Where will struggling households turn to after UK clampdown on payday lenders?

The South African-born entrepreneurs Errol Damelin and Jonty Hurwitz could not have predicted the impact they would have when they set out to disrupt the 120-year-old payday loans market in 2006.

The founders of Wonga set up the company to serve cash-strapped borrowers just as the UK was heading for economic meltdown in the 2008 financial crisis. But the now disgraced lender – which charged some vulnerable customers interest rates upwards of 5,000% – became a lightning rod for controversy before its collapse in 2018, and sparked a regulatory crackdown on the UK’s unscrupulous payday loans market.

Since then, the market Wonga once dominated has almost halved. More than 50 firms have collapsed or voluntarily closed. No new payday loan providers have gained the permission of regulators to operate since, leaving fewer than 40 high-cost, short-term lenders in operation.

While consumer advocates have cheered their steady demise, questions have been raised over where the country’s most vulnerable households might turn to next to make ends meet. Amid the cost of living crisis, some industry figures say a more tightly regulated payday loan sector could have a role to play.

Regulators at the Financial Conduct Authority (FCA), the City watchdog, aired concerns earlier this year about the relatively small number of high-cost lenders left in the market for borrowers who fail lending criteria for mainstream banks.

At its May meeting, FCA board members said the reduction in high-cost lenders, “with rising inflation … was likely to cause a number of pinch points where consumers will need access to money quickly and options would be limited”.

With the decline of the payday loans market, hopes were raised that more socially responsible options such as credit unions and nonprofit community development finance institutions could plug the gap. However, there are concerns that they will struggle to scale up quickly enough to help everyone who needs financial support over the coming months.

Fears have been raised that more people could turn to illegal loan sharks to make ends meet. According to the Centre for Social Justice, the thinktank co-founded by the former Conservative leader Iain Duncan Smith, more than 1 million people are now using illegal lenders in England.

Others are turning to unregulated but legal forms of lending such as buy now, pay later (BNPL) schemes run by firms including Klarna, Clearpay and Laybuy. Although borrowers often are not charged interest on their purchases, shoppers are still at risk of overextending themselves with debt. The firms are not required to offer forbearance or compensation when things go wrong.

“This cost of living crisis is the potentially the most worrying I recall in my 25-plus years as a campaigner,” says Mick McAteer, a former FCA board member and a co-founder of the Financial Inclusion Centre research organisation. “So the risk of people turning to loan sharks may well increase.

Wonga logo
Wonga collapsed in 2018. Photograph: Dominic Lipinski/PA

“[And] while BNPL may not have the sort of excessive, exploitative terms and charges as payday and other sub-prime loans, the product encourages overconsumption of borrowing. This is bad for consumers in the long run”

Research released by Barclays Bank and the debt charity Stepchange in June found that almost a third of BNPL borrowers said their loans had become unmanageable and had pushed them into problem debt. Shoppers who used BNPL were paying off an average of 4.8 purchases – almost double the 2.6 purchases in February, the research found.

With concerns about illegal and unregulated lending on the rise, some high-cost lenders claim they offer safer choices for borrowers, despite years of alleged mis-selling of loans to vulnerable borrowers.

Jason Wassell, the head of the high-cost credit lobby group the Consumer Credit Trade Association, says there is still a place in the market for private lenders. “At this point already, demand far outstrips supply,” he says.

“What we’ve seen over the last few years is the departure of a number of lenders. That’s led to a reduction in access to alternative credit, and that’s causing a problem for families around the UK, particularly those that have been underserved or not very well served by the banks in the past.”

Executives at the guarantor lender Amigo – which lets friends and family vouch for and agree to cover any unpaid loans for cash-strapped borrowers – say they have learned their lesson after a deluge of affordability claims almost pushed Amigo towards collapse, forcing it to pause lending at the start of the coronavirus pandemic.

Jake Ranson, Amigo’s chief customer officer, says his team are “not apologists for Amigo’s previous practices or products”, which included selling unaffordable loans to customers, who were typically charged about 49.9% interest.

He now hopes the FCA will give them the green light to restart lending under a new brand, RewardRate, from as early as September, offering new features such as lower interest rates if borrowers make payments on time.

“We will be doing weapons-grade affordability tests, using things like open banking, and making sure that customers speak to a human … and that they understand the responsibility that comes with having the product,” Ranson says. “It’s a very different proposition.”

Notes and pound coins
With concerns about illegal and unregulated lending on the rise, some high-cost lenders claim they offer safer choices for borrowers. Photograph: Dominic Lipinski/PA

However, consumer campaigners are worried. Sara Williams, of the Debt Camel blog, is sceptical that the wider high-cost credit industry is any safer or more suitable for vulnerable consumers, even after the regulatory crackdown. “Debt is rarely helpful in this situation,” she says.

Rather than a reboot of the payday lending market, more government support for struggling families is vital, she says. In the interim, consumers would be better off looking at debt management plans on any existing borrowing.

Last year, 4.4 million people across the UK borrowed money to make ends meet, according to figures from StepChange. About 71% said using credit had negatively affected their health, relationships or ability to work, while two-thirds said they were only able to keep up with payments by skipping housing or utility bills, or cutting back to the point of hardship, putting them at risk of further financial harm.

StepChange said the risks vulnerable borrowers faced were not because of a lack of high-cost lenders in the market. Instead, it pointed to the lack of other options available when consumers were hit by unaffordable bills or unexpected costs.

“Turning to sub-prime lenders should be a last resort,” McAteer says, adding that it is problematic that the UK has failed to build up a “larger nonprofit lending sector” to deal with the current crisis.

Nonprofit social enterprises lend only £25m a year, and serve as few as 35,000 customers on average. Despite their declining presence in recent years, payday lenders still managed to lend about £60.4m in the first quarter of 2022 alone, according to the FCA, while home-collected creditors lent about £95m in the final three months of 2021.

“We are seeing a welcome increase in the number of people using credit unions and other nonprofit lenders. Credit union membership has now risen above 2.1 million. But it’s not enough,” McAteer says. “There is a real chance that nonprofits will be outgunned financially by commercial sub-prime lenders supported by private finance institutions.

“We need emergency measures to help households survive the crisis, and then medium-longer term measures to help people build financial resilience against future shocks, which will come. We have made almost no progress in building financial resilience since the 2008 crisis. Will we learn the lessons?”