Day of reckoning for UK payday lenders

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When a wave of payday lenders set up in the UK in the late-2000s they were hoping for fertile ground.

Light-touch regulation and rising demand for quick credit as banks retreated meant the market was one of the few corners of financial services still flourishing.

But after years of strong growth, an industry that has been heavily criticised by politicians and consumer groups is under threat.

New rules introduced by the Financial Conduct Authority, which began regulating consumer credit in April, have made it impossible for the vast majority of payday lenders to survive. The largest operators – such as Wonga, which has about a third of the market – are having to rethink their business models.

Such lenders have become notorious for offering short-term loans but for extortionate rates of interest – sometimes higher than 5,000 per cent a year. Many firms have been coined “payday lenders” as they offer cash to tide over hard-pressed borrowers until the end of the month.

Store-based payday lenders first emerged in the UK in the early 1990s, following the Cheque Act which enabled consumers without a bank account to pay in a cheque in return for cash and a fee.

By the mid-2000s, fuelled by new technology, lenders started to migrate online. Tight regulation in the US spurred credit firms to branch out into the UK; Payday Express and the Money Shop are owned by American firm Dollar Financial, while QuickQuid is owned by Cash America.

Meanwhile a squeeze on credit during the financial crisis left many consumers short of cash and with erratic wage packets that did not see them through until the end of the month.

Around 1.6m people took out £2.5bn of high-cost short-term loans last year, borrowing £260 on average, over a period of 30 days, according to the regulator.

While short-term credit providers have long been attacked by MPs and consumer groups for overcharging on loans, the regulator is now forcing them to overhaul their businesses, as it seeks to “weed out” the vicious cycle of debt in the UK.

This week Wonga agreed with the FCA to introduce more thorough credit checks that will include tougher affordability criteria. The lender said it would write-off £220m of debt provided to 330,000 customers who would not have been issued loans under these new rules.

Clive Adamson, director of supervision at the FCA, said the intervention on Wonga “should put the rest of the industry on notice – they need to lend affordably and responsibly”. Citizens Advice this week said the lack of proper credit checks was a “widespread problem” within the payday loan industry.

The FCA is examining other big payday lenders such as Dollar. Dollar said its affordability process was compliant.

Russell Hamblin-Boone, chief executive of the Consumer Finance Association, the body representing short-term credit lenders, said the watchdog’s tighter affordability rules were already having an impact on the market.

He said 54 per cent fewer loans had been granted year-on-year, while the number of times loans have been rolled over – extended past their original repayment date at a cost to the borrower – has dropped by 75 per cent.

But the FCA’s move to cap the cost of loans from January is set to wipe out all but a handful of payday lenders.

The proposed cap, which will be finalised next month, will limit fees and interest on loans to 0.8 per cent a day and will ensure no one pays back more than twice the amount borrowed. A loan taken out over 30 days that is paid back on time will cost no more than £24.

While the FCA has said that only four payday lenders are expected to remain in the market after the cap is introduced, Stella Creasy, a Labour MP, said the restriction should be the “starting point to drill down further into the industry”.

“Everyone looks at the banks as if they are the Tyrannosaurus Rex you should be scared of; but the payday lenders are the Velociraptors,” she added. “They are clever and adapt. The FCA needs to be ahead of where these companies are going.”