Non mainstream credit reform: What it is and why we need it

What’s the problem?

More and more Britons are taking out short term loans with high rates of interest - often higher than 4,000% APR - so that they can make it through to pay day or because they cannot find access to other types of credit. Currently more than 1 million people take out payday loans, while more than three million take out home credit loans which are administered door to door.

Many are low and middle income workers trapped between stagnating wages and high street banks’ unwillingness to lend following the 2008 financial crisis.

Meanwhile, 5 to 7 million Britons have no choice but to turn to the short-term market, as they do not have a bank account or credit history, according to the Better Banking Coalition.

The result has been an explosion in the UK short-term loan market, having more than trebled since 2006 to £1.2 billion in 2009 according to Consumer Focus. We have now reached a situation where:

• Private debt in the UK stood at £1,500 billion in April 2010;

• Ten per cent of those taking out pay day loans have an income of less than £11,000 according to indepenent researcher Policis;

• Forty six per cent of those taking out pay day loans have a hosehold income of less than £15,500;

• Around ten per cent of single parent households rely on non-mainstream loans, such as payday loans, home credit loans or pawnbrokering services; and

• Around a million Britons are struggling with debt but are not seeking help.

So what’s being done about it?

Backbenchers in the House of Commons are trying to guide the Consumer Credit Regulation and Advice Bill though Parliament to regulate the industry, just as credit and store cards work within legal guidelines as well. It is due to be debated on Friday. But without government backing, it will struggle to reach the statute book.

The MPs behind the bill are proposing a motion on Thursday, which calls for the introduction of a variable caps on interest rates for different loans. If enough parliamentarians vote for the motion, then the government may decide to back the bill as a whole.

The bill itself – which campaigners hope will receive a second reading on Friday - would further restrict creditors when chasing payments for debts that were missold, introduce a levy on creditors to fund debt advocacy services, empower local authorities to regulate credit selling companies in their areas and help credit unions expand.

Hold on. Surely if you take out a loan, it’s your fault if you don’t pay it back?

Personal responsibility has a massive role to play in this. But, as noted above, we are currently in a period when most people are seeing their wages stagnate, and prices increase. The whole point of payday loaning is that it is used by people who are earning enough (at least initially), but have problems with cash flow. Payday debtors typically run out of money on the 20th day of the month according to the Association of Business Recovery Professionals.

The chief executive of the country’s largest payday lender, Peter Crook, recently said that he was likely to see a large increase in his “target audience” owing to rising levels of unemployment, while Consumer Focus predict a potentail growth of 40-45% in the number of short-term borrowers in the next few years.

Surely this is an imposition on the free market?

A free market is not a free for all. Just like a game like football needs rules – like the offside or back pass rules – to make it more effective, so too does the market. The government already regulates store and credit cards, and some of the stiffest regulation of short-term lending is found in the US, where some states have a cap as low as 12 per cent APR.

In fact, high interest rates can distort the market, as it becomes in creditors’ interests to keep people in debt rather than have them pay off the loan. The regime this bill proposes is closer to the European than American model – where a regulator sets variable caps on interest rates, depending on the product.

Will it drive the poorest to illegal loan sharks?

Extensive European research, published in September 2010, found that while the 12 per cent cap found in some American states did lead to a rise in illegal loan sharking, there was little correlation between the different levels of caps in european countries, which vary considerably.

For example, while the interest cap on short-term loans is 133 per cent in France, it is 453% in Slovenia. In fact, higher rates of illegal loan sharking were found in countries without a cap. This may reflect what happens when individuals become seriously indebted to legal loaners.

Isn’t this just banker-bashing from a vote-hungry Labour Party?

While the bill is being spearheaded by the respected Labour MP Stella Creasy (Walthamstow), it has received support from Conservatives as well, especially at committee stage. It is being co-sponsored by Justin Tomlinson, MP for Swindon North.

Those who have either publicly backed the passing of the bill or backed giving it parliamentary time include Mike Freer (Finchley and Golders Green), Andrew Bingham (High Peak), Andrew Percy (Brigg and Goole), Tracey Crouch (Catham and Aylesford), Jackie Doyle Price (Thurrock), Chris Kelly (Dudley South), Robert Buckland (Swindon South), Anna Soubry (Broxtowe), James Wharton (Stockton South), and Stephen Barclay (North East Cambridgeshire).