A ‘very intrusive proposition’ . That was the verdict of the Financial Conduct Authority in early October 2013 on price controls for payday loans (see para 6.71 of Detailed Proposals for the FCA regime for consumer credit ). The FCA was forced almost immediately to change course and implement this proposition when George Osborne directed the agency to introduce price controls on payday loans (see for details the Financial Services (Banking Reform) Act 2013 s131). This requires the regulator to determine how to establish a price ceiling and to conduct a systematic analysis of the consequences of such a ceiling. The response by the FCA is a watershed in policymaking. It is the first time that a UK ‘expert’ agency (such as OFT, FSA, Competition and Markets Authority) recommends interest rate ceilings for credit and makes the case for them based on an evidence based, cost-benefit analysis.
Why have UK technocrats and policy makers historically been reluctant to recommend interest rate controls on credit?
It is not simply a story of the political influence of interest groups, but reflects ideas about credit regulation with a long historical pedigree. Usury laws were repealed in the UK in the mid 19th century under the influence of the ideas of Jeremy Bentham. In the late 19th century the UK government rejected the re-introduction of price controls on moneylending–in response to public outrage about the practices of moneylenders. The Moneylenders Committee rejected ceilings in 1898 because ‘interest rates may not be the best measure of the cost of small loans, different conditions are applicable to different types of loans and ceilings would be circumvented’. Instead of price controls extremely broad powers were conferred on judges to hold a bargain to be unconscionable. This measure had little impact on working class moneylending after the First World War in many industrial cities and in 1927 a presumption was introduced that a loan was unconscionable if it exceeded 48%. But the courts did not use this as a price ceiling and upheld higher charge unless there was evidence of advantage taking. In any event the main working class credit was hire-purchase which because it was not technically a loan, was not subject to the Moneylenders Acts.
The modern story begins with the Crowther committee which reported in 1971 and which provided the ideological and practical foundations for the Consumer Credit Act 1974. My research in the archives of the Committee show that the initial draft of the relevant section of the report was written by legal academic Roy Goode who proposed the abolition of price ceilings. Ultimately, however the issue was controversial within the Committee and it maintained the presumption that 48% was unconscionable. However when the Conservative government introduced the Consumer Credit Act 1974 ceilings were abolished and in its place an ‘extortionate credit bargain’ provision substituted. This vague standard which imposed a very high standard of proof on a consumer proved to be a useless form of market regulation. Given its uncertainty and dependence on private action it had little regulatory bite.
The Labour government of 1997 had contained an electoral pledge to address problems of loan sharking as part of a review of the Consumer Credit Act 1974. Debt on our Doorstep mounted a sustained campaign to introduce ceilings on high cost credit. An attempt was made to introduce amendments during the Parliamentary process leading up to the 2006 amendments but failed to gain acceptance. The government based its resistance partly on a comparative study by Policis which had been commissioned by the relevant department. This study argued that ceilings in France and Germany had resulted in significant exclusion of debtors from credit and higher levels of illegal lending, as well as channelling individuals to use inappropriate credit products designed for mainstream consumers. This study remains controversial and has been critiqued. Resistance to a price ceiling also found support in a coalition of mainstream consumer groups, advisory agencies and academics who wrote a collective letter of opposition to price ceilings to the House of Lords Committee considering the Bill. Gerry Sutcliffe, then Undersecretary at the DTI claimed in Parliament that a new ‘unfair credit relationships’ test which permitted a court to look at all the circumstances of the contract would substitute for price controls. In his words ‘I am very confident that the unfairness test …will work and that there will be no need for interest rate caps’. The new ‘unfair relationships’ test has in fact had little, if any, impact on controlling the price of credit.
The continued growth of payday lending after the Great Recession of 2008 with jaw-dropping APRs in the thousands, and the public campaign of Stella Creasy MP for Walthamstow and Damon Gibbons of Debt on our Doorstep continued pressure for the introduction of ceilings. The Select Committee on Business Innovation and Skills in 2012 suggested that the government should consider a cap on interest rates. The government attempted to defuse the situation by commissioning another study of the impact of price ceilings, conducted by the Bristol Personal Finance Research Centre. This report was unable to provide definitive advice on the impact of ceilings although it did conclude that individuals denied access to payday loans would be unlikely to use illegal lenders. Meanwhile the OFT, having found substantial non-compliance with statutory obligations in the payday loan industry, referred it to the Competition Commission which produced very useful information on the industry but a set of unimaginative proposals which had not worked with the home lending industry. I commented on this here.
