Should Payday Loans Be Regulated - Essay Example

Should Payday Loans Be Regulated Payday lending has been a very controversial that has received heated debate between the economists and policy makers without consensus over the last two decades. The cause of contention is in regard as to whether the payday loans make the lives of borrowers better or worse off. A Payday loan can be defined as short-term unsecured loan of a small amount and is payable in lump-sum on the borrowers next payday or within one month (Step Change, 2014). The advocates of payday loans have argued that it is the best option for the clients has the financial emergencies such as unexpected medical bills and electricity bills among others. They are helpful when other sources of funds such as bank overdrafts or credit cards may be unavailable or more expensive during such emergencies (Office of Fair Trading, 2013. p.6). However, critics have argued that rarely customers use payday loans for emergency issues and the majority are borrowing for recurring expenditures and even long-term use such as paying rent (Gibbons, Malhotra & Bulmore, 2010. p. 3). In addition, repeat borrowing has caused many borrowers get trapped in a cycle of debt hence negating the benefits of borrowing (Citizens Advice Bureau, 2014. p. 4). Payday loans are an important source of funds for the poor borrowers and the lack of government regulation has plunged the poor people into difficult financial situations. Considering both arguments it is apparent that regulating payday loan is necessary to maximize welfare for both lenders and borrowers. The escalating shortage of funds in Britain has compelled citizens to engage in short-term loan borrowings that are characterized by high interest rates thus resulting to gigantic soar in lenders Wonga’s revenue. For example, the payday lender has disclosed a turnover increase of 225 percent in the year 2009 compared to that of 2008 (Glass, 2012). The payday lenders have been operating without proper regulations on their activities. However, there is criticism over the way they have been carrying out their activities since they have been seen to encourage irresponsible borrowing (Edmonds, 2013). When borrowers take the first loan they are compelled to take another loan to repay the previous one hence resulting to unmanageable debt. The payday lenders operate under the authority of the Office of Fair Trading (OFT). Since 1974, all payday lenders have been required to obtain a licence from OFT in order to operate as a money lending company (Office of Fair Trading, 2013. p. 8). ThePayday loans lenders give the borrowers short-term credit for purchasing furniture, paying bills and solving other short-term financial issues until payday. Nevertheless, the interests charged by the payday lenders range from 300 percent to 4500 percent due to lack of interest limitations (Glass, 2012). Such highly inflated interest rates can cause borrowers to get into difficult financial situation during repayment of the amount borrowed and the interests. Furthermore, payday debt increases the customer spending at present, but in the future it causes financial constraint because consumers cannot be able to budget for a lower amount of income hence causing the problem during the time of making budget (Office of Fair Trading, 2013. p. 13). This implies that OFT has not been able to set standards for guiding the lenders and ensuring customer awareness of various financial products and the consequences associated with each source of finances. Some borrowers are not aware of various borrowing options available to them hence they engage in highly expensive borrowings that end up draining their debit (Edmonds, 2013, p. 2). Lack knowledge of different financial products among the customers has been caused by a number of factors. First, the government has not put a lot of considerations on payday loans although these financial products are meant for poor low income earners (Glass, 2012). The OFT has only been involved in issuing operating licences to the lenders and has the power to revoke the licence of the lending firm that violates the market standards. However, without clear standards to govern the operations of financial lenders OFT cannot achieve anything in their regulatory role (Consumerfocus, 2010). The OFT cannot has not been able to protect consumers against unscrupulous payday lenders due to low consumer awareness. Most of the payday loan borrowers have inadequate knowledge regarding the characteristics of financial products available in the market (Edmonds, 2013, p. 3). Consumers are unaware of different products and the interest rates they charge or even repayment periods. Majority of the applicants believes that all sources of funds are the same hence they opt for payday loans since it easy to obtain than other financial products (Citizens Advice Bureau, 2014. p. 5). The existence of such a huge knowledge gap has been caused by media advertisement inclined toward lenders and has disclosed information on availability of the financial products without differentiating their characteristics and consequences they may have to the borrowers. Lack of transparency among