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Should Households repay their debts?

This post is a video. Here at:  https://www.youtube.com/watch?v=_sCAG3Cn0O0&index=24&list=PL_voamVqJ_ZyVoZdGh4ov5u1PseEJxwEX

 

 

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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.

How useful is debt counselling in bankruptcy?

Several countries (Canada, US, Scotland)  now include debt counselling as part of the  individual bankruptcy process but evidence is limited as to its beneficial impact.

Many official inquiries have supported the integration of counselling in the debt enforcement system.  In the 1960s and 70s  counselling was justified  by the  perception of a debtor as needing assistance in managing her financial affairs and possibly having wider problems in coping with life.  The English Payne Committee (1970)  proposed a social service office for debtors as part of a state enforcement office based on ‘abundant evidence that many debtors incur and fail to pay their debts because they are inadequate personalities or irresponsible in managing their affairs… They need to be assisted to financial health and stability.” (para 1210) Social workers would ‘perform for financially incompetent or inadequate or irresponsible debtors, the functions which are discharged for more successful members of the community by bank managers, accountants or solicitors’ (1216).   The influential Brookings Commission study (1971) in the US  proposed that financial counselling should be available to all debtors after finding  that 31 percent of debtors attributed their problems to poor debt management,  and  the US Bankruptcy Commission(1973) proposed that access to bankruptcy should be dependent on a debtor receiving counseling by the new administrative  agency which would administer the bankruptcy process. The Bankruptcy Reform Act 1978 contained no formal requirement for counselling. The US National Bankruptcy Commission in the late 1990s endorsed the introduction of counseling on a voluntary basis.

Canada pioneered in 1992 the legislative  introduction of two counseling sessions during bankruptcy for individual bankrupts (see here).  The objective was to prevent repeat bankruptcies and to further rehabilitative goals of behavior modification.  The Insolvency regulator (Office of Superintendent of Bankruptcy), debt counselling agencies and the Canadian Bankers Association supported its introduction.   In Canada the trustee (or their delegate) must now: (1) make a pre bankruptcy assessment outlining options including that of a consumer proposal (repayment of a portion of debt usually over three years), (2) provide an initial counseling session shortly after bankruptcy is declared entitled consumer and credit education and (3) a second session shortly before discharge which normally takes place nine months after the declaration of bankruptcy. Counselling is financed by a fee which comes out of the bankruptcy estate– $85 for each stage of counselling-usually made from income payments by bankrupt. Ninety percent of the sessions last under one hour. Counselling is  a condition for receiving a  discharge. The current Directive (OSB 1R3) defines it as ‘educating debtors on good financial management practices, including the prudent use of consumer credit and budgeting principles, developing successful strategies for achieving financial goals and overcoming financial setbacks and where appropriate making referrals to deal with non-budgetary causes of insolvency (ie gambling, addiction, marital and family problems)’.

Has the Canadian system of counselling achieved its objectives? It is difficult to measure this rigorously because one ideally  needs a  control group who go through  the process without counseling.  In early reviews  bankrupts generally were favourable in their assessments of counseling.  But does counselling change behavior or result in fewer repeat bankruptcies?  The only rigorous study of the Canadian system using a control group, conducted  by Saul Schwartz and published in the American Bankruptcy Law journal in 2003,  concluded that counseling did not lead to ‘any appreciable improvement in future creditworthiness’ and ‘has little effect on repeat bankruptcies in the first five years after an initial bankruptcy filing’. In Canada the overall repeat filing rate has increased from 10 percent in 2002 to 15 percent in 2011 and 16 percent in 2012.  Notwithstanding these data a recent evaluation  in 2013 by the Canadian Department of Industry argues that counselling has a positive impact because ‘debtors found the sessions useful’. The report  admits that ‘determining the effectiveness of mandatory counseling is challenging because it is difficult to disentangle the results of two counseling sessions from the broader changes that occur in a bankruptcy or insolvency’.  The study  suggests some short-term changes in understanding and behavior by debtors and notes that repeat bankrupts were slightly less likely to cite overuse of credit as a reason for bankruptcy. But the study is hardly a ringing endorsement for mandatory counselling for all bankrupts.

