This week the FCA published an update on its work in the high cost credit market. A fuller picture of the FCA’s position and potential interventions in the rent to own, home credit, catalogue credit and overdraft markets is expected in May 2018.
The FCA rightly recognises that there is a place in the market for high cost credit, and that when done fairly and with reference to affordability it provides a social value. But problems arise because many users of high cost credit are unable to access mainstream finance (usually due to a thin/poor credit file) and are often on low or precarious incomes, so they are vulnerable to high cost products becoming unsustainable. The nature of high cost credit products means that rent-to-own debts are larger and home credit is held for long periods of time so the interest charges compound. For vulnerable consumers this can translate into unmanageable problem debt, which has proliferated in the UK consumer credit market in recent years. Given that outstanding borrowings from high cost credit more than doubled in 2 years it is right that the FCA is concerned.
Responsible Finance welcomes the FCA’s investigation beyond payday lending into the wider high cost credit markets. We also welcome the emphasis that the FCA is putting on supporting ethical alternatives to high cost credit, such as responsible finance providers. Regulatory intervention in the payday lending market resulted in firms tightening their affordability criteria and rightly so. But that meant some consumers lost access to credit. After the payday lending interest rate cap was implemented the FCA estimates that 800,000 consumers became excluded. For many of these consumers the inability to borrow meant going without an essential car repair, borrowing from friends and family which comes with its own complications or turning to illegal loan sharks. This highlights the difficult balance between lenders operating more fairly and affordably and supporting vulnerable consumers facing financial challenges.
Responsible finance providers offer a solution to maintaining this balance. As mission driven lenders, responsible finance providers offer affordable credit and financial capability support to consumers who may otherwise borrow from high cost credit. On average the sector is at least 2 to 3 times cheaper than a high cost lender, providing immediate consumer savings. Affordable finance and wrap-around services such as access to savings accounts and advice ensure the consumer is better off and more financially resilient at the end of their journey. There are roughly a dozen responsible finance providers operating around the UK lending £22 million to 55,000 consumers each year. So while responsible finance providers are a proven alternative to high cost credit, the sector needs to scale significantly to reverse the consumer detriment currently at play.
The FCA recognises the potential risk to consumers by intervening further in the high cost credit market and identifies responsible finance providers as a key to unlocking a fairer and more inclusive consumer credit market. The update highlights several challenges to scaling:
- Access to capital: responsible finance providers do not take deposits so they must raise all of their capital to on-lend externally. Currently there are limited sources of capital for the sector. Between £1 million and £4 million is secured each year mostly from social investors. This is not enough to fuel the transformational growth that is needed.
- Marketing: although they are innovative in how they reach their customers, responsible finance providers have limited marketing budgets compared to the commercial lenders and struggle to become a household name. The majority of customers come through word of mouth and referrals from other local institutions such as housing associations, credit unions, and advice agencies. This reflects that they are trusted providers and provide a positive and respectful customer journey.
Responsible Finance is advocating several innovative solutions to address these challenges, which are also flagged in the FCA update.
- First, we propose establishing a responsible finance fund for personal lenders. We are currently exploring routes with social and commercial investors. But first loss capital is an important element for de-risking and catalysing private investment. The lack of first loss capital in the sector is the major barrier to the launch of a fund.
- Second, we are advocating for a personal lenders tax relief. There are currently no policy tools in place to incentivise private investment into the sector. A tax relief incentivises investment through providing additional return in the form of a relief on the investor’s tax bill.
- Finally, we are exploring the possibility of credit unions as a source of investment into responsible finance providers. This was identified as a potential opportunity in our 2017 research on local finance partnerships. We are applying to the FCA Sandbox to test this model out.
The FCA states that they believe “the sector needs to be self-sustaining in order to offer the prospect of expansion and long term service… although we have seen evidence of pump-priming being effective”. Without any policy support for at least five years, responsible finance providers have had to be entrepreneurial and develop sustainable business models that operate at tight margins.
The “pump-priming” levers highlighted above would set the sector on a pathway to scale, with greater lending volumes stimulating investment into marketing, infrastructure and systems. With a greater presence, responsible finance providers can forge new partnerships and continue to grow their brand.