Payday lending and other providers of short-term credit are in for an interesting ride in the UK with the FCA confirming price caps on the market. With an interest cap of 0.8% per day, fixed default fees and a total cost cap of 100%,the caps aim to lower the cost for borrowers and protect borrowing from escalating debts. The objective is admirable and aims to walk the fine line of crushing the industry business model and preventing spiraling payday debts.
If the price cap was any lower, then we risk not having a viable market, any higher and there would not be adequate protection for borrowers.
The sad reality of the market, as tempting as it may be to paint the entire ‘payday’ sector in a negative light, is that the economics of providing a payday loan is expensive. When one puts together the costs of acquiring customers and giving out small loans, it’s a tough business to build sustainably, no matter your intentions. Just ask microfinance organizations founded upon social missions that charge triple-digit APRs and are still not self-sufficient.
For there are fixed costs that must be paid in making the lending decision, having the physical infrastructure to make the loan. There’s a default rate that must be covered. Lending small sums of money for short periods of time is just an expensive thing to do. Therefore borrowing small amounts of money for short periods of time is an expensive thing to do.
As Wonga has shown, eliminating a lot of these fixed costs can make a business profitable. According to the FCA, maybe too profitable. But to look at why it’s so profitable we need to dig deeper and not ask about just the lenders, but the borrowers as well. Because without the borrowers, we wouldn’t have lenders. So is this market really demand- or supply-driven? Clearly many people in many cases need short term loans for various things. If the FCA regulations kill a strong portion of the short-term lending market because their fixed costs don’t allow them to operate sustainably at the lower interest rates, to whom will this market turn?
Likely, they will have two options: either existing service providers who have to rapidly reshape their business models to survive and compete or new service providers who are digital, lean and can provide these products profitably. Wonga may have been the biggest, but we believe this is just the start of the market shift. Categorizing payday lending in one bucket does the borrowers a disservice. Each borrower needs short- to middle-term access to small capital and the product that the market has been putting out there has been categorized ‘payday loan’. Yet, the needs of the borrowers are different, and until now they have had few choices but to choose a ‘payday loan’ product. Now we’re seeing more new, innovative and digitally-provided products come into the market via cost-efficient channels which can directly address needs, rather than just supply.
As the FCA regulations hamper many existing payday lenders, new business models will rise up to take their place. Some, like SavvyLoans, are exploring longer-term securitized loans. Others, like L.O.A.F.™, are leveraging social behaviour concepts to go back to the roots of lending and provide flexible payback at a fraction of the cost of alternatives. Yet others, like StudentFunder, address the root financing needs for investments and hopefully can reduce the need for payday lending altogether.
Businesses like VexCash in Germany show this market can be serviced at lower interest rates in profitable ways. Which models will thrive though remains to be determined: technology-driven efficiency, product pricing, marketing, brand, reputation and service quality are all at play to make payday lending alternatives viable.