Illegal lending: new evidence from the Debt Need Survey

Over the last 18 months, Fair4All Finance (F4AF) have issued two reports¹ arguing that Financial Conduct Authority (FCA) regulation has contributed to a ‘credit vacuum’ leading to increased use of loan sharks.

F4AF call for regulatory changes; more investment in ‘responsible finance’², and (2024, p.8) for banks to provide low-income households with “more appropriate provision of credit”.

According to F4AF (2023, p.5):

“As the subprime lending market has shrunk, the opportunities for obtaining credit for people from low to middle income households have become harder to find. As these doors close, illegal lending appears to be taking the space of the subprime lender.”

However, they have also (2023, pp.34-5) acknowledged some limitations with their analysis. Specifically, they:

“… cannot prove a causal link between credit refusal and illegal moneylending, because we do not have access to the clients’ credit reports and formal timelines of their money borrowing behaviour, we cannot ascertain if the high level of debt became unmanageable for the participant so they defaulted on loans and began to be refused credit, or if the high level of debt is because many of the participants who were using illegal lenders, were also borrowing from both mainstream lenders at the same time and more than one illegal lender.”

Our recent analysis of the Debt Needs Survey³ provides important evidence in this respect and contradicts the theory that a credit vacuum is driving a rise in illegal lending.

People using illegal lenders have not only had access to legal sources of credit in the recent past, but still do.

We found that three quarters of people using illegal lenders in the year before the survey had also borrowed from legal, non-mainstream credit sources⁴ in the last six months. Nine out of ten users of illegal lenders also had access to credit cards and overdrafts at the time of the survey, with a third of these going up to or over their limits either “very” or “fairly often”. A further 45% did so less regularly.

Rather than being excluded, most users of illegal lending have ‘maxed out’ their legal credit options. The likelihood of using an illegal lender is highest amongst low-income households who have accumulated credit card, personal loan, and catalogue debts that they are now struggling to repay.

Importantly, we also found other potential drivers of illegal lending: gambling; losing money in financial frauds or scams; experiencing delays in obtaining wages, benefits, or tax credits; and experiencing a loss of, or reduction in benefits or tax credits. These should be investigated further.

This is not to deny increasing use of illegal lenders. The Debt Need Survey indicates around 450,000 people used an illegal lender in the past 12 months, nearly twice the number reported by the FCA’s Financial Lives Survey in 2020. But this has been driven by cost-of-living pressures and an increase in debt problems, not by a ‘credit vacuum'⁵.

Credit needs or basic needs?

F4AF say (2024, p.6): “For many lower income households it has become harder to borrow. However, their need for occasional access to credit to smooth expenditure and manage their finances remains”.

Similarly (2023, p.15): credit “is not available to lower income households for a variety of reasons, including failed affordability assessments and tighter credit criteria. The demand appears to be unabated, the supply diminished, the opportunity for illegal moneylending increased”.

But how is the 'need' for credit being defined here?

Of course, many people struggling to afford the essentials (food, heating, clothes etc.) will, in desperation, apply for credit to obtain these. But credit is not an affordable or appropriate solution when it is driven by poverty. These are basic needs, not credit needs.

It is poverty, not a lack of access to credit, which is the real problem:

• The Joseph Rowntree Foundation ('JRF') reports (p.4) that very deep poverty⁶ has increased over the past 20 years.
• JRF also finds that households in the bottom 40% of incomes are on average around £300 worse off than they were before the COVID-19 pandemic.
• And that seven million low-income households have gone without essentials in the past six months.

Our recent analysis of the Bank of England’s ‘NMG survey’ also found that although the poorest households are less likely than other income groups to have outstanding consumer credit debts, those which do so hold more of it relative to their gross incomes than those higher up the income distribution. The poorest also pay much more of their disposable incomes on debt repayments.

Attempting to provide people in poverty with credit by relaxing the FCA’s affordability rules will only make things worse.

The real story on why high-cost credit has been exiting the market

F4AF say (2024, p.6) a significant driver in the reduction of credit supply to households “has been regulatory reform”. Although they recognise the very high cost of credit previously charged by firms who have since exited the market⁷, they argue (p.3) that these nevertheless “provided access to legal credit when other options...were limited.”

The regulatory reforms referred to are those implemented by the FCA in 2014/15. These included a total cost cap on payday loans as well as rules relating to:

• Default fees - capped at £15.
• Restrictions on how many times a loan could be rolled over, and
• Restrictions on how many times a lender could attempt to take repayment via a Continuous Payment Authority.

But these reforms were restricted to payday lenders, whilst recent years have seen other forms of high-cost lender (e.g., door-to-door moneylending companies such as Provident Financial) also exit the market. This indicates that other factors are likely to have had a more significant impact.

We need to go further back. The Consumer Credit Act, 2006 led to the Office of Fair Trading’s (OFT) 'Irresponsible Lending' guidance in 2010 and also established the Financial Ombudsman Service (FOS). Although the OFT’s guidance was not enforced, its subsequent translation into rules by the FCA in 2014 led to a much more robust approach over the following five to six years.

• In 2019, FOS reported a 130% rise in complaints against payday loan firms, leading them to criticise “unacceptable” lender behaviour. Over that year, FOS upheld 70% of complaints against payday lenders.
• During the period April-June 2020, new complaints about home credit had risen 77%. In the second half of the year, FOS had over 10,000 complaints about Provident alone.

