There’s little doubt that the clampdown on payday lenders that saw limits on interest charges and a cap on the total cost of a loan was necessary to control the UK’s growing personal debt burden (source). However, the requirement for short-term credit has not gone away, and with fewer lenders competing for customers, we are now seeing the return of high-cost personal loans.
Initially, credit unions were touted as the answer to the UK’s demand for short-term personal loans. They charge comparatively low-interest rates on small loan amounts and even aim to improve the financial literacy of their borrowers. However, credit unions continue to be few and far between and are not expanding quickly enough. In their place, private lenders are once again popping up and charging exorbitant interest rates, and with few other alternatives, borrowers are being left with little choice but to accept them.
To cap or not to cap
Payday lenders argue that higher interest rates were justified because of the substantial risks involved in lending to borrowers who had often been refused a loan elsewhere. Although the caps were successful in reducing the cost of borrowing, another consequence was that many short-term lenders left the market (or simply died off in many cases).
As a result, some consumers now struggle to access credit as they cannot pass the more rigorous affordability checks that online lenders such as Wonga, which still operates in South Africa and Poland, now perform.
Given the reduced access to credit, there are concerns that some borrowers who may already be indebted could be left with little choice but to approach illegal moneylenders for a loan. They have interest rates and collection tactics that are far worse than those favoured by regulated payday lenders. Swayed by these arguments, several European countries, including Ireland, are considering whether increased regulation and high-cost debt warnings in loan advertisements could provide a better solution than caps which force lenders out of the market and reduce the credit supply.
The role of credit unions
As things stand, credit unions are one of the few potential solutions to the personal debt problem in the UK, as they provide short-term loans at affordable rates while encouraging regular saving and providing financial education and information. However, there are just 440 credit unions in the UK, with market penetration relative to the total population of just 3.5%. Clearly, credit unions need to have a greater presence, particularly online, and provide quicker lending decisions if they are to satisfy the demand.
Boosting credit unions would provide healthy competition for the digital lenders and give borrowers a viable and more affordable alternative. With demand for personal loans now bouncing back after a pandemic slump, credit unions must step up to provide ethical lending at competitive rates.
Have you borrowed money from a credit union? If not, why not? Please share your thoughts with our readers in the comments below.