In a previous article, Lending Times examined how the new CFPB rules may affect small-dollar lending in the US through the outlook of compliance attorney Justin Hosie. This examination continues in today’s article. Lending Times interviewed a representative from the Consumer Finance Association (CFA) about similar regulations that were enacted in the UK in 2014. Though the regulations in the UK did cause a decline in the number of small-dollar loans issued each year, the lending environment has become much safer and financially responsible for the consumer. By looking at how consumers and lending firms in the UK have evolved post-regulations, it’s easier to imagine the future of small-dollar lending in the US once the new CFPB rules go into effect.
The Decline of the Industry Also Means a Decline of Default Rates
The UK regulations that were put in place in 2014 focused on managing payday loan risk and had an immense effect on the number of small-dollar, single-payment loans. According to our CFA contact, “the loan volume was reduced by 70% between 2013 and 2016.”
UK regulators began the process of limiting the number of loans by first addressing the firms issuing payday loans. Companies were forced to reapply for specialized payday loan licenses, which immediately shrank the market from approximately 240 to approximately 60 licensed firms.
Not only did the number of companies offering small-dollar loans shrink, but so did the number of eligible consumers. In assessing risk, lenders were forced to ask “Should I lend to this person?” and “Will it cause them detriment?” rather than “Can I get my money back?”
As Hosie suspects of the number of consumers who can qualify for US loans under the new CFPB regulations, an enormous number of people were no longer eligible for small-dollar loans in the UK under the 2014 regulations. While this surely had a negative effect on revenue in the industry, it was slightly balanced by the positive effect it had on default rates. The main objective of both the regulators in the UK and in the US is to protect the consumer. With the decline of the industry, there has also been a decline in default rates; the traditionally high-risk small-dollar loans are becoming much safer for both the consumer and the lender.
The Inevitable Evolution of Regulated Small-Dollar Loans
The regulations in the UK created changes for the companies offering small-dollar loans as well as the type of consumer applying for small-dollar loans. The first change to discuss in the evolution of small-dollar loans in the UK is the shift in customer base. Our CFA contact attributes the decline to slight change in demographics of the typical borrower, who has a higher income than the typical borrower of the past. While fewer people are able to qualify for small-dollar loans under the stricter regulations, the people who can qualify are much more likely to pay the loan back in a timely manner. This creates a much less risky market for lenders and loan investors.
Although the evolution of the small-dollar loan consumer is notable, the more pertinent change that came along with the regulations in the UK was within the lending firms. After the Financial Conduct Authority (FCA) placed a .8% daily interest rate cap and 100% total cost cap on small-dollar loans in early 2015, many lenders had to significantly redefine their product in order to comply with regulations. For the most part, firms have shifted from single payment payday loans to short-term installment loans. Firms that were able to adjust in order to comply “came out in better shape” in the end, according to our CFA contact, with a “more robust business model and more long-term sustainability.”
Providing Protection or Leaving Consumers Behind?
Like the regulations proposed in the US, the regulations in the UK focused on affordability or the ability for the consumer to repay. For the millions of consumers who were no longer eligible for small-dollar loans due to their forecasted inability to repay, the options for credit were and remain limited. A good number of consumers in the UK have sought out other forms of loans, such as credit cards and home equity loans, and a small portion of borrowers even turned to illegal lenders, though it is very hard to monitor or gather statistics for illegal lending. Many opponents to the new CFPB regulations in the US argue that the rules on small-dollar loans could harm millions of Americans in financial need.
The Role of Technology on the Road Forward
The optimistic outlook is that while the new regulations might hinder some people from qualifying for small-dollar loans, in the long run both lenders and consumers will evolve to create a much healthier lending environment. A road to a financially secure and socially responsible America may be through the use of technology. After two years with the similar regulations in place, the UK market has proven to be “resilient and adaptable.” The US market may also persevere if FinTech companies can rise to the challenge. Our CFA contact believes that by using the latest in analytics, lenders can move past the notion that regulators are over-policing the market and work with them to “adapt and thrive.”
The UK market has looked to the US for help on the technology front since their regulations were put in place in 2014. It is time that the US take advantage of tech companies to comply with regulations. Through alternative data, lenders in the UK and the US have been able to “underwrite risk, profile clients, [and] predict behavior.” While the road to a fully compliant and a financially responsible US may start as a bumpy one, it will undoubtedly be made smoother with the use of technology and innovation.