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The credit card “sweatbox” and stagnant wages: life in the UK

The ‘sweatbox’ model of credit card lending was set out in a well-known article by Ronald Mann in 2007 (here) . Credit card companies through the use of sophisticated data could make substantial profits from individuals who had difficulties in repaying or were financially distressed. Although certain of these accounts would be written off,  the overall profits  from the various fees and costs levied on individuals who are locked in to an existing lender and struggling to repay were substantial. This sweatbox model benefited from the 2005 reforms to US bankruptcy law which delayed the ability of individuals to file for bankruptcy, extending the time an individual was in the sweatbox of increased financial distress.

Recent studies by the Financial Conduct Authority suggests that the sweatbox model is alive and well in the UK (here and here).  The Authority highlighted two issues. First  a significant group of borrowers carry potentially problematic debt for a number of years with some making repeated minimum payments. Second, they identified a higher risk  group who move swiftly from acquiring a credit card into potentially problematic personal debt.  A  quarter of cards opened in 2013  in this market segment were in serious or severe arrears a year later.  Over 20 percent with serious arrears did not have an active card in 2012 suggesting a ‘rapid descent into arrears’.  The FCA noted in an understatement that these data raise  problems about  the affordability assessments which companies are required to undertake of potential customers. A product which results in a  failure rate of 25 percent would normally not be permitted on the market.

These findings on the use of credit cards must be set in the economic context of the UK with relatively stagnant real wages for many, insecure employment and currently the lowest savings level (3.3 percent) since 1963.  Many writers have underlined how loans may substitute for stagnant wages but that this cannot be a long term fix for the economy.

The FCA propose several behavioural remedies for consumers and earlier intervention by creditors to address persistent arrears. However the ability to write-off debt swiftly would provide a way out for debtors and complement other techniques such as responsible lending. Unfortunately the complexity of current debt write down procedures (IVAs, debt management programmes, bankruptcy, Debt Relief Orders) in England and Wales make this more difficult. A damning report by the FCA on the debt advice industry (here) indicates that advisors often did not give balanced information about insolvency alternatives.

Credit card use raise wider questions about the contemporary role of credit in the UK.  The governor of the Bank of England introduced a recent  financial stability report  with a concern about existing vulnerabilities from high and rising UK household indebtedness. On April 4 the Bank of England Financial Policy Committee noted the continuing rapid growth in consumer credit (here).  At the same time the  respected Institute for Fiscal Studies reports that based on the Autumn  2016 budget statement  real wages will, remarkably, still be below their 2008 levels in 2021. One cannot stress enough how dreadful that is – more than a decade  without real earnings growth. We have certainly not seen a period remotely like it in the last 70 years’

The Institute of Fiscal Studies concluded also that middle income families with children are no longer so different from the poor: almost half middle income families are now renters (home ownership in the UK has reduced from 72 % in 2007 to 64% in 2016 ) and middle income families with children get 30% of their income from benefits and tax credits. This means that credit use is likely to increase as middle to lower income earners use it as a defensive strategy to maintain living standards . Austerity also means individuals having difficulties with current commitments such as utilities and council tax, described by the Institute of Fiscal Studies as a tax ‘deliberately regressive in design’.

These conditions fuel the growth of sweatbox lending and the resulting household misery for some. Solutions may require action at micro- and macro- level. But there is no doubt that action is necessary.

Damning report on debt management advice by Financial Conduct Authority–need for comprehensive review of insolvency alternatives

The FCA published on Thursday 25th June a damning thematic review on the quality of debt management advice, concluding that the quality of advice was of an ‘unacceptably low standard’.   Advisors often did not  make an adequate assessment of individuals’ revenues and expenditures  or give balanced information about insolvency alternatives.  For example, they often reinforced customers’ initial reluctance to consider bankruptcy and played on misconceptions about bankruptcy to deter them from this alternative. The FCA reported ‘many instances where customers were recommended very long-term debt management plans (often many decades…) when debt relief solutions are likely to have been more appropriate but adequate information and advice was not provided”(para 4.55). In one case a debt advisor failed to correct a debtor’s misconception  about the effects of bankruptcy and recommended a debt management plan lasting 125 years! Firms often had incentive structures for selling debt solutions.

The study was primarily of the fee-charging debt management industry but it was also critical of those firms providing free debt advice to consumers, indicating that there was ‘scope for material improvement’.

