Charlie Elphicke is the Member of Parliament for Dover and Deal.
Today’s announcement by the Chancellor on pay day lending is another step on the road in repairing 13 years of mismanagement by the last Labour Government. In this article I set out the lessons we could learn from other countries and the reforms that could be made.
Why Conservatives should reform payday lending now
There are some who will say this is not a Conservative thing to do. I disagree.
Conservatism at its best is about opportunity, aspiration and success – enabling people to climb the ladder of life. Our vision of Britain is a land of opportunity where people can get qualifications, jobs and achieve their full potential.
Yet there is a flipside. People in Dover tell me they are attracted to Conservatism that is deeply caring. Conservatism that seeks to protect people from the worst excesses of the system – from being taken advantage of – is something that really appeals.
Protecting people matters as much as the land of opportunity.
Protecting people applies to the utility companies who charge too much, egregious payday lenders, the industrial scale tax avoidance by those who shirk their civic responsibilities and the zero hours contracts the Government is now reviewing.
All these excesses arose under the last Labour Government and it’s right that the Conservatives should be tackling them.
The payday lending problem
Payday lending has flourished in recent years. As it has grown, so has scrutiny of the behaviour of payday lenders. There is a deep sense that the system just isn’t working: from extortionate interest rates to marketing loans to 13-year olds.
Many claim that introducing any form of cap on rates will only harm borrowers. They say people will be driven into the arms of loan sharks, or that payday lenders will simply raise their rates up to the level of the cap. However, this view is not borne out by the research.
The Bristol University Department for Business found (in “The impact on business and consumers of a cap on the total cost of credit”) that where customers couldn’t access short-term loans, most would either go without or approach a friend/relative for help.
A small number would try and borrow from other short-term lenders, but the use of an illegal lender was not an option the vast majority of people would consider.
For those who say we should do nothing: Britain is one of the few developed countries which doesn’t have some form of cap. Looking around the world we can see a number of approaches that we could learn from in undertaking reforms:
USA: Caps on rates and loans are mainly made at state level. (The only exception to this is a 2007 federal law which banned payday lending to members of the military at rates above 36 per cent.) 17 states have effectively outlawed payday lending. Meanwhile others have required all payday lenders to comply with the usury laws that apply to banks. This has capped the APR which the payday lender can charge, often to below 30 per cent. Such an approach effectively puts payday lenders out of business. Other states exempt payday lenders from the usury laws, but still impose interest rate caps at 36 per cent or below, which is viewed as unprofitable.
Canada: In Canada it’s a criminal offence to charge more than 60 per cent interest on a loan. Regulations were introduced to prevent payday lenders being classified as criminals. Individual Provinces have flexibility to set their own borrowing rates. Any Provinces which chose to allow rates greater than 60 per cent must licence all payday lenders in their Province, cap the loan amount to $1,500, and require all loan periods to be less than 62 days.
Eight provinces have introduced rules under these provisions. Caps that have been introduced range from $19 to $31 per $100 borrowed. Regulations also provide:
- A two day “cooling off” period whereby customers can cancel their payday loan within two days of taking it out without having to pay any fees/charges
- Establishing a payday lending education fund, which is paid for by payday lenders
- Banning the inclusion of fees in the value of the loaned amount, so applicants don’t borrow an amount lower than they apply for.
The payday loan industry has set up its own industry body, The Canadian Payday Loan Association, who have a strict code to which all members must adhere. The code includes rules banning:
- The rolling over of payday loans
- Issuing multiple payday loans to the same customer
- Taking collateral as security for repayment of a payday loan
- Charging an interest rate greater than $0.90 per week for the first thirteen weeks for a defaulted payday loan, with the fee falling to $0.50 per week afterwards.
Japan: Japan has adopted an interest rate cap approach. In 1954 it enacted the Capital Subscription Law, establishing that any lending had to have interest rates below 109.5 per cent or it would amount to criminal usury. More recently the Money Lenders Law 2006 moved the level of the interest rate cap under the Capital Subscription Law down to 20%, the same level as set out in the Interest Rate Restriction Law. This was implemented in June 2010.
Australia: Australia has only introduced payday loan regulations relatively recently. In March 2013, new laws came into effect in Australia under the National Consumer Credit Protection Act 2009. Any loan with a value of less than $2,000, which needs to be repaid within 15 days or less is now illegal. Further changes came into effect in July 2013. Loans worth less than $2,000 offered over a period of 16 days to one year will have fee caps. Lenders are only able to charge:
- One-off establishment fee, which can’t be more than 20% of the value of the loan
- Monthly account keeping fee, which can’t be greater than 4% of the value of the loan
- Government fees or charges i.e. tax
- Default fees and charges, which must not be greater than 200% of the loan amount
- Enforcement expenses, where the credit provider needs to take the customer to court.
Alongside this, the legislation introduced caps on larger loans. The following limits were introduced to loans worth $2,001 to $5,000, paid over a period of 16 days to one year:
- A one-off fee can be charged worth no more than $400
- The maximum interest rate which can be charged is 48%, inclusive of all fees and charges
The legislation allows exemptions for banks, building societies and credit unions. The international experience is something the UK could learn from
Options for reform
Bank overdrafts A key area for reform is how the banks operate overdrafts. Often it is cheaper to borrow money from a payday lender than to have an unauthorised overdraft at the bank. We all know how banks charge high levels of interest, penalties and for sending unauthorised overdraft letters.
There needs to be a balance struck between protecting customers from being stung by banks for short term cashflow problems and giving people too easy access to irresponsible credit. The Government could introduce rules to give customers a short “grace period” where they are not charged fees for going overdrawn. However, if the overdraft lasts for beyond the grace period, customers would then be liable. Longer term, the way the banking system deals with overdrafts should be reviewed to promote fairness and avoid forcing people into the arms of the payday lenders.
The EU Consumer Credit Directive The ability for lenders to operate across EU borders makes it possible for payday lenders to bypass UK regulatory reforms by setting up in other EU countries. This should be reformed. Lenders should be required to comply with regulations in the place where the customer is located, not the location of the lender.
Capping payday lenders It’s right there should be a cap on the cost of borrowing. We need to protect people from those who would exploit them. It would also bring us into line with other major economies.
In addition to measures already being proposed by the FCA, the Government could draw on the international lessons and:
- Set a ceiling on the total cost of borrowing for pay day loans/short-term loans equal to £25 for every £100 borrowed. The number of times that a loan can be rolled over should also be limited.
- Seek reform of the European Consumer Credit Directive to require loan terms to be compliant with the legislation of the country of the customer as opposed to the country of the lender.
- Introduce tougher sentences for illegal lending, including mandatory prison sentences and enable victims of illegal lending to recover all payments made to the lender (maybe a higher penalty as exists for rental deposits not held in a licensed deposit scheme).
- Require payday lenders to form an accredited industrial body to ensure lenders behave according to a clear code of conduct.
- Require banks to give a three working day grace period before customers are charged for unarranged overdrafts; and open a consultation on banking fees.
It’s well understood that the last Labour Government mismanaged the economy and took Britain to the brink. Yet it wasn’t just the economy they mismanaged. They also left of toxic legacy of mismanagement of our tax and regulatory systems that have continued to make life difficult for hardworking families.
Conservatives have always been on the side of hard working people. That includes protecting people from the worst excesses of the system.
Reforms to protect people who strive to make ends meet and are just trying to keep the wolf from the door are deeply Conservative. This is because we are not just the party that is fixing the economy. We are also the party that cares.