THE RISE OF PAYDAY LOANS
The use of high-cost, short-term credit, such as payday loans, has grown very rapidly in recent years. In 2013, an estimated 1.6 million people took out 10 million loans with a total value of £2.5 billion.
Customers are attracted by the speed and anonymity of payday loans – money can be deposited in your account within 15 minutes from the major online operators. However, Martin Lewis of moneysavingexpert.com has highlighted the danger of "grooming" a whole generation to become dependent on instant credit, rather than encouraging saving or careful budgeting.
The majority of payday loans are taken out simply to make ends meet by people who are already in a financially precarious situation. Faced with very high interest rates and penalty charges, it is no surprise that many borrowers are unable to meet the repayments and find themselves in a crippling spiral of debt.
In a telephone survey commissioned by the University of Bristol, 68% of retail customers and 42% of online customers said that payday loans had trapped them in a cycle of borrowing.
THE FINANCIAL CRISIS
Although the payday lending industry has been rightly criticised for poor and unethical lending practices, the growth of the sector is just the latest and most visible symptom of wider problems with our economic and financial system.
Slow wage growth coupled with rising living costs and government spending cuts have increased the demand for short-term credit, as people’s finances have come under increasing strain. Almost 9 million people in the UK constantly struggle to keep up with bills and credit commitments.
At the same time, traditional sources of credit have dried up as the high street banks have tightened their lending criteria following the financial crisis. This has left a big gap in the market, which payday lenders have exploited very effectively, using digital technology and large advertising budgets.
According to a CDFA report, the size of the finance gap is estimated to be worth £3-3.5 billion per year in total, most of which is currently being met by exploitative high cost lenders. Up to 7 million people use one or more forms of high-cost credit, including home credit, pawnbrokers, and rent-to-own, as well as payday loans.
Whilst the financial crisis and the recession that followed have undoubtedly made the situation worse, many of the underlying problems have been evident for a long time. People have been borrowing more and saving less for at least the past two decades, encouraged by consumerism and ready access to credit (prior to the 'crunch'). For the low paid, whose earnings have been lagging since the 1980s, debt has helped to fill the gap created by rising inequality.
Meanwhile, the major banks have become too large, too centralised, and too far removed from the communities they are meant to be serving. One of the consequences is that those families who can least afford it have ended up paying the most for their financial services, or have been excluded altogether.
WHAT IS THE ANSWER?
There is clearly a need for effective regulation of payday lenders and other high-cost credit providers in order to tackle the worst excesses. Some of these measures are already being implemented, including a cap on the cost of credit from January 2015. But, that is not enough on its own.
We also need to ensure there are credible alternatives to payday loans and other forms of exploitative lending. This is where credit unions have a key role to play. Whilst credit unions and other community finance organisations do not generally offer a direct substitute for payday loans, they do represent a more responsible alternative for borrowing and saving.
In addition, the big banks need to look at how they can more effectively serve the large minority of the population who do not have access to essential financial services, such as a bank account; or the millions of customers who are regularly hit by bank charges, because mainstream financial products are not suited to their needs.
UNDERLYING ECONOMIC FACTORS
Last, but not least, it is important to address the underlying economic factors that are driving the demand for short-term credit: low wages, zero hour contracts, rising rents, and benefit cuts. That is why the problem of exploitative lending cannot be considered in isolation, and must go hand in hand with other actions, such as support for the Living Wage, fairer employment practices, more affordable housing, and an effective welfare safety net.