Subprime lending and the fight against the sharks

Mark’s friend always said he would be there to help out if he ran into trouble. The two men worked together in a supermarket, came from the same immigrant background and shared mutual friends in their local community in London. So when family problems left Mark short of cash, an offer of £2,000 to help him through sounded very useful.

“A week later, he started to change,” says Mark (not his real name). “He showed his true face. Every day he would text me like ‘you have to pay the interest in 20 days, the next one is only 19 days away’. Every day he’d keep coming, harassing you, humiliating you.” 

High interest rates, missed payments and arbitrary additions led Mark to repay the initial £2,000 he borrowed several times over. Eventually, he says: “I worked out I will never get off his hands, will never be able to pay off the loans,” and he reported his one-time “friend” for illegal lending.

Mark’s experience is not uncommon. Though “loan shark” may conjure images of heavy-set men collecting cash with baseball bats in hand, in reality they are more likely to look like a work colleague, a fellow parent outside the school gates, or a member of the neighbourhood WhatsApp group.

It is hard to know the full extent of the problem in the UK, but experts say the breadth of customers vulnerable to illegal moneylenders is growing.

Cath Williams, a manager in the government’s England Illegal Money Lending Team, says that when she joined the unit in 2008, more than 80 per cent of victims it worked with were single mothers living in social housing and relying on state benefits. By 2019, more than half of victims were employed and one in five were homeowners.

Williams’ team was formed in the early 2000s as part of the Labour government’s efforts to improve financial inclusion. Two decades later, the Financial Conduct Authority estimates that 28m people — more than half of UK adults — have some elements of “financial vulnerability”. In February 2020, up to a third of adults had less than £1,000 in savings and one in 10 — about 5.6m people — had been paying a high-cost loan at some point in the preceding 12 months. The FCA defines high-cost loans as any with annual interest rates above 100 per cent.

As the country struggles to limit the economic disruption caused by the pandemic, many in the industry expect those numbers to rise, but the number of legal credit providers catering to poorer people is plummeting.

The “subprime” household lending sector once epitomised by names like Wonga, BrightHouse and Amigo is on the brink of collapse.

A small group of alternative providers is attempting to fill the gap, hoping to replicate the success of non-profit lenders in the US and elsewhere with a focus on local expertise. Despite the support of regulators, however, they are only meeting a fraction of the demand and sceptics question whether they will ever be big enough to make a difference.

Much depends on the success of such lenders and the recovery remaining subprime specialists such as Amigo: it will determine whether millions of poorer Britons continue to access credit or whether, as a group of MPs warned last year, a “perfect storm” of rising demand and falling supply will push more people toward illegal operators.

The end of doorstep lending

Bradford-based Provident Financial epitomises the rollercoaster journey that has led to a reduction in the number of regulated credit companies. The group spent more than a century providing “doorstep” loans through a team of local agents who would regularly visit clients to collect repayments and discuss their products.

Provident benefited from a surge in subprime lending following the 2008 financial crisis, when mainstream banks became increasingly reluctant to lend to anyone with even minor blemishes on their credit file. The share price quadrupled between 2009 and 2016, propelling it into the FTSE 100 index of the UK’s largest companies.

But its downfall was equally swift. A mismanaged restructuring was exacerbated by regulatory probes and rising volumes of consumer complaints until, earlier this year, it called time on the doorstep business entirely.

FCA action not only forced lending companies such as Provident to cut down on repeat lending and introduce stricter affordability checks, but allowed customers and claims management firms to retroactively complain about earlier loans that breached the new standards.

The weight of historic complaints crushed Provident’s home credit business, along with payday loan providers including Wonga and rent-to-own retailers such as BrightHouse.

To many, they will not be missed. Wonga drew particular ire for tactics such as encouraging students to pay for holidays with payday loans at more than 5,000 per cent APR, but it was far from the only lender that regulators said behaved badly.

Laura (not her real name), a nurse from Wales, says her local Provident collection agent coached her on how to answer questions to ensure she was approved for additional loans she should not have taken out.

“Thinking back on it now it makes me feel sick,” she says, but she listened to the agent’s recommendations at the time because “it felt like you knew her . . . she was a nice person”.

Malcolm Le May, who took over as Provident chief executive in 2018, once described his office in London’s landmark “Walkie-Talkie” skyscraper as an “embarrassing” symbol of Provident’s post-crisis boom. He says the company “lost touch with its roots” by chasing growth at the expense of customers’ wellbeing.

However, he believes there is also a “lack of understanding” among some politicians and campaigners who have been happy to see lenders disappear.

“Fewer and fewer products are available but I don’t know that the demand has changed . . . if it carries on like this you have to assume that part of the community is going to go to the unregulated market.”

Executives are divided over how feasible it is to sustainably lend to borrowers with the weakest credit histories or lowest incomes.

Provident will continue to offer what it describes as “mid-cost” credit through its credit card and vehicle finance businesses, but will not return to the riskier end of the sector. Le May says “a number of forms of lending have become, frankly, uneconomic”.

Gary Jennison, chief executive of Amigo Loans, is more hopeful. He came out of retirement last year to try to lead a turnround of Amigo after it too was laid low by historic complaints.

Amigo specialised in guarantor loans, lending to people with weak credit records if a friend or relative agrees to step in if they miss repayments. Jennison says the company has designed a new business model to help customers gradually build their credit ratings and lower their interest payments, rather than trapping them in cycles of repeat borrowing. However, it cannot launch until it settles a long-running dispute with regulators and courts over its backlog of compensation claims.