Payday and home credit lenders have been forced from the market not because of payday lending regulations in 2014/15 but because much of their lending was irresponsible: trapping people in debt and exacerbating poverty. The surge in consumer complaints led to investor uncertainty about potential liabilities and capital dried up, ultimately forcing companies out of business.

Trojan horse?

In both F4AF reports, they indicate their support for the USA Small Dollar Loans program⁸. This encourages banks and credit unions to lend to households with low or no credit scores. For example, F4AF say (2023, p.44):

“We believe the regulator [the FCA] ought to consider and reflect on how measures most constraining access to small sum credit might be appropriately mitigated or eliminated … with greater emphasis in some circumstances on access as well as affordability, which appears to us to be the lynchpin of USA Small Dollar Loans”.

Though it is not particularly clear in the passage, F4AF appear to be calling for new lines of credit to be provided to people currently unable to pass appropriate affordability checks. To do this would require reversing some of the existing affordability rules. This would be a step backwards, and counterproductive.

We support the principles underlying the FCA’s rules on affordability. In particular, the rule in CONC (the sourcebook for credit-related activities) requiring lenders to ensure that borrowers are always left with sufficient money to live a “basic quality of life”⁹ . This prevents lenders from advancing credit to people who clearly can't afford it.

It is impossible to see how the current affordability rules could be relaxed without abandoning the preservation of the borrower’s “basic quality of life”. For many this would mean destitution: opening them up, once again, to irresponsible and exploitative lending.

The main challenge we face today is the horrific increase in poverty, which has occurred in the past few years. Commercial credit markets cannot and should not be expected to provide a solution to this.¹⁰

Poverty is a problem for government, not credit markets, to address. The recent Budget contained some welcome announcements in this respect, including the increase in the National Minimum Wage and the 2025/26 extension of the Household Support Fund and Discretionary Housing Payments.

But there also remains a prospect of benefit cuts and above inflation increases in social housing rents. Those affected will become even less likely to meet the affordability requirements for credit.

Benefit cuts and rising rents will also exacerbate debt problems and are likely to create additional costs for the taxpayer down the line. Our analysis of the Debt Need Survey indicates 25% of the adult population (13.5 million people) need debt advice.

As well as raising the levy on financial services firms to expand provision, we urge the recently established Ministerial Taskforce that is developing a new Child Poverty Strategy to consider – as a specific strand of its work - how we can reduce the shockingly high prevalence of debt problems in the UK today. We also recommend the Department for Work and Pensions publish an assessment of the likely impact of future benefit changes on the need for debt advice services. This should be used to inform future funding levels for the sector.

Improving social protections and addressing the cost-of-living-crisis is the only way to arrest the increase in illegal lending. Talk of ‘credit vacuums’, and calls to water down vital consumer protections, are distractions from the real challenges ahead.

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Notes

1. Fair for All Finance (2024). ‘Access to credit andillegal lending: The shape of the market is as important as the size’. Available at: Access-to-Credit_Fair4AllFinance_May2024.pdf and Fair for All Finance (2023). ‘As one door closes: Experiences of illegal moneylending during an emerging cost of living crisis’. Available here: As-one-door-closes_WFF_V3_FINAL1.pdf
2. The term 'responsible finance' is used here as an umbrella description for credit unions and Community Development Finance Institutions (CDFIs). We do, however, have concerns about the high cost of credit being charged by some CDFIs and the potential for some of their borrowers to become trapped in a cycle of repeat borrowing and increasing indebtedness.
3. A large-scale survey commissioned by the Money and Pensions Service, with over 22,000 respondents drawn from across the UK and weighted to be nationally representative. The full report is available at https://www.responsible-credit.org.uk/reports/the-need-for-debt-advice-and-the-challenges-ahead
4. Buy Now Pay Later, payday and other short term high cost credit loans, pawnbrokers, unauthorised overdrafts, and logbook loans.
5. This confirms our assessment of the drivers of illegal lending from last year, when we wrote (‘What is driving the use of illegal moneylenders?’, p.16) “it is plausible that the use of illegal lending has grown in recent years. For example, the FCA has recently reported that the number of people finding their debts to be a heavy burden (a factor that is associated with the use of illegal lenders) has increased from 5.8 million in February 2020 to 7.2 million in May 2022. Similarly, abrdn Financial Fairness Trust’s Financial Impact Tracker survey reported that 16% of the UK population were behind with their credit or domestic bills in June 2020 but that by October 2022, this figure had increased to 22.9%.”
6. Very deep poverty is defined as having a household income which is less than 40% of the UK median.
7. F4AF (2023, p.15) point to a 90% reduction in high-cost credit, mainly due to the demise of payday and ‘home credit’ (door to door moneylending) between 2013 and 2022.
8. For further details see, for example ‘Fourth Major Bank Launches Small-Loan Program: New affordable options represent first widely available alternatives to payday loans’, Pew Charitable Trust, 16th November 2022 at https://www.pewtrusts.org/en/research-and-analysis/articles/2022/11/16/fourth-major-bank-launches-small-loan-program
9. The FCA’s rules (CONC 5.2A.17R) require lenders to consider whether credit is affordable for the borrower. This includes assessing whether the borrower will be left with sufficient ”non-discretionary expenditure” to cover their household bills, essential living expenses, other debts and expenditure which it is hard to reduce to give a basic quality of life.”: https://www.handbook.fca.org.uk/handbook/CONC/5/2A.html
10. There is, however, a case for interest free products to assist. For example, our evaluation of the not-for-profit lender, Fair for You, and its partnership with Iceland Foods indicates small sum, interest-free, credit with reasonable repayment schedules does have positive social impacts.