financial distress could create a great deal more misery than it prevents.