In the US the  2005 Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA)  introduced mandatory counselling  at the pre-bankruptcy stage as an eligibility condition for filing for bankruptcy and also  required bankrupts to undertake a financial education course during bankruptcy as a condition of receiving a discharge.   Pre-bankruptcy counselling is premised on the assumption that debtors turned too quickly to bankruptcy as a solution for their problems.  The Act is vague on the contents of the financial education course but the Federal US trustee has promulgated rules   which indicate that the course must include budget development, money management, wise use of credit (including distinguishing wants from needs), consumer protection, and coping with unexpected financial crisis. The financial education course must last a minimum of two hours  but may be completed in person, over the phone, or through the Internet.

Michael Sousa  in a recent article surveys existing  pre- and post- BAPCPA studies of voluntary counselling in bankruptcy.  He also  presents the results  of a qualitative study of  the effects of the BAPCPA counselling requirements.  Most debtors did not find the courses helpful. Pre-bankruptcy counseling was just ‘jumping through hoops’.  It did not have the consequences hoped for by Congress–where debtors rethought their decision and entered a debt management plan. Rather it either confirmed the correctness of  an individual’s decision  to file for bankruptcy  or helped to allay any fears about declaring bankruptcy.  Most debtors thought that a two-hour financial education course was not enough to provide long-term effects and in any event was  often inappropriate since many  individuals filed for bankruptcy because of  external economic changes unrelated to financial capability. Sousa concluded that the existing BAPCPA counselling requirements  are ‘by and large misguided and are in desperate need of overhaul and reform’.

Scotland  recently introduced counselling in the 2014  Bankruptcy and Debt Advice (Scotland) Act which Act will, according to the relevant Minister, Fergus Ewing,  deliver ‘the most significant change to the bankruptcy process in Scotland for a generation and take us closer to making the financial health service a reality’ (more on this claim in a subsequent blog).  Individuals must consult a money advisor before obtaining access to any  statutory debt relief. The policy objective is that of ensuring that individuals are aware of all debt relief options, although I suspect that it is partly motivated by the objective of ensuring that individuals do not enter too easily into writing down debt rather than the statutory Debt Arrangement Scheme which will generally require full repayment (again more about this on a further blog).   Financial education during bankruptcy is not mandatory for all debtors.  Only repeat bankrupts within the previous 5 years,  or debtors subject to  a bankruptcy restriction order made against them must undertake a course.  In other cases a trustee may refer a debtor to a financial education course where  ‘the trustee considers that the pattern of behavior is such that the debtor would benefit from a financial education course or the debtor agrees to undertake a financial education course.’  The Scottish legislation recognises that counselling is not necessary for all debtors. This suggests that legislators do learn something from comparative experience, since they seemed to be  aware of the criticisms of the US provisions.

England and Wales rejected  counselling in the 2002 reforms primarily because most groups consulted opposed its introduction. Debtors may therefore experience a variety of advice before and during insolvency,  depending on whether they seek advice in the public sector through Citizens Advice Bureaux,  non-profit debt counselling such as Step Change, or a private intermediary.

The UK is sometimes contrasted with continental Europe where it is assumed that a more ‘social’ approach exists to counselling debtors. But this is not the case. Counselling is not an integral part of the French process. Although debt counsellors play a central role in Germany, the large demand for their services means that they function more as processors rather than being able to provide substantial financial counselling. In Sweden, a recent official report was very critical of the standards of debt counselling which are operated by municipalities.

Debt counselling in bankruptcy is a programme which in the abstract can attract a broad support.  It is a policy around which a coalition of creditor, consumer and debt counselling interests can agree, and for regulators it gives a sense of purpose to the bankruptcy system–so the Scots view it as  part of a  ‘financial health system’. It is likely therefore to continue to be attractive but experience suggests an unwillingness by governments to invest significant resources in the project.