The FCA intervened after Amigo’s first attempt to cap compensation payouts earlier this year, and it has repeatedly warned that it faces collapse if it cannot win approval for its next proposal.

“When we do come back to lending, we will have the scale to meet the demand to try and satisfy some of this gap in the market, but [in order to do that] we’ve got to be allowed to lend,” Jennison says.

Non-profit lenders

Regulators at the FCA have so far been unsympathetic to the claims of executives such as Jennison who see their businesses as the only alternative to illegal loan sharks. The FCA has instead encouraged the growth of not-for-profit alternatives such as credit unions and community development financial institutions — CDFIs.

The history of non-profit lenders has been intertwined with civil rights movements in the UK and abroad since the second half of the 20th century, as campaigners, religious groups and philanthropists sought to help marginalised groups gain greater access to financial services. The UK’s first modern credit union was co-founded by future Nobel Peace Prize winner John Hume in 1960, while the CDFI model was started by activists in Chicago in the 1970s and imported to the UK at the turn of the 21st century.

Credit unions act like community-focused banks, using deposits from members’ savings accounts to fund low-cost loans with interest rates capped at 1 per cent per month in Northern Ireland and 3 per cent per month in the rest of the UK — about 43 per cent APR.

British CDFIs don’t hold deposits, which gives them more flexibility in who they can lend to but means they have to find external sources to fund their lending, ranging from government grants to expensive commercial loans.

“The reality is not enough people know about CDFIs and credit unions, so having the regulator behind the sector is helpful in and of itself,” according to Theodora Hadjimichael, chief executive of Responsible Finance — the trade group for CDFIs.

However, she adds that the sector needs more than just greater awareness to fill the gaps left by other lenders.

“Our personal lending members currently lend about £36m a year to 30,000 customers . . . Provident alone had over 300,000 customers before it closed doorstep lending. Scaling that, making it 10 times larger or more, is not impossible, but it does require a number of inputs . . . the pool of capital we can access [at the moment] is fairly small compared to what we would need.”

The credit union sector is larger and has grown in recent years — it had about £1.6bn in outstanding loans at the end of 2020, up 19 per cent since 2016 — but also faces challenges in keeping up with regulations and changing customer expectations for services such as online banking. The number of UK credit unions has fallen more than a fifth in the same period as smaller unions closed or were taken over by larger groups.

Credit unions and CDFIs can use their local expertise to make more tailored lending decisions. But that local touch is difficult to scale, and is not available everywhere.

The bigger [credit unions] that are swallowing up some of the smaller ones do seem to be in a place where they can compete, which posisbly they couldn’t five years ago,” says Williams of the Illegal Money Lending Team. “But,” she adds, “there are still gaps”, with even some large towns like Stoke-on-Trent not served by any credit unions. 

When Laura’s fridge and washing machine broke down in quick succession this year, she borrowed from Salad Money, a CDFI that specialises in lending to NHS and other public sector employees, instead of taking out another doorstep loan.

She was happy to be able to repay her 12-month loan early without extra charges, instead of being encouraged to roll over her debts. “No one pushes or nags; if you log on to the website they pop up and say ‘can we help?’”

Salad charges annual interest rates of about 35 per cent for employees at organisations that have a prearranged partnership with the lender, or close to 70 per cent for those that don’t. Laura was aware her loan was “quite expensive”, but appreciated that Salad looked “fairly” at whether she could afford her repayments instead of relying only on her credit history, which had been damaged by earlier debts and a recent separation.

“Now I am at a point where I know it is slow, but I’m rebuilding my credit record,” she added.

While Laura was understanding, others question why “ethical” organisations should charge such high rates. Moneyline UK, the country’s largest CDFI, charges up to 169 per cent APR for short-term loans to the lowest-income households.

Diane Burridge, Moneyline chief executive, says annualised rates are an unhelpful way to think about the costs of short-term credit, and some degree of higher rate is a natural outcome of trying to lend to consumers who may have variable or insecure income and have a higher risk of not repaying their loans or taking longer to pay.

Moneyline started in Blackburn in 2002 with the backing of the local council and groups such as a local housing association to combat deprivation and provide an alternative to loan sharks.

“People ask ‘why can’t you run with volunteers?’,” Burridge added, “But then you wouldn’t have the skillset within the business to grow, deliver with technology, meet the growing needs of regulation and compliance — we don’t get a free pass on that just because we’re not for profit . . . it’s pointless me setting something up and pricing it such that I know we’ll lose money forever.” 

The subprime conundrum

Moneyline plans to expand fivefold over the next three years. Greater investment and scale would allow it to charge lower interest rates, but many institutions are reluctant to back organisations providing any sort of high-cost loan, which in turn makes it harder for them to grow enough to cut their rates.

The challenge highlights a broader viewpoint, common in discussions of subprime lending: if the only sustainable way to lend to a certain demographic is to charge extremely high interest rates, surely those people should not be taking out a loan in the first place?

However, even the regulators that have clamped down on high cost lending stress the importance of maintaining access to credit across the income spectrum, though they disagree with some firms on the best ways to do it.

Williams says measures such as stronger financial education could help some people avoid running into difficulties in the first place. But as long as there are more than 10m Britons who are unable to withstand a £50 reduction in their monthly income, demand for emergency credit is not going to go away.

“I read commenters on news stories saying ‘these companies need to go to the wall and force people to live within their means’,” Williams says. “But what we have the people going to loan sharks for, it’s not massive TVs or extravagant holidays. It’s ‘funeral costs’, ‘a bill I wasn’t expecting’, ‘the car’s knackered’, it’s ‘the fridge broke’. It’s not aspirational things they’re going for — it’s ‘I need this to survive’.”