Many ‘experts’ in the UK including civil servants in DBIS, the OFT and the FSA have been unenthusiastic about price controls as an effective method of regulation of high cost credit. And mainstream consumer groups have also been reluctant to support ceilings. Which? (then the Consumers’Association) was lukewarm in support of them as long ago as its submission in the late 1960s to the Crowther committee. This stance may partly reflect an ideological aversion to limiting consumer choice, even if that choice is to purchase high-risk credit, or the influence of neoclassical economic models. In addition the spectre of the loan shark has haunted UK discussions on high cost credit with the argument that those denied access to the legitimate high cost credit market would be forced to enter the unpleasant world of the illegal loan shark. A heavy burden has existed therefore over the past 25 years on anyone proposing price controls (see discussion here). It might be said that there was a dominant coalition of regulators, mainstream consumer groups and ‘experts’ who weaved an influential narrative about the dangers of interest rate ceilings. It was not surprising therefore that the FCA, which inherited the conduct of business jurisdiction of the FSA, would initially set its face against price controls using the time-worn mantra that ‘more research’ was needed before price controls could be contemplated.
The recent FCA consultation paper is therefore a watershed. It may herald a change in regulatory thinking.
The FCA proposes a limit of 0.8 percent per day with a total cost of credit limit of 100% of the amount borrowed. A loan of £100 for 30 days would thus cost £24. Default charges will be capped at £15. The FCA estimates the impact on consumers to be lower prices for those eligible for loans under the new system but 11% of individuals who would currently qualify will be excluded from the payday loan market. The FCA argues that for most of this group payday loans are not beneficial. Based on existing studies (Bristol PFRC and Competition and Markets Authority) and their own analysis they do not think that those unable to obtain payday loans will turn to illegal moneylenders. Fewer than 5 percent of people turned down for high cost credit had considered using an illegal moneylender. The impact on the payday loan industry of the ceiling would be a consolidation with only three or four firms operating successfully.
The FCA is to be complimented for engaging in comprehensive data analysis as part of its cost/benefit analysis. They claim to have undertaken ‘the most extensive analysis undertaken by a public body when setting a price cap for credit’ obtaining substantial data from firms, Credit Reference Data on successful and unsuccessful applications, and a consumer survey of individuals who applied for a loan. With these data they were able to model the effects of a cap on profits and access as well as evidence of harm. In particular they compared the experience of those who just qualified for a loan with those who marginally failed to obtain a loan. For the former group there was a greater than 40% chance that an initial loan would not be repaid, 41% of borrowers surveyed regretted taking out a payday loan and analysis of Credit Reference Agency data indicated that using payday loans increases the likelihood of missing payments on other debt. Although the loan seemed to solve problems with an overdraft in the short term, this group were more likely to exceed their limit after three months.
Several issues arise from the proposals.
First, the proposals are restricted to short-term loans(under 12 months) where the APR is over 100 percent. Unauthorised overdrafts, doorstep lending (home credit) are excluded from the proposals although their costs may be similar to or higher than the cost of a payday loan. The question is how far to extend the regulatory role of interest rates. Apart from technical issues of regulation here there are political challenges. It is one thing to take on the payday loan industry which hardly has a positive public image or strong political influence. It is quite another to take on the British Bankers Association or UK Cards Association with their ability to finance extensive expert reports in their defence, seek judicial review of any proposed change, and wield their substantial lobbying influence.
Second, the consolidation of the industry with price controls may lend greater legitimacy to the high-cost credit market. However few believe that high-cost credit is a desirable method to borrow. Supporters of ceilings argue that a rejuvenated credit union movement should fill the the need being met by payday loans but credit unions have had a difficult time taking off in the UK. I discussed this problem here. The real challenge is the development of a credit system which is not regressive or reducing the extent to which individuals must use credit for meeting basic needs.
Third, experience in other countries has demonstrated the influence of the industry in establishing ceilings. In Australia and some Canadian provinces this resulted in legislation which has had little effect on the industry (see here). Hopefully the careful work of the FCA will not be undermined in this way in the UK.
Fourth, lenders have incentives to circumvent the ceiling by restructuring the loans perhaps over a longer period, or go offshore. The FCA indicates an awareness of these issues which will require continuing monitoring.
Finally, one question is whether the Authority would have countenanced price controls in the absence of the political intervention by George Osborne. It seems unlikely given their initial consultation paper. This raises questions about the deep assumptions or ‘world views’ which guide the thinking of ‘expert’ agencies. It also raises the relationship of technical expertise to political decision-making. Much policy making is supposed to be ‘evidence driven’. This is indeed a good idea. But powerful interest groups are able to buy much more expertise from management consultants than diffuse groups such as consumers.