Payday Loan Cap; Britain Bans Credit For The Poor

Payday Loan Cap; Britain Bans Credit For The Poor

The UK has brought in caps on the amount of interest and fees that payday loan companies can charge to borrowers. This is, of course, in the name of protecting the poor from the rapacious capitalist b…..no, the not very nice capitalist people. The actual effect is, of course, simply to ban some poor people from being able to borrow money. Quite why this is a useful goal of public policy hasn’t been adequately explained by anyone. It is still true though, for this is always the effect of fixing prices as any first year Econ 101 textbook will tell you.

A cap on the cost of payday loans has come into force aimed at preventing debts spiralling out of control.

Fees and interest paid by customers using payday lenders will now be limited, lowering the cost of borrowing for most people.

The new rules also mean those who cannot afford to repay their debt on time will never pay back more in charges than the sum they initially wanted to borrow.

For all high-cost short-term credit loans, interest and fees must not exceed 0.8% per day of the amount borrowed.

Before the rules Britain’s biggest short-term lender Wonga’s annual interest rate was 5,853%.

The Financial Conduct Authority (FCA) said the move will ensure proportionate charges – and make credit much cheaper.

Martin Wheatley, chief executive of the FCA, said the payday loan cap will “make the cost of a loan cheaper for most consumers.

Well, no, not quite. It will make the cost of a payday loan cheaper to those who can get one and will make the price infinite to those who cannot get one as a result of this change.

There’s three points, one simply mathematical, one of detail, and then of course the larger economic point.

That first is that these loans are designed to be for a week or two, for a month maybe. Until the next paycheck that is. And as such using the APR to calculate the interest rate simply isn’t really valid. Because using the APR assumes that such a loan is being rolled over at the end of each week or month. These loans just don’t work that way making that calculation method a nonsense.

The second, in detail, is that there’s simply a cost to lending someone some money. Forget interest for a moment, don’t even think about default rates and the rest. Someone, somewhere (or something, maybe an algobot) has to decide whether this particular person is good for £100 or whatever for a week or two’s time. Making that decision, collecting the information to do so, just costs money. This is why your bank charges you a £35 arrangement fee on your overdraft. One part of the thrift store network in the US tried a zero interest and no calculation for default loan system a few years back and found that just administration costs meant a 280% APR even as a non-profit.

And that cost has to be paid by the borrower or there won’t be anyone willing to lend money to them. We can all argue about how much that cost should be, £5 maybe, £10 possibly, but it’s going to be a large percentage of a £100 loan. That’s what really makes these loans look so expensive. Simply that lending small amounts of money on a short term basis is expensive in terms of the simple fixed costs of lending small amounts of money for short periods of time.

And then there’s the larger economic point. Price fixing, the fixing of the price for anything, always goes wrong. Before this price fixing the market was in balance. Those who wanted to borrow money at these prices could do so, those who wished to lend money at these prices were also doing so. That price was therefore the market clearing price. So, in we come to change that price by law. We are obviously going to end up with a price that is not the market clearing price (for if we did set the price at the market clearing one then why the heck are we bothering?). If we set the price above it then there will be more people willing to supply but fewer willing to borrow. And if we do as is being done, set that price below the market clearing price then there will be a reduction in the number of people willing to lend at these new, lower, prices. Which means, inevitably, that some people who wished to borrow at the old prices will not not be able to borrow at all.

The end result of which is that, inevitably and without any doubt whatsoever, the payday loan cap will ban credit for some of the poor.