History of Payday Loans
Though lending and borrowing may seem like a modern day phenomenon, it has been practiced since the first formal financial institutions were established. But banking hasn’t been as accessible as it has been in the last 50 years. In the beginning, banks would offer their services only to the wealthy, safeguarding their property while providing them with liquidity when needed.
The concept of short term lending had existed for hundreds of years in the form of a barter system. However, official reports trace Payday loans back to 19th century America, where it was common for coalmine workers with low wages to borrow from mine owners in order to make ends meet. Overdrafts and bank accounts were still in their infancy and could only be procured by a small percentage of the population. Household commodities such as food and clothing were the most borrowed items at the time; the principle amount plus a premium would automatically be deducted from the workers’ next pay. Payday loans, Cheque cashing and pawn broking were the go-to financial instruments for the working class during that era.
The practice, though unlicensed, eventually spread out and started gaining public attention. While the majority of the loans were illegal, it wasn’t seen as such by the authorities and no regulations were introduced. As the demand for these loans grew, many loan sharks started advertising themselves as Payday lenders, resulting in a string of controversies. Borrowers would be threatened with excessive force by collectors, often resulting in violent incidents. The most prominent of these is the 1935 beating of a young clerk who failed to repay his debt. The matter became a national issue, prompting a series of investigations by the New York governor at the time, Thomas E. Dewey. As a result, more than 25 individuals were charged and arrested for using unfair collection tactics and the term “Payday” became synonymous with loan sharks.
As a result of the bad press as well as the aforementioned incident, many U.S. states imposed anti-usury measures such as interest capping in order to discourage lending. Even the metropolitans, such as New York and Chicago, were capped at a rate of 6%, the lowest seen in the past ten years. The anti-usury laws allowed for states to cap the interest rate of nationally charted banks, even if they were conducting business in other states. This made it quite difficult for borrowers to acquire loans from official institutions as they weren’t willing to provide high risk loans at a reduced interest rate.
In what seemed like a case of history repeating itself, the new regulations gave way to numerous underground lending shops just as they did in the Prohibition era; Payday loans were cast in the negative light yet again. The industry seemed well on its way to a slow and steady death until the late 70s, when the anti-usury laws were challenged in the high profile case of Minneapolis v First of Omaha Service Corp. The verdict overturned the state’s authority to set a fixed interest rate in other states. Many saw this as a prime opportunity to lend out short term loans for profit. And with the relaxation of the interest capping laws, a lot of short term lenders partnered with banks to provide rebranded products such as “high interest bank loans”. The foundations for legal short term borrowing were set during that period.
Though many banks and credit unions started offering short term high risk loans, they weren’t really Payday loans. There was no postdated cheque placed as collateral; in fact, many of the bank loans required a credit record in order to be approved. William Alan Jones Jr., a businessman from Cleveland, came up with the idea of offering cash in exchange for a payroll cheque, a first in over 50 years. He went on to establish the Check into Cash enterprise in 1993 based on this business model.
Even though Jones was criticized for allegedly buying out the state legislation to allow for relaxed interest rates, he had, in effect, formed the archetype for modern payday lending. Just six years after Check into Cash was established, $8billion in loans was issued in the U.S. alone. 5 years after that, this number increased to $50billion, more than a 500% increase. Seeing the success of the product, many other countries adopted payday lending, most prominently the U.K. and Australia.
Payday Loans in the U.K
Though Payday loans originated in America, their use has become so widespread in the U.K. that according to a survey conducted by the ACCA, the Payday loan industry has multiplied 8 times in size within the last decade.
The loans were first introduced back in the early 90s, when U.S. based companies decided to branch out internationally. Several payday companies such as “The Money Shop” were set up and the market started growing from there.
While the growth was impressive, it was pale in comparison to the growth that occurred after the 2008 financial crisis. As banks tightened their credit criteria, many failed to qualify for loans and started looking towards Payday loans for liquidity.
Their use has grown exponentially since then. The 2009 statistics showed a 400% growth since 2006, the industry being valued at £1.2billion. This figure increased to £2.2billion in 2012 with an estimated 8.2million loans taken out that year. Whereas Payday loan was an unknown term just 2 decades ago, the average U.K. resident saw about 150 Payday adverts in that year.
The rise was not without controversy, as several politicians accused Wonga, the largest payday lender in the U.K., of charging unfairly high APR percentages in 2011. The company, along with CashGenie, was also accused of sending threatening letters and emails to borrowers who were behind on payments.
Because of the aforementioned incidents, the FCA made several amendments regarding Payday laws in 2014. FCA chief Martin Wheatley stated:
“For the many people that struggle to repay their payday loans every year this is a giant leap forward. From January next year, if you borrow £100 for 30 days and pay back on time, you will not pay more than £24 in fees and charges and someone taking the same loan for 14 days will pay no more than £11.20. That’s a significant saving.
For those who struggle with their repayments, we are ensuring that someone borrowing £100 will never pay back more than £200 in any circumstance.
There have been many strong and competing views to take into account, but I am confident we have found the right balance.
Alongside our other new rules for payday firms – affordability tests and limits on rollovers and continuous payment authorities – the cap will help drive up standards in a sector that badly needs to improve how it treats its customers.”
Following up on these comments, new interest caps of 0.8% per day were set, with the fixed default fee capped at £15. The purpose of these amendments was to raise borrower awareness about the costs associated with procuring a Payday loan while making sure that lending institutions avoided bad loans.
The new regulations did have a positive outcome for lenders, with just 2 interest only rollovers allowed per loan. Rollovers allow borrowers to pay the interest in the first month, delaying the principal amount repayment to the next. The regulation was a much needed step as the Telegraph reported in 2013 that as many as 34 out of 100 lenders were promoting multiple rollovers.