As 2015 gets underway, short-term lenders have retained their place in the media and regulatory spotlight with the introduction of a cap on the amount customers can be charged for their loans. This fundamental intervention in the market is not the only test facing the industry this year. Additional measures from the Competition and Markets Authority are still to come, even before lenders have gained authorisation from the industry regulator.
There's no doubt that the Financial Conduct Authority (FCA) has already created a new lending landscape for short-term lenders. Since it took over regulation of consumer credit in April last year, payday lenders have introduced tighter affordability checks using the latest technology that have had a significant impact with 54% fewer loans being granted and rollovers down by 75%; these will become an exception for new loans.
The cap came into force on 2 January 2015. It has three components: an initial cost cap of 0.8% a day; fixed default fees capped at £15; and a total cost cap of 100% of the amount borrowed. So customers will pay £0.80 per day for a £100 loan over a month (£24 per £100 borrowed). If you are unable to pay, then your debt can never be more than double the amount you originally borrowed.
All of the Consumer Finance Association's members have revised their products to ensure they are compliant with the new rules. However, the cap will undoubtedly have consequences for some borrowers and is a game changer for all lenders. Indeed, the regulator believes that it will be game over for some lenders due to the commercial impact on their business models.
With the cap still in its infancy, prices of loans have been set at or very near the cap. This is inevitable as lenders face the dual demands of a significant revenue drop at the same time as rising regulatory compliance costs. In time we may see risk-based pricing, but initially any innovation is stifled by the threat of the regulator and fear of being accused of regulatory arbitrage.
So we can expect to see fewer people getting loans from fewer lenders and the loans on offer will be evolved from payday to take account of the cap. The commercial reality is that the days of the single-payment loan are largely over - payday loans are being replaced by higher value loans over extended periods. So perhaps the start of 2015 is the time for a new definition of the market. Rather than 'payday loans' or 'high-cost, short-term credit', it should now be fixed-cost short-term credit.
The full impact of the cap on the short-term credit industry will only be known in time, but history shows that choking supply distorts markets and does not reduce demand. Unfortunately, illegal lenders profit most.
This is borne out by recent research of UK borrowers, which showed that only a quarter of people turned down for loans under tougher lending criteria said that they were better off not getting the money; the rest incurred charges for missed payments. A third said they considered using an illegal or unlicensed lender. So the regulator will need to monitor this closely and act to prevent illegal lenders filling the credit gap.
Those that doubt this significant risk need only look towards the United States. Forty-five US states have some form of price cap on short-term loans yet a new study by Policis found that six-in-10 online payday transactions made in the US are arranged with unregulated lenders, and 37pc of US payday loans are made in states where such borrowing is already banned or severely restricted.
So into 2015 and beyond we can expect to see fewer lenders granting fewer loans, resulting in a greater dependence on state support and rise of the grey and black markets.
The leading lenders are, of course, embracing the new regulations, including the cap, but it is clear that the challenges for the industry are not yet over. Lenders still need to be granted full authorisation, or permission to do business, from the FCA and the market inquiry by the Competition and Markets Authority is still ongoing.
Payday loans (fixed-cost short-term loans) account for less than 1per cent of consumer credit, but the regulator's intervention in this market clearly demonstrates its commitment to stamping out poor lending practice and protecting consumers from becoming over indebted. For that reason, providers of overdrafts and credit cards and other high cost credit providers should take note.