Introducing price caps in the UK – a discussion fraught with myths

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:

  1. 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.
  2. 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
  3. 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:
    1. 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.
    2. 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.

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9 Responses to Introducing price caps in the UK – a discussion fraught with myths

  1. Andrew Smith says:

    I agree high cost credit is the outcome of a flawed system and ti would be good to reform this.

    You said: “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”.

    I’m not sure it’s true we don’t know what high cost lenders are making. Take Provident, in 2010. Annual report shows year end receivables of £1,219m and profit before tax of £142m. That’s a profit of 11.6%. Doesn’t sound unreasonable to me.

    • Veronika Thiel says:

      I’m not sure these profit calculations are enough to decide if the prices are unreasonable or not – this is the murky waters of accountancy that I would be very reluctant to stick my toes in. I think extracting 11.6% in profits from the poorest is not really palatable, but that’s an ethical discussion that the blog is probably not the best place for.
      Would also be interesting to see the profits of payday lenders – but that’s even more complex given their often international ownership structures.
      The fact remains that risk profiling for most lenders, be they mainstream or not, are by all accounts and purposes black boxes. More transparency would be a good thing in any case.

  2. Andrew Smith says:

    The thing is that, if you reduced their current profit down to the level they might achieve if only allowed to charge £35 per £100 borrowed they would,pro-rate be making profit of less than 1.5%. Very few would stay in a market to reap that sort of reward. These ratios seem to fit quite well with the risk/reward balance identified by the Rowntree studies. Charities could do it cheaper – but not by much.

    For me, real solution is to force mainstream banks to lend in a market place where risk indicates they are going to lose – but we’ve a snowballs chance of that happening… So, why not say that above a certain rate, lenders can make no more than a total annual advance of X% of income, that they cannot make more than Y advances per year and none may be concurrent?

    • Veronika Thiel says:

      I’m totally in agreement with you that we need to get banks to lend in a market place, so a CRA style legislation is needed. I’m on the other hand not sure if you’re ideas re restricting the amount people can borrow would work – incomes fluctuate, proof of income is not as simple to check as you’d think (especially when it comes from similar sources), and income doesn’t tell you anything about expenditure patterns – you’d have to look at disposable income, which banks are supposed to do now, but which the high cost credit market tends not to do. As per limiting the rolling over of loans – sure, that would be good in any case (albeit some evidence from the US suggests there are ways around it, and a C4 programme a couple of years ago showed that Payday lenders in the UK circumvented their own rules – would have to dig around for that programme…). But it remains that if you don’t cap the cost of credit, lenders in this market will always be tempted to go as high as possible. Re the JRT reserach you are referring to – it leads me straight back to my question how important home collection really is, especially if there were a cheaper alternative. Why the insistence on home collection?
      (for me, it has a lot to do with the oligopolistic structure of home credit and the subsequent power the sector has obtained- I hope to tackle this in another blog soon once my day has more than 24 hours…).
      And again, profit calculations can be tweaked, one way or the other. Before there isn’t more transparency, I won’t buy it…

  3. In 2003 Richard Murphy produced this analysis of Provident Financial, which shows the case for a price controls on doorstep lenders:

    • Veronika Thiel says:

      so sorry for the delay in approving your comment – it somehow landed in the spam folder…
      Many thanks for sharing!

  4. Brendan says:

    If someone you had never in your life met before (or maybe never met at all in the case of online lending) asked you for $300 out of your pocket. How much would you want to be paid to make the risk worthwhile. remember these people have been turned down by everyone else because of bad credit and they are considered high risk. I personally feel that $21 per $100 isn’t enough. Of course lenders lend to more then one person so its not this cut and dry but the principal remains the same. Also I in no way agree with multiple rollovers. That practice is indeed predatory and should be regulated. Just some food for thought…..

    • Veronika Thiel says:

      Brendan, it’s very difficult to compare situations across countries, but it is a bit of a myth that Payday lenders have a massive risk – after all, they do have a legal right over your paycheck, and if you look at my next blog, or this research ( opens as pdf), it becomes clear that lenders make their money (in the US – we don’t know about the UK) – mostly from penalty fees. It’s all good to say that only roll-over practices need to be tightened up, but in reality, it appears as if the industry finds a way around this. Also, there are affordable lenders, both in the UK and the US, who manage to offer loans for cheaper than payday lenders. Again, lots of caveats for country- and product comparison, but if there is a way to give people access to credit when they need it, at cheaper prices, then that should be promoted, at the expense of the expensive lenders.

  5. Brendan says:

    Just because a company has a legal right over your paycheck does not mean that they are guaranteed the money. (In the USA, UK laws are different) Many payday loan companies will use EFT charges to your bank account and if someone is really looking to avoid paying the debt they can simply remove the funds before they have a chance to get “dinged”. In the UK the borrower must approve every EFT before it happens making it even harder for a lender to collect. Also Payday lenders can and do use variable pricing. The higher the risk the higher the price. This means that you will receive a higher rate the first time you borrow from a lender and a lower rate with access to bigger loans the more loans you take out and repay. As someone within this industry I can say that (within my company) profits are not made off the first few loans. There are simply to many customers that default on their loans. (for clarification my company allows 1 rollover). For a lending company to be successful it must create a stable base of borrowers that it can rely on to have a low NSF (default) rate.

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