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Thursday, 29 November 2012

Caution On Payday Loans Cap: It's A Midata Problem

The government is right to resist automatically capping interest rates for short term or 'payday' loans, and to insist on an evidence-based approach to the market which takes account of unintended consequences. Powers to cap rates, prevent endless renewals and aggressive, unsupportive collections activity are important. But it's critical to understand the real problem confronting the payday borrower before leaping to solutions.

Until now, the popularity of short term loans has been positioned in Parliament as a moral problem (rich for MPs!) for which an interest rate cap is the solution. 

But the annualised percentage rate (APR) for short term loans is misleading and unhelpful for borrowers in context. It only enables comparison of one short term loan against another. And it produces such a strange result against longer term loans that borrowers ignore it - especially, as those loans may not be available to short term borrowers anyway.

Typically, a short term loan is applied for when other debts are due, fees are about to be incurred and other consequences are biting or about to bite. The relevant data points include the cost of unauthorised overdrafts, default fees on card accounts, the consequences of missing the rent, failing to pay a phone or energy bill, and so on. Borrowers react to the worst of the known consequences when borrowing, but may not be aware of them all, let alone take them all into account when assessing the best option.

This is a data problem, not an interest rate problem associated with just one of the options available to the borrower.

What would be helpful is a tool that enables comparison of all the options facing a short term borrower in the borrowing context.

Such applications are evolving, and it's important to note that the government is also playing a role to foster that evolution.

The Midata initiative, for instance, is aimed at producing solutions to meet exactly this kind of challenge. It aims to drive the development of simple applications that will access a person's own transaction data (including fees) to enable that person to make better purchasing decisions. Initially, the government is targeting suppliers in markets for energy, mobile phones, current accounts and credit cards. But it has issued a warning to others. 

If only we could get our MPs to focus on proportionate solutions to the root causes of society's problems rather than embarking on populist moral crusades and fiddling their expenses!