The credit counselling requirements are often  based on the assumption that bankruptcy is a consequence of imprudent or unwise use of credit or the need for individuals to adapt their credit behaviour to more desirable norms. But this is clearly not the case for many debtors who are subject to adverse changes of circumstances, unforeseen health costs or small business failures.

 

 

 

Troubling IVA statistics?

The Insolvency Service released  earlier this week statistics on Individual Voluntary Arrangements which provide over-indebted individuals the opportunity to repay over time a portion of their debts. Originally designed for  individual business debtors, enterprising accountants transformed IVAs into  a mass-produced consumer remedy in the early 2000s.  In a recent submission to the Insolvency Service, Joseph Spooner and I raised questions about the extent to which IVAs serve the public interest. The  recent IVA statistics underline these questions. The statistics indicate increasingly long IVAs of at least 5 years (the original model envisaged a three-year repayment plan). Only 33 percent of IVAs registered in 2008 had completed by October 2014. Over 35 percent of plans begun that year were terminated with the possible consequence of a subsequent bankruptcy for the debtor. These statistics are on their face troubling and demand further investigation. Perhaps the longer plans reflect the fact that individuals miss some payments because of a change of circumstance such as a period of unemployment or plans are modified. But these individuals might have been better to declare bankruptcy initially and make a swift fresh start,  benefiting the economy from greater productivity and  increased consumption.

Unfortunately no systematic empirical studies exist in England and Wales of the economic and social costs and benefits of  IVAs. No studies have attempted to assess debtors’ experiences of IVAs and whether they have a genuine fresh start at the end of five years.   Policy making on IVAs has been effectively privatised. The terms of IVAs are determined through private bargaining between creditor and debtor, against the background of a ‘protocol’ developed by bankers and insolvency professionals with modest input from public interest groups.

Debt Relief Orders should be more widely available

The Insolvency Service review discussed in a previous blog also raised the possibility of reforms to the Debt  Relief Order procedure.

Debt Relief Orders are a transplant  from New Zealand, which first promoted the so-called ‘no asset procedure’ in 2002.  The  English Department of Constitutional Affairs  floated the idea of  the DRO in 2004.  Its objective was to  provide a low cost alternative for individuals who could not pay their debts but who also could not afford bankruptcy (see here). It was viewed  as an alternative  for individuals currently using  the  administration order procedure. Evidence indicated that many of this group, primarily women, were unemployed  or living on a low-income.  They could not afford the bankruptcy fee and perhaps feared its stigma. The DRO would, according to the Department,  provide a less stigmatizing alternative.

The DRO is a highly targeted debt relief option, permitting a discharge of most unsecured debts after 12 months. It is limited to individuals with £15000 in unsecured liabilities, less than £300 in assets and no more than £50 in surplus income. It has certain attractive characteristics. It is an administrative process initiated online, uses ‘trusted intermediaries’ (e.g. CABx)  to screen debtors and attempts to reduce stigma by not using the term bankrupt (although the media sometimes call it bankruptcy lite). It also builds in safeguards. It can only be exercised once every six years and there is the possibility of sanctioning debtors under a Debt Restriction Order. Because England insists on a ‘user pay’ model of bankruptcy, applicants must pay £90 to access the procedure.

Preliminary evaluation  by the Insolvency Service in 2010 of the demographics of users indicates that the majority of users are unemployed (48% in 2013-14) at the time of entry.  Women are disproportionately represented (63 % compared with 51% in the population).  More under 25s (12 percent compared with 5 percent in population) use the procedure and  also slightly more in the over 55 population.  Almost 50 percent of users are single, a  larger percentage  than in  the bankrupt population.