the lenders has contributed to inadequate consumer knowledge. When consumers are applying for loans the clerks responsible for selling the credit to the consumers hardly disclose essential information to the consumers. The lenders never disclose to the borrowers that the amount payable as minimum fees is not inclusive of the principal amount (Edmonds, 2013, p. 5). The lack of such awareness has lured borrowers into taking loans without the knowledge of the actual amount they are required to pay as interest on the amount borrowed. The lenders state the weekly interest rate without disclosing to the borrowers that the interest will continue multiplying on a weekly basis. Consequently, most consumers mistake the weekly interest rate for annual interest rate (Consumerfocus, 2010). The consequences of such nondisclosure are huge interest charges on the borrowers that plunge them into huge debt and sometimes it becomes hard to repay the outstanding amount. The payday lenders have engaged in reckless lending because they do not conduct sufficient affordability assessment before advancing loans and have failed to comply with required standards for payday lending (Citizens Advice Bureau, 2014. p. 6). OFT has also raised concern over the way payday lenders collect their debts with aggression and how they harass borrowers who in difficult financial situations. Indiscriminative lending of such high interest loans to the low income earners is detrimental to the economy because it is likely to result to high inflation and unplayable debts (Office of Fair Trading, 2013. p. 11). The government has a lot of concern for the welfare of its people. Therefore, regulations are essential to ensure the citizens are protected against harassment by the lenders. Furthermore, the government has a mandate to protect the citizens against overexploitation by the payday lenders. The regulators can achieve their goals by ensuring lenders have an equal chance to operate in a fairly competitive environment. A consumer focus group has requested for precautionary measures from the debt regulators and the payday lenders to discourage the borrower against overdependence on high interest credit loans (Consumerfocus, 2010). The government should ensure the society has full information on how to acquire and budget for their finances in order to ensure a streamline borrowings and lending in the society. For example, students should apply for hardship grants instead of payday loans whenever they are in difficult situations (The Guardian, 2012). Regulating of the payday lenders activities will require a coordinated effort of the government, OFT, Advertising Standards Agency, Committees of Advertising Practice and financial industry to ensure the advertisement does not entice customers to apply for loans that are inappropriate for them. Payday loans have significant benefits to some individuals who lack access to conventional lending methods such as banks and credit cards. Fifty five percent of persons aged between 18 and 24 years, and forty eight percent of individuals aged between 25 and 34 years lack access to traditional loans (Javid & Swinson, 2013). There are various reasons such people cannot qualify for traditional loans such as lack of credit history, poor credit rating and frequent change of address. The importance of the short term lending cannot be overlooked and that is the reason regulation is essential to ensure it carried out in a fair environment (Lawrence, 1991, p. 63). The government has much concern on the way payday lenders are carrying out their operations because it remains the core source of funding for the low income earners. The UK government has suggested a shift of regulatory mandate for the payday lending sector to the Financial Conduct Authority (FCA). FCA will have more powers than OFT to set standards to govern payday lending activities and prohibit risky products from the financial market (TheGuardian, 2012). Currently OFT lacks such mandate hence has not been able to protect borrowers against unscrupulous payday lenders in UK. FCA will be able to impose authority to borrowers. FCA shall have the mandate to restrict the lending rates, the loan duration and the number of times the lender can advance payday loans to the same borrower in a year. There are various regulatory strategies available includes price caps, size caps, prohibitions on repeat borrowings, prohibitions on simultaneous borrowings, “cooling off” periods, mandates to provide amortizing alternatives, etc. (Silvera, 2014). The regulatory authority should implement various strategies to protect consumers against aggressive lenders of financial products and ensure consumer awareness regarding various financial products available in the market. For example, the regulating authority is considering putting limits to the percentage of interest that a lender can charge the borrowers (Business, Innovation and Skills Committee, 2013, p. 14). The UK recognizes the importance of payday loans the citizens since they are best alternative for the borrowers who lack access to the conventional borrowings. However, the government concern is the way lenders are operating their activities by