Originally published 29th June 2011
Recently there has been a proliferation of online providers of so-called 'micro loans'. These are relatively low value loans (sometimes referred to as 'payday loans') typically £50-£300 which are repayable within a very short time, usually no more than thirty days later. One of the most prominent recent examples is the service provided by 'Wonga'.
This article looks at some of the reasons why this proliferation has taken place and speculates on the future regulation of this kind of business.
Office of Fair Trading Review into Micro Loans
In April last year, the Office of Fair Trading (OFT) (the regulator for loans regulated by the Consumer Credit Act 1974 (CCA)) published a report into the market for micro loans. Its conclusions were broadly positive. The OFT found that in a number of respects, these markets were working reasonably well, for example, suppliers have met the demand for easier access to their products and complaints to the OFT are low. However, the OFT did have concerns on whether there was enough competition within the market. The OFT made several recommendations such as that the Government helps consumers make informed decisions and that the relevant trade associations promote best practice.
This has given something of a boost to companies interested in participating in this market since it is clear that the OFT does not have this high up their agenda and is not likely to take steps to limit the amount of interest that can be charged. That is not to say that the OFT is ignoring such companies: there were two cases at the end of last year1 where the OFT imposed requirements on the micro loan companies involved, in particular to prevent the misuse of contractual rights of the lender to make multiple attempts to withdraw overdue sums directly from a customer's bank account.
Consumer Credit Directive
In February of this year, the Government implemented the Consumer Credit Directive 2008/48/EC. This brought about a very significant change in consumer credit regulation generally. The main changes were:
- advertising and APRs – changing the rules about the information to be provided about interest rates and a new concept of a "representative APR" (which must reflect at least 51% of the business expected to result from the advertisement);
- creditworthiness and adequate explanations – introducing a requirement to assess the borrower's creditworthiness (ie how affordable the loan is) before granting credit and ensuring that the borrower is provided with an adequate explanation of the proposed credit agreement;
- pre-contractual information and agreements – the borrower is to be given specific pre-contractual information in good time before entering into the agreement; and changes were made to the required form and content of loan agreements; and
- right of withdrawal – a right for the borrower to withdraw from a credit agreement within fourteen days following the completion of the agreement, subject to the borrower repaying the credit and paying interest for each day the credit was drawn down.
In practice, none of these changes greatly impacts on the ability of an online micro loan provider to carry on its business:
- Advertising for many micro-lenders will be done mainly online, which allows changes to be made rapidly as necessary to reflect the requirements of the "representative APR".
- The CCA does not spell out how creditors should go about assessing creditworthiness, other than to require that this must be based on sufficient information obtained from the borrower – it is for creditors to judge when information should be sought. Arguably, in the case of small loans this could be relatively little information and in any event typically micro lenders will carry out a credit reference check before proceeding.
- By the same token, the extent of "adequate explanations" will depend on the circumstances and context. It seems likely that the simplicity of many micro loans and the information that micro lenders give on their website and in the loan and pre-contractual documentation will be sufficient to fulfil the requirement.
- In terms of the loan documentation and pre-contractual information, the CCA has for many years permitted loan agreements to be executed electronically and there is no need to supply the potential borrower with a hard copy of the loan to sign. The changes brought in by the directive to the pre-contractual information do not impose a great burden, given that the information will be largely the same for all its customers (making changes only for the commercial terms applicable to payment, amount borrowed, interest and APR etc). If anything, the changes made to the Agreements regulations make it easier for lenders to present a relatively user-friendly form of agreement without the many restrictions and limitations that were presented under the previous Agreements regulations.2
- The new right of withdrawal is also unlikely to trouble online micro lenders since the customer is required anyway to pay back the interest for each day the credit was drawn and the applicable rate of interest will have been calculated on a daily basis in any event. It seems unlikely that in practice many borrowers who are seeking the convenience of ready cash into their account will opt to use this right.
More entrants into the market?
This seems highly likely. The barriers to entry are surprisingly low.
This kind of lending is not regulated under the Financial Services and Markets Act 2000 and so a prospective lender does not require a Financial Services Authority (FSA) authorisation, with all the exacting requirements and detailed scrutiny that that involves.
The lender simply requires a licence under the CCA. This is surprisingly easy to obtain by means of an online application form. Applicants apply for the applicable category of licence, which for this kind of lending would be Category A (Consumer Credit Business). The licence is normally issued within 25 working days unless the OFT regards the application as being high risk, in which case the non-binding target for responding is 90 working days. The licence fees are currently £1125 (including the CCJ levy of £150). There are no capital adequacy requirements and the main concern of the OFT seems to relate more to confirming that the "controller" and individuals involved in the business do not have previous "form" for regulatory infringements, director disqualifications, insolvencies etc.
At the same time, there is a ready availability of outsourced providers of all of the related services that an online lender would require. This is not only with respect to debt collection, but also in terms of back office processing. The third party that provides these services may also require a CCA licence, but other than taking reasonable steps to ensure they behave in a way that does not jeopardise the validity of the loan agreements, the lender is unlikely to be troubled by any regulatory issues in outsourcing in this way.
In practice, new entrants will be competing with existing providers on who can set up the most user-friendly websites and related documentation, terms and conditions etc as well as on the basis of competitive rates (as compared to the alternatives, such as bank overdrafts).
It is also likely that the size of the loans will increase. It was reported today that a new entrant to the market "Borro" has made a £1 million online loan, albeit secured on a fine art collection owned by the antiques collector borrower.
More changes on the way?
There is a 'Private Members Bill' (the Bill) which proposes to limit the amount of interest that may be charged on micro loans, together with a proposal for a levy to be paid by lenders to fund assistance to vulnerable borrowers. However, the Bill is at the very earliest stage (having completed the first reading) and has been brought by means of a "10 minute rule bill". Typically such bills do not become law as they are not backed by the government and time is generally not made available in parliament for them to complete their passage into law. Frequently they are just brought before parliament to raise publicity for a particular cause or member of parliament.
That said, there is much discussion about whether consumer loans would be better regulated by the FSA (or, in its new guise, the Financial Conduct Authority – FCA) and whether it is justifiable to continue to have an entirely separate statutory regime applying to consumer loans when the FSA already regulates, for example, first charge mortgages.
It is probably fair to say that this kind of lending will be under further review by the Government and the regulators as time goes on. However, for the time being, the wind is set fair for new entrants to enter this market and enjoy the relatively benign regime whilst it lasts.
1. SafeLoans Limited 271778 and CIM Technologies Limited 615666
2 The Consumer Credit (Agreements) Regulations 2010 replace, for these purposes, The Consumer Credit (Agreements) Regulations 1983.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.