Have MPs forgotten consumers in the payday debate?

payday shock bill

In a report released yesterday, MPs strongly criticised Financial Conduct Authority (FCA) plans to regulate the payday loans market.

The Business, Innovation and Skills Committee report argued that many of the measures to protect payday consumers announced by the FCA in October last year and due to be implemented from next week are inadequate.

The Committee said that rollovers, due to be capped at two a month, should instead be limited to just one.

MPs also argued that payday loan advertising should be banned outright when programming aimed at children is showing, among other criticisms (full report here [pdf]).

The report represents growing dissatisfaction in Westminster about what is perceived to be the regulator's 'light touch' approach to the high cost credit market.

Protecting payday users?

At the end of last year, George Osborne announced that the Government would push cost of credit caps into the Banking Reform Bill, for example, ignoring the FCA's plan to undertake more research.

More on payday
An overview: here
Alternatives guide: here
On Wonga: here

"The Government is determined to protect hardworking people from sharp practice in the financial sector. The payday loan sector must get its house in order," the Financial Secretary to the Treasury, Sajid Javid, said as the cap was announced.

On the highly visible and emotive subject of the payday loan market, calling for stronger action is clearly seen as a popular move.

But it may also be a merely populist one.

There is extremely mixed evidence on the effects of clamping down hard on the payday market.

When, last year, the FCA decided not to cap the cost of payday loans it clearly cited concerns that doing so could result in poor consequences for those most likely to use high cost loans.

"Many consumers use payday loans because, despite high APRs, that is the only source of credit available to high risk borrowers in emergencies," the FCA report read.

"They might be made worse off by caps on APR or restrictions on how often they can borrow if they reduce availability to some consumers. Indeed, usury laws and similar provisions have been cited as an example of regulatory failure driven by regulators' own behavioural biases."

In taking this view, the FCA followed consumer groups including Consumer Focus, which recommended a number of regulatory measures in a detailed 2010 research paper, not including a cap on costs, and Credit Action (now called The Money Charity) which said in its response to a Government consolation that they, "fear that caps, even if only applied to one specific section of the credit market, could create flight on the part of certain lenders which would prevent borrowers from meeting their needs and prospectively drive [illegal] loan shark activity."

The bigger picture

In addition, there is plenty of evidence that high cost loans are part of a larger picture.

Non traditional forms of borrowing aside from payday are also booming.

23.5% of respondents to a Debt Advisory Centre poll released today said that they had used store or catalogue credit to pay for goods. 5% said they'd used doorstep loans.

According to a recent Competition Commission research, many payday users see the short-term loans as preferable to the ways they could borrow from the mainstream banks, citing fear of high unauthorised overdraft costs, for example.

By calling for further restrictions such as a limit to one rollover, MPs are arguing from the point of view that payday loan users are making a mistake, or a series of mistakes, when they choose to take short term high cost loans.

Under that model, borrowers extending their borrowing period is seen as an indicator that they didn't mean to spend so much to borrow or as a sign of financial distress, showing that the borrower is risking falling into a spiral of debt, with one unmet commitment leading to another.

If consumers had better understood their choices when they went to borrow, MPs are saying, they would often have chosen not to take a payday loan. Regulators should therefore take steps to increase understanding and save consumers from themselves.

Yet there is evidence that many payday loan customers, perhaps even the majority, are making logical decisions, even if they look illogical from the outside.

A study due to be published in the Supreme Court Economic Review this year (working paper here) found that 60% of payday loan users actually forecasted when they would repay pretty accurately.

More than half of borrowers in his sample expected extra repayment cycles - that is, they expected to roll their loans over and understood how much that would cost.

And although 43% of borrowers in the study failed to clear their debt by their predicted date, less than half of them were out by more than a week.

If we actually want better outcomes for consumers, not just to beat down the payday industry, it might be worth MPs considering these and other findings which show that many consumers have their eyes open but find the risk of high interest and lenders with poor reputations preferable to their alternatives.

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