By Mark Lunn, founder, Caburn Communications
When I tell friends I’ve been working with a new lender for three years on market entry into the High Cost Short Term Credit market, they pull a face of disgust and say, “eeew, you’re helping a payday lender like Wonga… how do you live with yourself, they charge immoral amounts of interest”.
But here’s the thing. Credit is cheap and readily available for those of us in the financial mainstream with a bank account and decent credit rating. In fact, it can be zero percent if you pay your credit card bill on time.
The problem is that a significant “poverty premium” exists in the UK consumer credit market. Individuals on low incomes with limited credit history and poor credit scores get excluded from mainstream forms of credit, such as bank loans or credit cards. The lack of alternatives means they are forced to pay a premium to specialist lenders.
This impacts a huge proportion of our society. The Money Advice and Pensions Service noted that nine million people use credit for everyday essentials[1]. Many have no alternative than to borrow high-cost credit. This starts at 100% APR but is typically priced between 400% APR and 600% APR. Sometimes it is more than 1000% APR for ‘payday’ loans.
Despite the cost, demand for credit continues to rise. The ongoing cost of living crisis is very real and supply and consumer choice keeps shrinking.
Why? Because the high-cost short-term credit market is one of the most challenging sectors in UK retail financial services.
Several regulated lenders have retreated from subprime lending recently, notably Provident Financial after 140 years. Meanwhile mainstream players and high street banks have long avoided what they consider a too-risky sector. This has resulted in a lack of innovation, investment and price competition for consumers.
Even the regulator, the Financial Conduct Authority (FCA) is now calling for new investment and innovation in unsecured, subprime lending.
The FCA Woolard Review in 2021 noted that “the market has not delivered access to more affordable credit at scale”. It recommended that the FCA itself “encourage more mainstream lenders to participate at lower costs” because “mainstream lenders have been reluctant to offer or fund alternatives to high-cost credit.
“Greater involvement of these lenders directly in non-prime credit markets, with their expertise and economies of scale, is essential to driving competition and innovation. Consumer choice and outcomes will likely remain limited without this”.
There is surely a huge market opportunity for new lenders who bring more affordable credit to this underserved market if they lend responsibly, sustainably and at scale.
Open banking and is a game changer for lenders because it enables a quick and accurate analysis of a customer’s financial situation making possible informed and responsible lending decisions based on what they can afford to repay. This de-risking minimises bad lending and defaults, it reduces the cost of lending and, in turn, can drive down the price consumers pay for credit.
There is also strong political support for credit, on the right and left. Yet the government is looking to the market for solutions rather than providing affordable credit itself, despite talk recently about guaranteeing no interest loan (NILS). Social lending, so called Community Development Finance Initiatives (CDFIs) offer affordable credit but sadly they lack the resources and technology to lend at scale.
Worryingly, there is growing evidence that users of short-term credit are experiencing rising declines from regulated lenders. Instead, they are having to turn to unregulated lenders, whether they are family, friends, Buy Now Pay Later or even loan sharks. This is not a happy picture.
This is risky for borrowers because there’s less clarity about the consequences of missed repayments. There is no Financial Ombudsman to appeal to for support when things go wrong.
Some loan sharks continue to lend to people who have borrowed before and can’t repay, ratcheting up the interest on ever bigger loans because they can.
This was arguably one of Wonga’s bad practises that triggered a wave of consumer complaints and resulted in a huge number of fines from the Ombudsman, ultimately sinking the business. Sadly, completely unregulated loan sharks get away with it.
The punchline. The lender might not enter this market after all. Despite having raised very significant funding and investing it in high calibre teams and leading tech, the fintech is struggling with its second fundraise.
I told you it was one of the most challenging and underserved markets in UK financial services and likely to remain broken for the foreseeable future. But it is also crucially important that we get it right for the customers who once turned to Wonga. Despite rising prices and all the economic uncertainty of the cost of living crisis, they now have nowhere left to go.
[1] source: MaPS UK Strategy for Financial Wellbeing