These findings are perhaps not surprising given the continuing concerns expressed about practices by some debt management companies by Parliamentary Committees and the Office of Fair Trading.  Studies in other countries have raised similar concerns. In a recent  article Stephanie Ben-Ishai and Saul Schwartz studied how not-for-profit  Credit Counselling Agencies in Canada gave advice to individuals with debt problems. Using carefully scripted mystery calls to credit counselling agencies  Ben-Ishai and Schwartz found that the agencies surveyed  did not present the options for dealing with a debtor’s financial in a complete and impartial manner and did not present bankruptcy as a viable option. The focus was on ‘fitting the caller into the requirements’ of a debt management plan. They concluded that although the agencies portray themselves as debtor-friendly they operate rather as collection agents.

A fundamental concern in England and Wales raised by the FCA report is whether these practices by debt management companies are  undermining public policy on debt relief by steering individuals to debt management plans rather than permitting individuals to make a ‘fresh start’ through bankruptcy or a debt relief order and becoming productive again. Joseph Spooner and myself have commented elsewhere on whether England and Wales has struck the right balance between the wide variety of repayment plans, sometimes lasting many years, and the straight discharge of most debts. Almost one-third of Individual Voluntary Arrangements fail to complete. Many individuals may choose a repayment plan because they assume it will be better for their credit rating (and they may be able to retain their home) but credit reference agencies make little distinction between bankrupts and those who have been on repayment plans. The complexity of the English system with its many alternatives also creates difficulties for individuals choosing the best option, and increases the power of private and public intermediaries in the system, whose financial incentives may not align with public interest concerns.

“A very intrusive proposition”?–the long and winding road to payday loan price controls


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.


Payday lending–high profits and debt collection practices

Two recent interesting events occurred in the regulation of payday lending in the  UK. First, the provisional findings of the Competition and Markets Authority (formerly Competition Commission) investigation  into payday lending.  The Authority’s research provides a wealth of carefully documented  data on the industry and users of payday loans; that they are more likely to be male, in full-time work, younger than the general population, often using the loans for living expenses and as a response to an unexpected change in income.  They are not the poorest consumers with median incomes of £16,500. The average consumer takes out 6 loans a year with repeat business accounting for 80 percent of new loans. The industry is dominated by three large lenders, Cash Euronet and Dollar Financial (both US owned) and Wonga.

A central conclusion of the Authority  is that because of  competition failures  lenders have been making supranormal returns : the average return on capital of the major lenders being ‘high and in some cases exceptional’.  The provisional remedies proposed include :  a trusted comparison website, improving consumer awareness of additional charges, helping consumers to assess their own creditworthiness, periodic statements of the cost of borrowing, and measures to increase the transparency of lead generators.  The Competition Authority  has been here before.  After  its investigation of home lending  it proposed a not dissimilar set of remedies to make the market work better.  These remedies  had a very modest impact on the market. The report is therefore disappointing in its response.

The second is the revelation  that  the payday lender Wonga between 2008 and 2010 was sending  debt collection letters from fictitious law firms threatening further legal action if the overdue loan was not repaid.  As the  Financial Conduct Authority (which succeeded to the investigation initiated the OFT)  notes ‘this practice was adopted with a view to maximizing Wonga’s collections by unfairly increasing pressure on customers. Charges were added to customer accounts before and/or after these letters were sent out’.  This practice appears to be  a  breach of the Consumer Protection from Unfair Trading Regulations in relation to consumers, licensing rules for credit companies,  and more generally section 40 of the Administration of Justice Act 1970. The  Financial Conduct Authority (FCA ) required  Wonga to establish a consumer redress scheme overseen by an independent entity under section 166 of the Financial Services and Markets Act 2000.The expected compensation is over £2million to approximately 45,000 customers.

The practice of using misleading letterheads to unfairly threaten debtors is not new. Section 40 of the Administration of Justice Act 1970 was enacted because of extensive evidence presented to the Payne Committee on the Enforcement of Judgment Debts of the use of misleading techniques  at that time such as the ‘blue frightener’—debt collection letters written to resemble court documents. The Wonga case demonstrates that we cannot assume that companies learn from the past or will comply with widely known legislation unless strong regulation exists to ensure that the ground rules of a fair marketplace exists.

