Are alternatives to high-cost credit feasible?
26 September 2019
The high-cost credit market has had its fair share of change since the FCA took over regulation of the sector in 2014. As an ever present priority for the FCA, improvements to consumer outcomes in this market have been made through product interventions and by requiring better transparency, fairer collection practices and responsible lending. In tandem with these more immediate changes, the FCA has also been reflecting on longer-term solutions - alternatives to high-cost credit - to more sustainably protect the three million UK consumers using high-cost credit products. A shift towards cheaper, more sustainable alternatives could reduce instances of consumer harm and financial vulnerability, but a number of business model, legislative and consumer barriers currently stand in the way. What are these, and how can they be solved to improve the feasibility of alternatives to high-cost credit?
The element the FCA and Governmental bodies have the least control over are the business models alternative lenders choose to adopt, and the subsequent barriers these create. Credit unions, Community Development Finance Institutions and local authority assistance funds all present credible alternative products to high-cost credit. But, the way they operate makes wide-spread adoption less feasible. One challenge is the face-to-face, branch-based nature of these models. A lot of high-cost credit users need loans quickly (often the same day) to cover short-term funding issues. Combine this with a lack of automated lending technology and it is apparent that alternative lenders often won’t be able to meet the needs of typical high-cost credit users. Without changes to acquisition channels and investment in technology, the feasibility of alternatives to provide for the wider high-cost credit market is very limited.
But not all barriers are a result of firms’ operating models. Legislative barriers, ones that the FCA and Government do have control over, are also creating obstacles to growth and feasibility. A number of policy changes have been implemented recently, or are underway, to help foster greater uptake and understanding of alternatives, such as clarifying rules for registered social landlords (RSLs) and the credit information market study. But some existing legislation is actually detracting from innovation and growth - most notably for credit unions. Credit union legislation limits activity to certain statutory objects and caps the amount of interest that can be charged to 3% per month. This gives unions very limited ability to offer loans to higher credit risk consumers as they cannot price in the risk. Eligibility for unions also requires a ‘common bond’ - something all customers have in common. This could be geographical proximity to the lender or certain employment or occupation conditions. While these requirements work well on a smaller scale, they present a barrier to wider growth, especially with regards to higher risk customers.
The third and final barrier to feasible alternatives to high-cost credit is consumer awareness. The FCA’s research shows that many high-cost credit consumers are unaware of, or do not fully understand, the offering of existing, more affordable alternatives. For these consumers, who are typically financially vulnerable, ‘mainstream’ high-cost credit appears to be the easiest and most convenient option. Unfortunately for some, the lack of awareness of alternatives can be the start of spiralling debt. This is especially the case for users of home-collected agreements and payday loans. Decisions may also be influenced by consumers’ attitudes towards money, financial literacy and the lack of information by service providers about more suitable alternatives.
This is where banks and other mainstream lenders can help. Banks and lenders should consider the best strategy for when, and how, support is sign-posted to customers who are experiencing financial difficulty. The need to find alternatives to high-cost credit also presents an opportunity for banks and lenders willing to take on higher risk consumers. Consumers who, if nurtured with credit building, low-cost products, could well form loyal customers in the future.
A large part of the solution though is for HM Treasury, the FCA and the BoE to review the way credit union objectives and powers are framed; and the way in which membership restrictions operate. Given the various factors affecting the feasibility of alternatives, it is evident that no “one size fits all” solution is possible to replace high-cost credit. But a joint effort by support services, firms, regulators and Government will help make alternatives more feasible and accessible for those who need them most.