Part of the UK financial system is being squeezed out of existence. It’s time to have a proper plan for what takes its place.
To get a sense of the mood in the UK subprime sector, look at Amigo: its shares dropped as much as 60 per cent on Tuesday after a court rejected a scheme to cap compensation payouts to 1m current and former customers. The proposal was a response to a deluge of complaints regarding mis-selling and affordability checks.
Amigo charges 49.9 per cent APR on loans (defined as mid-cost) that require a family member or friend to act as guarantor. Its shares had already plummeted by a third on Friday as investors digested the objection of its regulator, the Financial Conduct Authority, to its plans. Amigo has said the alternative could be administration, but on Tuesday said it was considering all options, including appeal.
Separately, door-to-door lender Provident Financial has proposed its own scheme amid rocketing complaints, which also needs a court blessing, and said it would close its high-cost home credit unit.
These companies’ troubles rarely inspire much sympathy. A tighter framework around repeat lending and affordability was needed. But a sharp shift in regulatory attitudes, and a wave of complaints geed up by claims management companies, is creating a market failure, when rising financial vulnerability means alternative finance is most needed.
This is not a niche problem. The FCA, pre-pandemic, said 3m consumers used forms of high-cost credit, excluding overdrafts. But the number ill-served by the current system is far larger: Fair4All Finance, a group that works to tackle this issue, says there are 11m people in the types of vulnerable financial circumstances that exclude them from mainstream provision, 3m higher than before the pandemic.
The backdrop is a subprime credit sector that has been shrinking as regulation has ramped up. In high-cost, short-term credit, one subsegment where prices were capped in 2015, the number of lenders has fallen by nearly two-thirds since 2016, and the number of quarterly loans is down more like 90 per cent. Much of that is down to payday lender Wonga’s demise. But less egregious business models, such as home credit, have also shrunk.
The conversation tends to get stuck debating whether aggressive regulation is forcing people into the arms of illegal money lenders. This is not just big guys with baseball bats: illegal credit providers can operate online, be surprisingly slick and become entrenched quickly. The FCA argues that people turn to informal sources instead, like friends and family, itself not necessarily benign nor ideal.
What’s needed is more attention (and money) directed at expanding alternatives that can provide financial products in a sustainable and responsible way. Evidence suggests that affordable credit provision, such as through community development financial institutions (CDFIs), can help reduce the poverty premium and improve financial resiliency, according to the University of Salford.
If companies such as Amigo and Provident look for a new model, that may mean moving up the credit spectrum. Not-for-profit CDFIs tend to serve people in more vulnerable circumstances, even compared to other community lenders such as credit unions. They cover their costs and provide a return to their investors. But a limited pool of funding, plus little money spared for corporate infrastructure or marketing, means the sector remains low profile and tiny: it lent £26m in 2018.
The government has effectively acknowledged this issue. It has since 2019 given Fair4All Finance £96m in money from dormant bank accounts, of which £35m is dedicated to demonstrating how affordable credit can be expanded.
But the pace must increase to match the unravelling of the commercial sector and the growing need. The US is putting $12bn into its CDFI sector as part of pandemic relief. Other countries, such as Italy, France and Mexico, have an established public-private model where upfront investment helped create a large microfinance institution focused on areas of market failure.
Longer-term, there may be a need to look at the mainstream banks’ obligations. High-cost lenders such as the Provvy grew out of the reluctance of mainstream lenders to serve those markets. The US has since the 1970s pushed banks to meet the credit needs of whole communities, including low-income households.
Tougher regulation was one step towards a better functioning credit market. There is a big job left to do.
helen.thomas@ft.com
@helentbiz
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