A new breed of lenders is overwhelming the regulators. These are the online lenders who account for 75 percent of payday loans made to consumers in Australia. ASIC (the corporate regulator in Australia) has them in its sights as the level of lending increased exponentially since they first began to advertise their loans. The advertisements suggest they can easily solve all your short-term money requirements instantly.
Even the Advertising Standards Board believes these lenders are exploiting people in financial hardship. One lender’s ad includes a woman who cannot pay her phone bill because she took too many selfies! Then the lender’s mascot appears and suggests she get a loan from them. Another has a young couple enjoying an extravagant birthday party for their son but cannot afford to pay the entertainer. Once again the lender’s mascot appears with the offer of a loan. It is however clear that these quick and easy solutions can easily end up as long-term problems.
We can make fun of these two examples and even suggest that consumers who make irrational spending decisions should suffer the consequences. Aren’t these exactly the type of people who actually take out the loans and who regulation is meant to protect?
The costs are significant, e.g. an establishment fee of up to 20 percent of the loan amount, a monthly loan fee of 4 percent per month and an interest charge equivalent to 39.2 percent per annum on top of everything. If you are already in financial difficulty, it is hard to see how this will get you out of it unless you are planning to win the lottery next week to pay it off. There is yet to be a good study on who are taking out these loans in Australia. But it is unlikely to be those who understand the financial implications — it is likely to be those whose level of financial literacy is low.
Another of the problems with payday loans is that they often require borrowers to have an automatic and direct debit taken from their bank accounts, or a deduction from their pay. This, of course, reduces lenders’ risk. Yes, payday loan companies have to spend money in court to collect on some debts. But, in general, the bank accounts of borrowers and the paychecks of employees make very good sources of repayment.
The ASIC has pointed out that some online lenders are also not adhering to responsible lending policy, i.e. some are using algorithms that do not properly take consumers’ financial information into account. Nor do those algorithms assess the spiral of debt created through refinancing loans over and over. One such lender has been ordered to refund $1.6 million to over 7,000 customers after being found to be engaging in irresponsible lending.
This type of lending is infinitely more abusive of those who can least afford it and are often those already marginalized in society. Many consumers are not going to understand the problems likely to ensue from such loans. Rather, the uninformed borrower just sees a quick and easy solution coming in the form of a payday loan. Perhaps a bit more financial literacy and more effective regulation would reduce the debt spiral.
Regulatory issues must be addressed, but without better financial acumen the consumer will continue to be a mark for predatory lenders. These egregious lending practices do however provide an opportunity to reinforce the need for financial literacy classes in the school system. The price of education is high but the price of ignorance is higher.
John Hoffmire is director of the Impact Bond Fund at Saïd Business School at Oxford University and directs the Center on Business and Poverty at the Wisconsin School of Business at UW-Madison. He runs Progress Through Business, a nonprofit group promoting economic development.
Deborah Cotton, Hoffmire’s colleague at Progress Through Business, did the research for this article.
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