The discussion around price capping for credit has warmed up again over the past few months thanks to the sterling work of Stella Creasy who is campaigning to introduce a cap on the total cost of credit in the UK.
There are many good arguments for the cap, which would prevent the usurious pricing practices that are in place at the moment, e.g. charging £85 for a loan of £100, for the sole reason that the banks won’t touch you. The Competition Commission in its inquiry to the home credit market has found that the cost is too high – but the measures it suggested to rectify this have not resulted in decreased lending costs.
Opponents to a cap bring some arguments forward that are in and of themselves logic – but there is not a lot of evidence to back these arguments up. Furthermore, they often confuse interest caps with price caps, two related, but different things. In this blog, I will briefly summarise the opposition’s views and set out why they are wrong.
Firstly though, a word on interest rate caps vs total cost of credit. Interest rate caps put a limit on the annual percentage rate that you can charge on loans, for example, a maximum of 20%. This is not a good measure, as APRs are confusing and not a good indicator of price. The longer the loan repayment terms, the lower the APR – but the higher the overall cost of credit, and vice versa. Also, interest rate caps can be circumvented as there is no clear agreement what costs should be included in their calculation – e.g. admin fees, early repayment fees and similar. Hence we are talking about a cap on the TOTAL COST OF CREDIT, a level which still has to be set, but would probably be somewhere between £25 and £35 per £100 lent. This is clear cost structure that people can understand and which is much harder to circumvent. This is what is currently proposed and opponents should be aware of this. Suggesting that Stella Creasy is proposing an interest rate cap is misleading and heats up an already charged debate.
But now for the arguments:
- Caps on the cost of credit would drive people into the arms of illegal loan sharks. A logic argument, but albeit a hypothetical one. As I have pointed out in my report Doorstep Robbery, the research suggesting that there are high levels of illegal lending in countries with interest rate caps (note that this research was NOT about a cap on the total cost of credit is flawed. Furthermore, a report for the European Commission on interest rate restrictions in European countries (opens as PDF) on has also found that there is no empirical evidence for this link.
- A cap would put high cost lenders out of business. Again, a logic argument, but not one necessarily borne out by reality. The industry justify its charging of high prices with the high risk that they incur. However, payday and home credit lenders won’t share their pricing models, so we don’t know if their prices are actually justified by the risk. The aforementioned Competition Commission investigation is littered with blanked-out numbers in the name of protection of commercially sensitive information, so we simply don’t know if the high prices are really just down to the high risk profiles of customers, or if they are routinely overcharging their clients. Given the fact that companies keep on lending to the same people, it would suggest that clients do repay, and that their risk profile is actually not as high. Furthermore, companies like Provident Financial does operate in two countries with a form of price ceiling – namely Poland and Ireland. So, there is again no evidence that a price cap would necessarily result in the demise of the high cost lending sector
- People like home credit. A form of high cost lending that is often singled out is doorstep lending where collectors will come and collect instalments from their clients home. The Joseph Rowntree Foundationconducted research in 1994 that shows that people liked this element of home credit as it requires them to be disciplined and have the money ready at a fixed date in time. The Competition Commission’s report also found high levels of satisfaction, and clients were aware that they were paying a high price. So, why try and stop something people like? Two reasons:
- Firstly, home credit is for many the last option, especially for those without bank accounts. If you have not got an alternative, then of course you will like the services offered by the one company that will deal with you. If there were an alternative, e.g. the increased provision of affordable lending that offers exactly the same services but minus the expensive doorstep collection, would people really baulk at dropping off their money at an office around their corner if it would save them around £50 per £100 borrowed? Somehow, I think not. The question is how important the home collection element really is, especially in those areas where affordable credit is available.
- Secondly, the research conducted is quite old now, especially the one by the JRF – things have changed in the meantime. Recent research by Human City* shows that debt is high on the list of problems among social housing tenants, and that would like to see social landlords offer them affordable credit options. This new evidence should be taken seriously as it suggests that people are falling out of favour with high cost credit. With the expansion of affordable credit provided by CDFIs and Credit Unions, people also have more options available to them, and it would be interesting to see the choices people make in areas where affordable credit is established.
In short, the potentially negative consequences of a price cap might be hypothetically logic, but are not borne out by empirical evidence.
There are many more points that I could discuss here, but a blog is too short to deal with them all at the same time – I hope to do so over the course of the summer. Two points to finish though:
Firstly, there is an absolute need to limit the availability of high cost credit as more and more households struggle to make ends meet and to service their debt. If people can’t afford repayment of their existing (and quite possibly cheaper) credit options, surely throwing extraordinarily expensive credit at them will only add fuel to the flames – it’s a short-term solution, but one that could quickly lead to a debt trap, and will hinder personal recovery.
Secondly, the continued insistence by opponents of price caps that it would especially be harmful to doorstep lenders and their clients is a curiously defeatist point of view. Is home collection really the best way to serve the poor? It is unacceptable in my view that the poorest have to pay the highest prices both from a moral as well as an economic perspective: high cost lending is not a social service to the poor, it’s the outcome of a deeply flawed credit and savings system in the UK that does nothing to help people out of poverty. A cap on credit costs is a first step in rebalancing this system.
*In the interest of transparency, this research was supported by Compass who are campaigning with Stella Creasy for the introduction of a price cap.