As Wonga twitches in the final throes of death, many will celebrate the downfall of the UK’s most famous pay-day lender. For many, Wonga epitomised everything that was wrong with pay-day lending in that it is perceived to have taken advantage of individuals who were not able to pay-off the loans they were offered.
In this article, we examine the downfall of the company once valued at $1 billion, and ask what role the FCA played in its introduction of new rules in 2014, as well as consider the future of the lending market in light of new rules that went live last November.
As we covered in last week’s blog, affordability has taken on a new prominence after the Financial Conduct Authority began promoting the cause within the context of creditworthiness.
The FCA has let it be known that irresponsible lending, by offering consumers credit and loans they cannot reasonably be expected to afford to repay, is no longer acceptable and will crack down on such practices. Financial institutions who had for years primarily concerned themselves with the concept of credit worthiness, “what will happen should the creditor stop / be unable / cease repaying the loan” now need to consider what the effects could be on consumers who are offered unaffordable loans. Together, the two concepts of ‘affordability’ and ‘credit risk’ are being repackaged into creditworthiness.
The strand of financial services that has come in for most criticism in recent years for their credit practices has been the pay-day loan sector.
Despite receiving a cash injection of around £10m from investors, Wonga succumbed after changes to the law and customer complaints regarding historical loans began to bite.
Wonga, which in its early days described itself as a “digital innovator” in FinTech, was valued at just $30m by the time of its demise, a collapse from 2013 when it considered an IPO with a $1 billion valuation.
The collapse of Wonga has stemmed directly from the volume of complaints it has received and resulting payouts for its lending practices. The public perception of Wonga was also increasingly negative, with many calling their lending practices “predatory”. Last week, Labour MP Stella Creasy, a prominent activist against pay-day lenders, tweeted she was targeting other significant lenders.
The negative persona attributed to Wonga is understandable. Prior to the FCA rule changes in 2014, short term loans based on an APR of 5,853% were available. Customers could further “roll over” loans, increasing interest further. While Wonga always claimed it sought to give loans to “professionals” and those that might need them “two or three times a year”, many customers were those least likely to be able to afford repayments.
2014 Regulations from the FCA
Following concerted pressure from campaigners over the lending practices of the UK’s pay-day lenders, the FCA introduced new rules that would limit the amount of interest that could be applied to a loan. The value of all loans was capped, so it became illegal to add interest exceeding the original value of the loan (ie, a doubling); an initial cost cap of 0.8% per day; and a £15 cap on default fees (for late repayments).
These new rules had the dual impact of adversely impacting Wonga’s business model, while also alerting claims management companies to the possibility of redress for past customers.
Where Wonga had been selling loans at 5,800% APR, these were seriously curtailed, adversely impacting profit margins.
Claims against Wonga for selling patently unaffordable loans have been the principal cause of its demise however. In 2014 alone, the firm wrote off £220m worth of debt belonging to 330,000 customers for selling loans that were unaffordable. Since then, claims to the Financial Services Ombudsman (FOS) have continued to spiral. The FOS reported a 215% rise in the volume of claims made against pay-day lenders in the first six months of 2018, against the last six months of 2017. Of these, Wonga was responsible for 4,513.
These claims have been detrimental because as well as having to pay back interest and charges where the FOS has found against them, they are also being charged an administration fee of £550 for each one. It is this bill and recurring redress payments to customers that has precipitated their decline.
The FCA has nailed its colours to the mast on this issue, insisting any firm that wishes to offer loans or credit to consumers, must do so in a considerate manner, taking into consideration both the credit risk aspect, and the negative impact that offering the loan or credit might have. To that end, following a number of policy papers, these new regulations went live in the UK on November 1st 2018.
Whether lenders are offering a credit card, loan or other type of credit, they now have a responsibility to ensure they obtain enough information from the consumer to ensure they can afford to pay it back. This will usually involve asking questions of borrowers to ensure that they can afford repayments, backed up by what’s in their credit file. The FCA have been deliberately vague in how lenders reach their conclusion on how a consumer is creditworthy, suggesting it is outcomes, not prescriptions that are required.
Future for lending
The Wonga loans will be repackaged and sold off to other debt management companies who will take their own approach to repayment. Current and prospective Wonga customers may still turn to one of numerous other pay-day offerings, of which there are several on the market. Or could it, as some campaigners hope, see a deluge of people seek the assistance of debt charities and agencies. There are thought to be some 8 million people in the UK struggling under the weight of debt, yet debt charities are currently only servicing around 1 million of them.
A 2018 report from Standard & Poor stated UK consumer debt stands at £200 billion – the same as before the financial crises of 2008. S&P has called this “unsustainable” and hoped it would raise flags with lenders. Household income is growing at a rate of just 2% year-on-year, while debt levels are rising at closer to 10%. Meanwhile credit card rates are at their highest rate in 10 years, with APR averaging 23%.
The need for consumers is clearly still there, and there are still myriad companies who will be happy that Wonga, who held the lion’s share of the market, is no longer a threat.
What the culmination of the Wonga saga has illustrated is that we are entering into a new age of lending. Pay-day lenders will continue to service the part of the population that require their services, but they, along with every other financial institution are legally obliged to check an applicant has the resource to pay back a loan without it causing them undue financial distress. Wonga’s failure to do so has ultimately lost them their place in the market. The challenge for other financial institutions is to now update policies and practices to be able to determine this information before a loan or offer of credit is offered. The FCA has deliberately not prescribed how this should be done and this leaves considerable scope for firms to determine the information required.
Failing to do so, could result in being Wonga’d.