With the growth of inequality  payday lending is an example of the extent to which individuals trying hard to make ends meet–some  of whom may be part of  the new precariat –borrow money at high cost  from  high income investors or savers. Borrowing can help to smooth consumption needs but this form of lending is problematic if it is compensating on a continuing basis  for insecure and stagnating incomes. Payday loans are a symptom of broader economic problems associated with an economy of unequals driven by private debt.  Effective regulation of the industry should therefore be only one part of both analysis of the role of  consumer credit institutions in contemporary society and  measures to reduce inequality.




Credit Unions: Fiftieth Anniversary

The Guardian notes that it  is the fiftieth anniversary of the establishment of the first credit union in England. Developed primarily in West Indian communities as a response to discrimination by the mainstream financial sector they drew on the ‘partner’ model of saving which existed in Jamaica and other Caribbean countries. It was not until 1979 that a proper legal framework was introduced. Although the Credit Unions Act 1979 was described by the Observer as ‘an acorn from which a veritable grove of credit union trees will grow’ credit unions remained a tiny part of the lending landscape in England and Wales. The Griffiths Commission in 2006 indicated that most credit unions have less than 200 members, lacked modern management skills and  suffered from the image of being the ‘poor man’s bank’. Legal restrictions on the scope of membership (the requirement of a common bond) limited their growth and in 2012 there were only about 400 credit unions in the UK serving under 1 million individuals.

Legislative reforms  have made it easier for credit unions to grow and the Coalition government is committed to promoting the growth of the mutual credit sector hoping that it might provide an alternative to the high-cost loan market. Credit Unions however continue to represent a very small part of the UK credit market. There is also the paradox that if credit unions grow to become more ‘modern’ they may lose their community and social orientation and become more like mainstream financial institutions.

A good question is why mutual credit institutions did not take root in England when they did in countries such as Germany, Ireland and Canada. The Crowther Committee  on Consumer Credit reported in 1970 that ‘the principle of mutual aid has never taken such strong roots in the credit field in Britain as it has in other countries’.

Consumer credit and consumers in vulnerable circumstances FCA report

The new Financial Conduct Authority has published a report on factors contributing to debt problems. Change in individual circumstances and high levels of existing debt are central factors. Others include  lack of savings, and lack of confidence in managing financial products.  Low income individuals are more vulnerable to these risk factors and have higher debt-to-income ratios than other groups. The FCA therefore conducted qualitative research on attitudes and uses of credit among individuals with low incomes (bottom 10-15 percent of household income). The research identified three groups: “survival borrowers”; “lifestyle borrowers” and “reluctant borrowers”.  The first two groups used primarily low-income credit such as home credit, rent-to-own,  and catalogues. The last group who had faced income setbacks and were struggling to manage credit, would ‘reluctantly’ access mainstream credit such as overdrafts and credit cards.

The research is part of FCA work on high cost short-term credit, problems with credit cards, overdrafts and log book lending, and debt management. The paper represents an ongoing discussion on the concept of “vulnerability” in credit relationships–a concept which the report admits is hard to define. They define a vulnerable consumer as ‘someone who, due to their personal circumstances, is especially susceptible to detriment”. This does not take one much further since it might include personal characteristics (impulsiveness, lack of confidence)  particular circumstances or  structural factors (low income).

A number of previous policy studies exist on  the vulnerable consumer by for example the Office of Fair Trading and Consumer Focus and  modern concern about  the high cost credit for low-income consumers goes back to  the famous books by David Caplovitz, The Poor Pay More (1963)and Consumers in Trouble: Debtors in Default (1974). The  continuing problem is that credit is generally a regressive product i.e. the more income and assets you have the less you pay.

The FCA  might find some  assistance  in the recent  book Scarcity  by Sendhil Mullainathan and Eldar Shafir. They  suggest that lower-income consumers have similar behavioural biases to other consumers but that the pressures of  poverty make it difficult to focus, resulting in a ‘tunnelling’ of vision. The poor are often as well-informed as affluent individuals but they have much smaller room for errors in decision-making  and therefore must make better quality decisions. The many pressures on their time mean that they are more likely to be myopic in decision-making and not attentive to long-term costs. Mullainathan and Shafir refer to the problem as an absence of ‘bandwidth’ –represented by scarcity of money, unpredictability of income, and lack of buffers. Policy solutions might  change the institutional context of lending along with measures which radically reduce the costs of decision making. Mullainathan and Shafir’s focus on the context of decision making  provides a better explanation of vulnerability than individualistic explanations which  ‘assume that the problem lies with the person’ and imply policies to change the consumer rather than the institutional framework.