A bad day for Wonga provides a valuable opportunity to reform the credit industry
Few will have shed tears for Wonga last week when it announced a pre-tax loss of £37.3m for 2014. Their plunge into the red follows the introduction of stricter rules for the payday lending sector by the Financial Conduct Authority (FCA), with the new regulatory regime following on the back of a concerted grassroots campaign across the UK.
The new rules have led to a 12 per cent rise in Wonga’s operating costs, while the FCA expects a significant number of payday lenders to exit the market in the tougher regulatory environment. Clearly, many lenders only flourished because the rules governing their behaviour were lax, to the detriment of hard-pressed borrowers.
Nonetheless, the underlying demand for access to short-term credit will not go away with a decline in the number of payday lenders. Insecure work, rising rent and stagnant low-income wages are the conditions in which demand grows. Moreover, if and even when living standards improve, there will always be demand for credit to smooth over unexpected costs.
It is therefore critical that alongside improving regulation of the consumer credit market, the UK also develops an affordable alternative for low- and middle-income households in the short term credit market.
In Jumping the Shark, IPPR set out a roadmap to capitalise and expand a network of exactly such providers. We argued for a new national institution – an Affordable Credit Trust – to be established with the remit of mobilising and capitalising a diverse range of local not-for -profit lenders. Affordable credit providers could draw down capital from the Trust and access the technological infrastructure necessary to keep costs low, in exchange for offering affordable loans and operating in a democratic fashion, with borrowers becoming members of the institution and having a say in how it was run.
The Trust could be capitalised by a one-off levy on the consumer credit market, taken as compensation for the direct financial harm it has caused, which the Office of Fair Trading says is worth at least £450 million. Credit unions, housing associations, social enterprise providers and mor, could partner with the Trust to service affordable, easy to use loans, while partnerships with institutions like local Post Offices or churches could help ensure they operate at the heart of their communities.
To keep the system sustainable, lenders would be able to use a repayment backstop mechanism as a last resort – similar to that employed with the DWP’s Budgeting Loan system, which consistently achieved over a 90 per cent repayment rate without placing the debtor in undue difficulty. We estimate that with this in place, and with the right support, loans could be offered for as little as £3 for every £100 borrowed per month, compared to nearly £30 for the average payday loan. At a time when household incomes continue to be squeezed, that amount can make all the difference.
However, we also know from past experience that the affordable credit market won’t grow on good wishes alone; it needs financial and technical support to get off the ground. This is how it has grown in places like America, where one in three are members of a credit union. However, a properly capitalised institution like an Affordable Credit Trust could have the means to really turn the tide against high cost lenders. IPPT research suggests it could potentially offer up to 2.5 million affordable, manageable loans a year once the Trust and local provider networks are fully established.
An Affordable Credit Trust capitalising affordable, democratic forms of finance captures the spirit of the times: it is about shifting capital and power away from the consumer credit industry and towards people and communities, giving them the means to build affordable alternatives to high cost credit. It means shifting away from a reliance on cash transfers from the central state and towards rooting democratic forms of capital that allow people to be more assertive in standing up to markets where they dominate.
So now we know Wonga’s business model is creaking it is time for us to take the next step, building up a network of affordable credit providers to help us all jump the shark.
Mathew Lawrence is a research fellow at IPPR and co-author of Jumping the shark: building institutions to spread access to affordable credit
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