The collapse of payday loan company Wonga prompted many calls for more responsible lending, including by MP Stella Creasy and the StepChange charity. They emphasize the need for responsible lenders who ensure that potential borrowers are able to repay their loans before entering into a contract.
New responsible lending regulations had a positive effect on the unsecured short-term loan market, leading to the demise of Wonga and others offering similar products in the short-term credit market. But it is clear that this policy has not addressed the heart of the problem. Several million UK citizens need short-term credit to supplement the poor and abusive pay schemes they experience in the workplace. The way many businesses operate must change.
The two phantom chancellors, John McDonnell, and Archbishop of Canterbury, Justin welby, recently spoke of the fact that too many people are stuck in precarious jobs, forcing them into “debt slavery”. This is corroborated by all the research, which clearly shows the growing problem of income inequality through abusive employment contracts.
About 4.5 million workers are on CDD or zero hour contract. Most of these jobs are in the service sector and reflect the needs and demands of society. The need for elderly care, the demand for fast food, and direct sales from warehouses, for example, are all driven by the odd-job economy.
Employers emphasize the need to control costs, matching workers’ hours to meet the changing nature of demand. The result is temporary or zero hour contracts, which tend to be poorly paid. These jobs represent a large part of Britain’s record unemployment levels and the expansion of the labor market in the coming years may well hinge on the expansion of these jobs in the service sector.
It is these relatively low-skilled, low-paid workers who are the targets of payday loan companies and other short-term credit providers – not the unemployed. It is these workers who may be able to repay at least the initial loan and interest. But it is these workers who often fall into the loan trap.
Initially, they may face the loan repayments, but then find themselves in additional debt due to an unforeseen incident, such as the need to replace or repair household equipment like a washing machine. This situation often results in default on one loan and the need to take out another loan, resulting in additional costs and interest payments on the renewal of existing loans. Subsequently, many borrowers find themselves in so much debt that they are unable to repay. It still remains an attractive proposition for greedy credit companies.
Nature of lenders
In this debate, it is important to appreciate the nature of the companies operating in the short term loan market to understand their motivations and how they interact with their customers. The pie chart below shows the various costs and benefits as a percentage of total revenue for Cash America, one of the leading payday lending companies in the UK, which was featured in the report. Payday Loans: Fixing a Broken Market commissioned by the Association of Chartered Accountants.
Similar trends can be expected and observed for other payday lenders. Losses are incurred due to non-repayment of loans (often classified as bad debts). But, as the graph shows, despite a significant number of people struggling to repay, the business is still able to generate a reasonable profit. Such business models in today’s struggling economy can only be described as toxic.
Another characteristic of these companies is the sophistication and extent of their advertising and marketing. Through television, sponsorship of popular football teams, and the use of social media, they are able to target and capture their customers. They also have fast and sophisticated systems for registering clients in less than ten minutes. Just type “quick loans” into a search engine and you’ll get multiple money offers within minutes with no credit history.
It is a highly competitive market with companies paying for high profile advertising niches. The question is: should companies that target vulnerable people exist in a modern society?
I would say that investors have a big role to play in shaping the behavior of the companies in which they invest. Investors should intervene by pushing for better behavior or withdrawing their investment. This would end toxic companies that have business models targeting vulnerable borrowers and also those that pursue bad employment practices.
United Nations support Principles of responsible investment is an international network that promotes responsible investment. It has a rapidly growing community, which has subscribed to its six guiding principles and strives to incorporate these principles into their own investment and ownership decisions. The signatories of the principles have estimated investments at 73 trillion dollars worldwide.
The principles are primarily driven by environmental, social and governance (ESG) issues, which are considered the three central factors for measuring the sustainability and ethical impact of an investment. There are growing evidence that these ESG factors, when integrated into investment analysis and portfolio construction, can provide investors with long-term performance benefits.
This gives one more reason to stop investing in companies with bad employment practices and payday lenders. Meanwhile, regulators should also promote investor action to tackle intolerable personal over-indebtedness in society.