oppressing and harassing the borrowers. The lenders of payday loans should charge reasonable interest rate to their borrowers. Although the lenders have claimed to be charging up to 400 percent as annual interest rates in reality they charge up to 4500 percent annually (Javid & Swinson, 2013). Regulations are necessary to ensure the lenders of payday loan charges interest that is equivalent to the value stated in their policies. In addition, the lenders should inform their clients in advance the amount they will have to pay as interest before applying for a loan in order to give them a chance to make an informed choice. Consumers with adequate information can be able to apply for a reasonable amount as loan. Payday loans should not exceed a certain amount because they are meant for emergency and a limited time. One of the challenges facing payday borrowers is inability to clear the outstanding debts within a specified time hence attracting high interest rates. The lenders are taking advantage of customer’s lack of knowledge, thus giving them large sums of money so that they can gain more interest income at the expense of poor borrowers (Gibbons, Malhotra & Bulmore, 2010. p. 6). The regulatory authority should intervene to ensure lenders give their customers a loan of a specified amount. The lenders should be compelled to assess the borrowers’ potential for repaying the loan and interests within the specified period so that borrowers cannot take more than what they can afford to repay (Stegman, 2007, p. 178). The borrowers should be discouraged from taking multiple loans in order to maintain the amount of borrowing to the specified level. The lenders have encouraged borrowers to take fresh loans to clear the outstanding balances. The multiple lending has escalated the debt level thus making it hard for the borrowers to get out of debt. The new government regulations will affect over fifty thousand firms in the financial industry and an outstanding debt of about 260 billion Euros (Javid & Swinson, 2013). Discouraging multiple lending will reduce the amount of outstanding debt, thus reducing the risk of economic crisis. The regulators should give borrowers adequate information regarding various sources of finances so that they can e able to borrow loans from the most appropriate sources. In conclusion, payday loans are very essential in the economy because they are quick sources of finances for the low income borrowers who have limited sources of finances. The lenders have not disclosed to the borrowers essential information pertaining to the interest rates they charge or the repayment period thus making lenders get stuck in debt. Regulation is necessary to protect consumers against overexploitation by the lenders and ensure fair operations in the financial market. Bibliography Business, Innovation and Skills Committee. (2013). Payday Loans: Seventh Report of Session 2013–14. UK: The Stationery Office Limited. Pp. 5-27. Available at: Http://www.publications.parliament.uk/pa/cm201314/cmselect/cmbis/789/789.pdf Citizens Advice Bureau. (2014). Backbench Business Debate on Payday Loan Companies. Pp. 1- 7. Retrieved from Http://www.citizensadvice.org.uk Consunmerfocus. (2010). The Number of Payday Loan Users has Quadrupled. Available at. Http://www.consumerfocus.org.uk/news/number-of-payday-loan-users-has-quadrupled-consumer-focus-research-reveals. Last accessed 10.02.14. Edmonds, T. (2013). Payday loans: regulatory reform. Library: House of Commons. 1 (1), 1-9. Glass, H. (2012). The Controversial Payday Lender Wonga Makes a Mint Out of Cash-Strapped Consumers as the Number of Loans Last year Rose nearly Three hundred Percent. Available at: Http://www.thisismoney.co.uk/money/cardsloans/article-2204442/Payday-lender-Wonga-makes-mint-cash-strapped-consumers-number-loans-nearly-300.html. Last accessed 10.02.14. Gibbons, D., Malhotra, N., & Bulmore, R. (2010). The Payday Lending in the UK: Review of the Debate and Policy Options. Centre for Responsible Credit. London. Pp.1-10. Available at: Http://www.responsiblecredit.org.uk/uimages/File/how%20to%20regulate%20payday%20lending%20final%2014th%20December%202011.pdf Javid, S. & Swinson, J. (2013). The Government Takes Action to Tackle Payday Lending Concerns. Crown, UK. Available at: Https://www.gov.uk/government/news/government-takes-action-to-tackle-payday-lending concerns Lawrence A. (1991). American Economic Review. Failure of Competition in the Credit Card Market. 81 (n/a), 50-81. Office of Fair Trading. (2013). Payday Loans. Pp. 1-38. Http://www.oft.gov.uk/shared_oft/Credit/oft1481.pdf Silvera, I. (2014). Young People Bear Brunt of Britains Debt. Available at: Http://www.ibtimes.co.uk/young-people-bear-brunt-britains-debt-1435779. Last accessed 10.02.14. Stegman, M. (2007). Payday Lending. Journal of Economic Perspectives. 21 (1), 169-190. Step Change. (2014). What is a payday loan? Available at: Http://www.stepchange.org/Paydayloanguide/Whatisapaydayloan.aspx. Last accessed 10.02.14. TheGuardian. (2012). Payday Loan Companies Target Vulnerable Students. Available at: Http://www.theguardian.com/education/series/guardian-students+money/payday-loans. Last accessed 10.02.14 Read More