The payday lending industry punishes people for its own faults

The payday lending industry punishes people for its own faults: they don't carry out the correct credit checks then continue to charge borrowers excessive fees and interest on loans they probably couldn't afford to begin with.

Despite the formal investigation being carried out on the industry by the Office for Fair Trading, payday lending has once again made headlines today for failing to uphold standards of responsible lending.

Citizens Advice have called the industry ‘out of control’ after seeing recent cases which included ‘lending to people who were aged under 18, had mental health issues or were drunk when they took out the loan’.

The debt charity also found that ‘seven out of 10 said they had been put under pressure to extend the loan, while 84 per cent said they had not been offered a freeze on interest rates and charges when they said they were struggling to repay. In 95 per cent of cases the lender had not checked to see if the borrower could pay back the loan if it were extended.’

This raises three issues which should be the backbone on any regulatory enforcement over the controversial industry:

–        payday lenders rely on return custom for proft maximisation;

–        the business model of a payday lender does not include grace periods or ‘cooling off’ periods for borrowers who struggle to repay loans;

–        payday lenders are discouraged from providing rigorous credit checks to ensure borrowers do not struggle after taking out loans.

The need for return custom

Since the OFT’s investigation the Consumer Finance Association (a payday lender trade body) have introduced in to their code of conduct a limit of three rollover loans (where a borrower takes out a loan to service the interest on an existing loan taken out). But worryingly their previous chief executive, John Lamidey, once commented that ‘payday lenders want repeat custom just like Marks & Spencer wants it’.

The OFT during their investigation was told by staff at two high street payday lenders that ‘encouraging rollovers was a deliberate commercial strategy and regarded as a key “profit driver” for the firms’, reported by Credit Today magazine.

It is a big ask to expect the payday lending industry itself to do something about this when so much of their profit is extracted from borrowers being trapped in a debt cycle.

Debt traps

It was once said that ‘money was intended to be used in exchange, but not to increase at interest’. This is exactly what is encouraged with payday lenders: when someone struggles to pay back money on time the charges on that transaction continue to rise, leaving that person in a worse situation than before.

The payday lending industry punishes people for its own faults: they don’t carry out the correct credit checks then continue to charge borrowers excessive fees and interest on loans they probably couldn’t afford to begin with.

No incentives for credit checks

Payday lenders compete not on price, but speed of getting money in to borrowers’ bank accounts, therefore time is money. This in turn disincentivises lenders carrying out proper checks on an individual’s financial commitments and encourages irresponsible lending, which is why people struggling to pay back these expensive loans is so frequent.

Free access over people’s bank accounts

One other controversial aspect is payday lender’s use of the continuous payment authority (CPA), which is like a direct debit system where a lender can take money from a borrower’s account whenever it feels like.

In theory lenders are supposed to notify borrowers before any money is taken out, but in practice this can happen without any prior notice at all.

This is entirely contrary to responsible lending as it is one of many examples of putting already vulnerable consumers in even more precarious situations with their finances.

Government should be tough and withdraw payday lenders’ ability to use the CPA as it has been shown they cannot be trusted with it.

All of the above show that even amid an investigation bad practices are commonplace in the payday lending industry – this is because they are firmly woven in to their business model.

Self-regulation in the industry is failing, and this falls upon the most vulnerable hardest. Tough action over this type of business is well-needed.

You can read more on the payday lending industry at Carl Packman’s website.

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