The central question is whether the procedure achieves its primary goals of financial rehabilitation and avoiding financial exclusion. Unfortunately the Insolvency Service cannot answer this question because of the absence of data. Although it was tasked with monitoring the success of the DRO, cuts to the  resources of the Service mean that it cannot undertake this type of research. Evidence based policy is therefore not possible and the Agency is reduced  in its consultation to asking ‘stakeholders’ about their views on this question. This approach hardly substitutes for systematic research on key issues such as the ability of individuals  to get credit again, manage precarious finances, not suffer discrimination from landlords, or face difficulties with work. We might hypothesise that the DRO would reduce stress and the  mental and physical health effects of debt, and  possibly costs to the Health Service. Individuals may however be deterred from taking work during the 12 month period since this might result in a revocation of the order.  If this is the case (the Insolvency service provides no hard evidence on this point) then a 6 month period might be more appropriate as adopted in the recent Scottish Bankruptcy Act amendments (see here).

New Zealand assessed its procedure in 2011 (see here). The users of the procedure have a similar profile to English debtors, with an overrepresentation of women, high levels of unemployment and reliance on social security.   The review found some real benefits from the procedure: individuals  found it easier to manage their household finances, and it had a positive impact on health and family relationships. However debtors on social security continued to have problems and there were some negative aspects such as the inability to obtain new credit, some debtors losing  their jobs because of the order, and some landlords refusing to accept them as tenants.

A primary drawback of the process is its limited availability. A swift administrative process should be more widely available. Most bankrupts do not have significant assets or substantial surplus income. About two-thirds of bankrupts in England in 2013-14  had less than £2000 in assets and less than £30000 in debts. They are generally unfortunate in having suffered a change of circumstances or miscalculated finances in an economy where high levels of debt are the norm. Few are trying to act opportunistically.  The court process is itself increasingly  administrative in character and will be replaced by  administrative adjudicators once current reforms are implemented in 2016. There is modest investigation by the Insolvency Service of the majority of bankrupts. And an individual is discharged after 12 months. The main difference is the cost of bankruptcy with individuals having to pay over £700 in costs to access bankruptcy.

Other countries such as Canada have swift administrative processes for individual insolvencies. The great majority of Canadian bankruptcies are processed through a summary procedure (where the realizable assets of an individual are not likely to exceed $CAN 15000) with an individual being discharged after nine months.

Finally,  the DRO may not solve the problems of those living in precarious employment or on the margins of society and more research is needed on the longitudinal effects of bankruptcy and DROs in providing a ‘fresh start’.  It is a pity that the Insolvency Service was unable to undertake such a study.

 

 

 

 

 

Should Bankruptcy be used as an individual debt-collection device?

The Insolvency Service published on August 6th a consultation paper  on two issues: the role of Debt Relief Orders and the amount of debt necessary for a creditor to commence a bankruptcy petition. These topics  raise important issues about the role of  English personal insolvency law.  I will discuss debt relief orders in a subsequent post, and examine in this post the role of creditor petitions to enforce individual debts.

A threshold question is whether insolvency should be a proceeding available to a creditor to  enforce an individual debt and my analysis draws on an excellent recent article on this topic by Jason Kilborn and Adrian Walters in the American Bankruptcy Law Journal (for open access see here) which deserves to be read by English policy makers.

Insolvency is a collective procedure providing a mechanism for distributing an individual’s available assets equally among his or her creditors. Historically in English law it did function as a debt collection measure given the limitation of common law remedies and  English law continues to permit an individual to use bankruptcy to collect a single debt for over £750 through the statutory demand procedure. Under the procedure the creditor serves a demand for payment which if not paid within 21 days generally entitles the creditor to obtain a bankruptcy order.  Twenty one percent of bankruptcy orders (5378) in 2013 represented creditor petitions and 11900 petitions were commenced during this period. This is a much higher rate than in Canada or the US where creditor petitions are extremely rare.

Evidence indicates that a small group of ‘Repeat Player’ creditors use  this process–HMRC (tax), some local authorities for council tax and some  professional debt collectors.  Kilborn and Walters indicate that 34% of petitions were brought by HMRC in 2011.  Why do these creditors use this remedy? After all in a bankruptcy they will have to share any assets with other creditors. HMRC no longer has a preferential priority.  The reason seems to be  primarily that bankruptcy is a powerful threat.  Bankruptcy may not only be very costly for a debtor (loss of control over any property, high trustee fees, loss of professional status) but it continues to carry a stigma which can be exploited by the creditor. Under 50% of bankruptcy petitions result in court orders, suggesting that the threats do result in some settlements and an RP creditor such as HMRC may calculate that the benefits to it outweigh the costs. Kilborn and Walters also suggest that they may use bankruptcy as a way of ‘closing a file’, passing on the problem to the Insolvency Service who may have to administer the bankruptcy.

