Payday lending offers small sums for short periods of time at very high interest rates. Society would be a better place if people learnt to manage without these facilities. But human frailty is such that they never will. As with prostitution, gambling, the supply of recreational drugs and the consumption of alcohol and tobacco, payday lending is undesirable but inevitable.
Last week the Financial Conduct Authority announced a clampdown on payday lending, capping interest rates, limiting the number of times a loan can be rolled forward and requiring more effective checks on affordability. The FCA claims that these curbs will put almost all payday lenders out of business. Last week Wonga, the highest-profile lender, had to write off a bunch of loans it should never have made.
Payday lending refutes the proposition that if you give consumers enough information, rationality will guide them towards wise choices, a claim central to financial regulation. Insistence that lenders give prominence to the effective annual percentage rate of interest they charge – typically several thousand per cent – has not checked demand.
The business has expanded because the internet has made application and assessment easy while social media have supplemented conventional sources of credit information. Once, you might have been refused credit if you did not have a bank account; now you might be refused credit if you tweet inappropriate things. It is a world apart from the time when the only route to a loan was an interview with a stern-faced bank manager.
Policy approaches to socially undesirable activities range from an outright ban to a free market with heavy taxation. Both have been applied to alcohol. America’s failed experiment from 1921 to 1933 showed that prohibition does not work. We are now learning, very slowly, the same lesson in relation to drugs.
The more determined are attempts at law enforcement, the more organised and menacing the criminal activity which continues the supply. In both the prohibition era and today’s war on drugs, the elaboration of criminal organisation reached levels which threatened the legitimate authority of states. The criminalisation of users fills prisons with people guilty only of lack of willpower and also stimulates other petty crime.
But the application of the opposite approach to tobacco – a legal but taxed business – has allowed smoking to remain a significant cause of death. The results are both fiscally and socially regressive.
So how much regulation is desirable? The trick seems to be to allow enough legal leeway to keep both crime and social harm at modest levels – a pragmatic approach which leaves no room for the moral fundamentalism which motivates many campaigners. Gambling in Britain illustrates this well. Liberalisation in the early 1960s went too far and encouraged “the mob” to cross the Atlantic. A tightening of regulation in 1968 centred on rigorous control of the integrity of business and individuals. Recent further liberalisation was driven more by ideological commitment to deregulation than a spirit of cautious compromise and may have given too much freedom to problem gamblers.
So what are the lessons for payday lending? Financial services regularly fail to draw on the experience of regulation of other industries. Change should always be incremental. Payday lending changed its character because technological changes made it possible to target a new demographic profile. A genie has escaped the bottle, and it has to be coaxed back gently; attacked directly, it is likely to prove slippery and evasive. The FCA has ample experience of regulation which fails for these reasons.