Thursday, 4 April 2019

How much redress is too much? The case of the UK payday loans market

Yesterday the collapse of another payday lender in the UK hit the headlines of BBC News. WageDay Advance, a middle-sized payday lender went into administration earlier this year due to a surge of claims for compensation for mis-sold loans. This follows the collapse of Wonga, the largest payday lender in the UK that went into administration last year for the same reason. So what exactly is going on?

Background

Payday loans are unsecured loans for a small amount of cash (usually between £100-1000)  for a short period of time. Traditionally they were repaid before the next payday (hence their name) although nowadays they may last up to 1 year. This type of financing is very popular in the UK, and has caused a lot of detriment to consumers in the past.

Advertisements targeted children and vulnerable adults, the loans were given to everyone without proper creditworthiness assessments, the application process was simple and easy, the basic price was extremely high (the annual percentage rate of charge of a Wonga loan could be as much as 5853%), and multiple extensions involving additional fees and charges were routine. Consumers who easily found themselves trapped in debt, were subject to unfair treatment and aggressive debt collection often being left without essential funds to live on. 

Needless to say payday loans gained considerable public attention, and hence when the Financial Conduct Authority (FCA) took over the regulation and supervision of consumer credit from the former Office of Fair Trading, the regulation of the payday loans market came top of its list of priorities. The Financial Services and Markets Act 2000 as amended in 2012 equipped the FCA with very significant powers, including to regulate the features of a financial products or to ban them completely (product regulation power) and a power to order consumer redress (so called regulatory redress power). Using these powers the FCA decided to keep payday loans on the market subjecting them to detailed rules and to robust enforcement. 

The initial forecast was that the new regime that made payday loans a much less attractive business than would drive out most of the firms. This has not happened (for more on the new regime for payday loans in the UK see my paper here), with a fair number of firms remaining in the market and operating under the new regime.

Reasons for failure 

While the new rules stopping firms from earning excessive profits did not drive these firms out from the market, their life was ended by the new approach to enforcement.  

Accepting the new regime meant complying with the stringent regulatory regime. It also meant  in the eyes of at least some lenders, that they needed to improve their public image and to establish a cooperative relationship with the FCA. In this effort, Wonga voluntarily agreed to compensate consumers for wrongdoings in lending irresponsibly before before the new regime. Within the redress scheme Wonga agreed to contact affected consumers and explain whether they were entitled to compensation under the redress programme, and also to write off the outstanding debt for 330,000 customers and to enable 45,000 consumers to repay their debt free of interest and charges. Wonga also agreed to compensate customers for unfair and misleading debt-collection practices, for sending debt collection letters from non-existent law firms threatening legal action. This action affected some 45,000 consumers and cost Wonga around £2.6m. In 2015 Dollar Financial UK (known as The Money Shop) followed Wonga's steps and agreed with the FCA to compensate 147,000 consumers for irresponsible lending practices costing  the company £15.4 million. In 2016 CFO Lending become subject to a redress scheme, agreeing to compensate 97,000 consumers for various unfair commercial practices costing the firm £34m. And so the list continues....

CFO Lending could not bear the costs, and collapsed into administration in 2017. Wonga followed suit in 2018. These companies collapsed because they could not bear the costs of the redress scheme.

In addition to the redress schemes, another trend affected the well-being of these companies. Following the FCA's approach to enforcement as 'credible deterrence' providing for exemplary and spectacular punishments with maximum publicity, the media and money advise charities took up the problem (see an example here) advising consumers how to claim compensation for unfair, primarily, irresponsible lending practices. In addition, consumers protecting their own interests, claims management companies took interest in reclaiming mis-sold payday loans, to an extent, that claiming this type of compensation became one of the most common complaints directed to the Financial Ombudsman Service.

While it is unclear what exactly happened with Curo Transatlantic Limited trading as WageDay Advance it seems that payday firms that stayed on the UK market are now paying the price for their past behavior, either within a redress scheme agreed with the FCA and/or by a surge of claims from claims management companies and consumers.

The consequence of failure on consumers 

How does the failure of a company affects its customers? First of all, consumers who have loans need to continue with the repayments. However, consumers who were due compensation might have suffered harm. For instance, CFO Lending's capital was not enough to pay compensation to all consumers, and WageDay Advance's consumers are still unsure how much compensation they are going to get as it depends on the amount of revenues earned from loans being repaid. The prospect of these consumers is not very good. They will become unsecured creditors at the bottom of the scale, and are likely not to be repaid.


Concluding thoughts

The case-study of the UK payday loans firms show the importance and the power of effective enforcement tools, but at the same time, it also shows the  danger of having too robust enforcement that may ultimately harm consumers. It raises two important questions. First, should we care about the well-being of companies, and should the redress schemed be tailored to what is sustainable for the firm in question? 'Sustainable redress' would ultimately also serve the interests of consumers by boosting competition on the market, and arguably providing better services and products. Secondly, should the FCA and other regulators having similar schemes rethink their approach to enforcement and design the redress schemes to protect the collective interests of all affected consumers? Bearing in mind the collective interest of consumers would lead to a reduction of individual sums of compensation, but every affected customer would get their fair share. And finally, one might also think about combining the two approaches. Reducing the amounts of compensation to individual consumers to an extent to compensate every consumer and to provide for sustainable redress. What do you think?

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