“There will only be four main payday lenders operating in the sector.”
This was the claim made by the Financial Conduct Authority (FCA) back in 2014, as I sat in a crowded seminar hall surrounded by other payday lenders and brokers. With the FCA taking over from the Office of Fair Trading that year, many industry players were expecting a shake-up as directors of payday loan companies and I huddled into this room trying to get some insight into the pending regulation.
Of course, we laughed off the idea of an industry with only four players. At this point, payday lending had been a booming business with a market valuation of £2 billion, over 3 million loans funded per year, around 200 lenders, and more than 200 brokers, easily. The industry was full of playboys on yachts, international millionaires, and soft regulation – how was it going to be changed so drastically?
Fast forward five years later and the controversial industry has changed dramatically with more and more lenders going into administration. The largest casualty has been market leader Wonga, who closed its books in Q4 last year, slowly followed by The Money Shop, Cash Genie, and recently Wageday Advance. But the question begs, how did these once formidable companies fall? And why are they going into administration?
Payday loans by numbers
In 2013, the payday loan industry was crying out for more regulation. The number of complaints was rising constantly, making headlines, attracting criticism from politicians such as Stella Creasy and religious figures such as Archbishop Justin Welby, and lenders were being accused of charging usurious rates as high as 5,000% APR.
On 1st January 2015, the FCA introduced a price cap on the amount that lenders could charge to 0.8% per day, meaning that, on average, a customer will repay a maximum of £124 per £100 and never repay double the amount they have asked to borrow. Other introductions included a maximum default charge of £15 per missed repayment and a strict authorisation process required for lenders and brokers to operate.
The initial costs and timescales of being authorised were too much for many brokers and lenders to handle with dozens leaving immediately, despite many being offered ‘interim permission.’
The introduction of a price cap, higher compliancy costs, and tougher regulation resulted in lower margins for lenders and a desire to run a stricter lending criteria to ensure maximum repayment.
Whilst many lenders have continued to trade, some have simply not been able to make the business model work – finding that the margins are too tight and the running costs are too high. For them, exiting the industry has been the safest option and, in 2019, we have only 40-50 payday lenders and a similar number of brokers.
High growth is catching up on them
Whilst the payday loan industry was booming pre-regulation, many lenders were issuing loans aggressively and growing exponentially. Wonga was notoriously cited for a £1 billion valuation.
However, this exponential growth came at the expense of issuing loans to customers that could not necessarily afford them, with soft affordability checks and funding based on more behavioural underwriting and aggressive collection practices than the traditional underwriting practices of credit checking and affordability.
The result? Millions of loans were funded to customers without employment, on benefits, no income, and no means of repaying their loan. Now, this group of debtors have a strong claim to ask for compensation, and this is now a thriving sector.
With PPI claims coming to an end in August this year, the role of payday loan compensation claims is taking its place. Those who were issued a loan that they believed lacked checks are able to claim compensation of hundreds of pounds.
Wonga has been the lender most affected by this and has repaid over £200 million worth of compensation claims in the last four years – the process that has put them into administration.
Moreover, the cost of issuing a complaint demands a £500 fee from the Financial Ombudsman Service, regardless of whether it is a strong claim or not, which makes compensation claims a far greater expense.
There are a number of smaller, traditional payday lenders that have been around for over 10 years and were not lending big volumes prior to the FCA price cap – and these companies are now reaping the rewards. Companies such as Wizzcash, Uncle Buck, and MY JAR have the knowledge, resources, and financial competence to continue trading and thrive. As per the statistics below, there are 10 lenders that accounted for 85% of new loans – and as the number of lenders fall, the loan volumes are rising.
The future of payday lending
Payday lending will always have a role in the UK society. It is an important anti-poverty measure which offers a very important service to the 3 million people that apply for it every year – and its existence diminishes the risks of black market economies and loan sharking.
Whilst we initially laughed off the idea of only four payday lenders operating in the market, the rise in administration of well-known lenders is making this a real possibility.
Beyond payday loans, there is an opportunity for new alternatives to enter the market that can offer more flexible products including app-related banking, flexible overdrafts, and installment lending.
A flaw in payday lending is that all customers are subject to paying a high rate of interest, regardless of their credit rating. So those with average or good credit scores are still prone to paying the same high rates as those with bad credit ratings. If there is a lender that can find this balance, providing affordable payday loans for good credit and finding a way to accommodate bad credit customers, they will be able to crack a very complex market.
Written by Daniel Tannenbaum, co-founder of Tudor Lodge Consultants.
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