Loan Smart

Features | 14/10/21

Can the harm of financial exclusion ever outweigh the benefits of increased consumer protection? The short answer is: yes.

There is no question that regulated lending standards have been raised under the FCA for the benefit of consumers. The non-standard lending sector has been a particular focus in recent years and there has been significant regulatory and structural change in most, if not all of the sector’s product categories. Operators have adapted their business models to cater both for enhanced regulatory requirements and for changes to the way in which existing rules and guidance are now interpreted by both the regulator as well as by the Financial Ombudsman Service.

Such changes however have inevitable consequences for the flow of credit, its cost at the point of issue and the returns that can be earned from its issuance. The payday lending, rent-to-own and guarantor loans segments have all but disappeared while home credit has declined significantly. The market leader in each of these sub-sectors has either stopped lending or is in the process of doing so.

While detractors might say “quite right” or “good riddance”, we believe that such rhetoric is masking a more worrying trend, one that should be of concern to government, consumer groups and society at large. Unfortunately, it is going unnoticed or worse, is being ignored.

Whilst the regulator has confirmed that it has seen no clear evidence that there has been any meaningful increase in illegal lending as a result of its strides to enhance consumer protection, it has acknowledged that there has been a material increase in the level of borrowing from ‘friends and family’.

Some may view such informal borrowing as being preferable to paying high interest rates to a regulated lender. However, this kind of borrowing has none of the protections available from a regulated lender and may also in fact represent illegal lending, albeit in a different guise.

By increasing the obligations of lenders operating within the regulatory perimeter, it necessarily becomes more difficult for consumers within that perimeter to access the credit that they need. Minimising the risk of harm within the regulatory perimeter is of course a valuable and important objective. However, as the marginal benefits of increased regulation diminish, so the unintended, but inevitable consequences of greater exclusion also need to be taken into account when determining the right balance between protection and financial inclusion.

The FCA has already identified that for vulnerable customers in particular, difficulty in accessing services “can lead to disengagement, exclusion, mistrust or even risk of scams as customers may instead rely on informal access methods.”

The focus on consumer protection in recent years has also created regulatory uncertainty and complexity and a number of major providers, including Enova, Elevate and Provident Financial have already withdrawn from certain segments of the market .

As we emerge from the pandemic, consumers will need access to credit as they seek to manage the peaks and troughs in their income and expenditure. Due to difficulties experienced during the pandemic and/or as a result of a reduction or loss of income through job loss or less working hours, many may find that they are no longer eligible to borrow from their regular lender and so will seek other forms of regulated credit.

If they are unsuccessful due to a lack of supply or because they fail to meet enhanced lending criteria, such consumers will do what they have always done, they will find a way to meet their need, even if that means accessing informal or even illegal lending.

But does this matter if the numbers of consumers using non-standard credit is relatively small and there is no evidence of any increase in illegal lending? According to the FCA , three million consumers were using high-cost credit products, some of which are among the most vulnerable in society, so this is not a niché issue and yes, we do need to worry.

While the long-term impact of increased informal borrowing will not be immediate, this is a time bomb that will take some time to go off. Such arrangements tend to be fine for a period but are likely to result in potentially disastrous consequences over the medium-term, not just for the individual concerned, but also their families, their communities and the economy as a whole.

At Loan Smart, we are trying to raise awareness about the dangers of illegal lending through our website (loansmart.org.uk) and social media channels (Twitter and Facebook). We welcome support from members and so please get in touch if you are keen to hear more.