But this use of bankruptcy  and its threat are  problematic. Individuals may become further indebted in order to repay the individual debt or take some unwise action in response to the threat. Individual creditor action may disadvantage other creditors. Payment to the petitioning creditor is in substance  a preference for one creditor at the expense of another violating the bankruptcy principle of equal treatment of all unsecured creditors (creditors try to avoid this by requiring payment from a third-party).  Court time is wasted if the court has to dismiss the petition. The process deprives the debtor of the protection of the ordinary courts  in individual debt collection where an instalment order may be made for payment.  Disproportionate costs and fees may result for  a bankrupt. A Newsnight  investigation in 2014  documented an  individual with council tax debts of £1350 which transformed into a debt of  £80,000 through bankruptcy fees.  The use of the threat of bankruptcy where there is no real intention of carrying through on the threat would constitute an unfair commercial practice under the CPUT regulations. The Office of Fair Trading in 2009 imposed conditions on the credit licence of  Ist Credit, a debt collection agency, for its practice of indiscriminate use of statutory demands where it had no expectation of carrying through with the bankruptcy but used them as a draconian threat. See  here and here .

Those  English creditors who use bankruptcy most often to enforce individual debts already have a wide range of special  enforcement powers including imprisonment in the case of Council Tax. Other countries place greater restrictions on  the use of bankruptcy as a single creditor’s remedy. In Canada it is possible for an individual creditor to use bankruptcy to enforce an individual debt but the burden of proof is higher. A creditor will have to prove that a debtor has ceased to meet his liabilities generally and  some courts require proof  that there is some reason to invoke the machinery of bankruptcy investigation  such as suspected fraud or concealment of assets.  Only a small percentage of bankruptcy petitions are brought by creditors. In the US, involuntary petitions are possible but  extremely rare. US law places several hurdles including a minimum requirement of three creditors for an involuntary petition. See here .

What ought to be the role therefore of bankruptcy as an individual creditor’s remedy in England?  The following reform possibilities (either individually or in combination) exist:

  • Abolish the statutory demand procedure and require an individual creditor to prove that a debtor has ceased to meet her liabilities generally as they become due .
  • Increase the minimum amount of the statutory demand to a more realistic levels (at least over £10,000; Ireland recently revised its limit to €20,000).
  • Permit an individual creditor to institute bankruptcy for a single debt where there is evidence that the powers of a bankruptcy trustee investigation would be desirable or that significant value exists.
  • Provide greater scrutiny of the withdrawal of bankruptcy petitions and significant sanctions for bad faith withdrawals.

The Insolvency Service is unlikely to adopt bullet point one given the political opposition by creditors and lawyers embedded in English bankruptcy tradition. But this issue should  stimulate debate about the role of personal insolvency in English law.  Modern  individual insolvency law is primarily about debtor relief rather than distribution of assets or investigation of an individual’s affairs. Few individual bankrupts have significant assets which would be worth realizing. An Insolvency Service study in 2008 indicates that  over 66% have no or under £1000 in assets. A minority may be able to make some income contribution.  Most European countries which have introduced procedures in recent decades  for individuals to write down debt only accept filings by debtors (e.g. France, Sweden, Netherlands). The Debt Relief Order in England follows this approach but it has very restrictive entry conditions (which I will comment on in a subsequent blog). General commercial creditors have a variety of sanctions (credit bureau ratings) and monitoring mechanisms. The World Bank recognised this in its 2013 Report on the Insolvency of Natural Persons arguing that modern personal insolvency systems should control carefully the use of insolvency by creditors as an individual remedy.

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

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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.