Pick up any newspaper, or go on to any news-related website today, and the chances are you will see a story covering payday lending – a type of credit selling, primarily (but not exclusively) geared towards low-income borrowers who have found it very difficult to live by their own means alone and on top of that are having trouble borrowing money from traditional avenues such as banks.
The Sun newspaper – not widely recognised to be the most sympathetic read to such concerns – carried an article recently stating that one in ten British consumers were planning to take out a payday loan in the next six months, which unsurprisingly includes Christmas – where a great many families realise the true extent to their financial problems.
One of the controversial aspects of this type of lending is just how expensive it is, which is a cruel irony seeing as those who are most likely to take out such loans are already from the bottom end of the income scale. A report in the Guardian in 2011 showed that some payday lenders were charging sixty times the ‘true cost of a loan’ – compared to a loan by My Home Finance, a not-for-profit organisation set up by the government and the National Housing Federation in 2010, which charges a representative APR of 69.9 per cent.
A typical online loan can have an attached rate of between £25–£30 for every £100 borrowed, which by comparison to other more mainstream forms of lending is absolutely scandalous. So how do payday lenders justify this? They do so by saying that the service is expensive and that the customers are often risky. Undeniably, this is true. But lenders are often quite conservative with the truth about how they make their money. Lenders often say that they don’t encourage consumers taking out too many of their loans (though I would strongly argue this is more to do with the pressure that is put on them by government and consumers themselves) and that their product is only short term. However if this were so, the payday-lending industry would be significantly less lucrative than it currently is in the UK.
It is worth somewhere between £2-4 billion, up from a mere £100 million in 2004, for good reason. According to an influential report by Flannery and Samolyk in 2005, a payday lender might just survive by the skin of their teeth if they provided only occasional credit to people, but it would drastically reduce its long-term scale. Instead a lender draws its larger profits from consumers coming back time and again. They were handed a giant golden cheque when the UK financial recession hit, with many more people finding it almost impossible to survive without recourse to these vulture lenders.
So where did they come from? According again to Flannery and Samolyk, the payday-lending industry originated in a shadow form, in the US in the early 1980s. It was seen by many to be the outcome of the Depository Institutions Deregulation and Monetary Control Act in 1980, which was a reaction by the federal government to the rise in inflation, effectively overriding all existing state and local usury laws, giving way to the elimination of interest rate limits.
It had had a precedent before this however. The US has always been thought of as one of the founding homes of illegal loansharking. In many states in the late 1800s the practice was pretty normal among workers who could not obtain bank accounts and was used in addition to pawnbroking and cheque cashing. But it wasn’t without its controversies. Many of the lenders knew that they were the last hopes of many consumers, and so being unlicensed, illegal but more or less tolerated by the law, loan sharks would go about collecting their money in very heavy-handed ways. It was only when there was violence that anyone really paid attention to it.
One such violent incident took place in 1935 where a young clerk was beaten outside of his place of work for failing to meet a series of debt repayments. This sparked a special investigation led by Thomas E. Dewey, a well-respected man who stood twice as the Republican candidate for president in 1944 and 1948. The outcome of Dewey’s fightback was the arrest of twenty-seven individuals for loansharking activities. From that day the practice was no longer privileged with a blind eye.
There were enormous degrees of difference between the salary lenders of the late 1800s/early 1900s and the racketeer loan sharks, particularly in the manner with which they handled repayments. The similarities were in charging illegal rates of interest. Of course, in America there has been a history of usury laws, and in many states interest has for a long time been capped. This isn’t, admittedly, a purely positive thing. Interest rate caps in New York and Chicago were once so low (around six per cent) that virtually every credit lender had to operate illegally in order to operate at all. In many states throughout the next years this was largely unchanged.
In the American states where usury was made illegal or payday lending better regulated, lenders would still lend, but operate as best they could within the new rules. Notably, in 1978, there was the case of the Marquette National Bank of Minneapolis vs. First of Omaha Service Corp.: a Supreme Court decision ruled that state anti-usury laws could not enforce against nationally-chartered banks in other states. This decision upheld the constitutionality of the National Bank Act, permitting chartered banks to charge their highest home-state interest rates in any state in which they operated. Subsequently, as payday lenders were partnering with banks and seeing their product repackaged as ‘bank loans’, some lenders were setting up shop in states where usury laws were more relaxed and lending to people in states where usury laws were tighter, but effectively overriden.
As lenders found it increasingly harder to operate, large swathes of the industry was exported to the UK, taking advantage of the relaxed regulatory architecture in place. In the 1990s the Money Shop, a payday lender owned by US company Dollar Financial Corp, expanded from having one shop in 1992 dealing primarily with cheque cashing, to 273 stores and sixty-four franchises across the UK in 2009. Today five of the seven biggest payday-loan companies in the UK are owned or controlled by a US company.
For these businesses now could not be a better time to tap into the UK market. Tim Harford repeated the claim in his article, asking whether the industry was really so immoral, noting that payday lending was up from £100 million in 2004 to £1.7 billion in 2010. Modest, he argued, compared with over £55 billion of outstanding credit card debt or more than £200 billion of consumer credit; but for a relatively new product that is having another growth spurt since the financial crash of 2007-08, it is considerable.
Like with so many things, there is no simple solution here. But the history should give us some indication of what is lacking, namely that this product has been largely the preserve of people who are not served by mainstream products. From the illegal loan sharks in the US to payday lenders in the UK, a failure for the mainstream to properly accommodate is a running theme. No surprises, then, to find that the success of payday lending has come when wages are not keeping up with inflation, and banks are less willing to lend to vulnerable individuals. For the sake of squeezed households who are resigned to more and more dangerous debt, it is high time the government and banks took a look at what they can do to stop this next financial crisis hitting consumers hardest.