What is driving the use of illegal lenders?

In June, Fair4All Finance published a report concerning the experiences of people borrowing from unlicensed lenders. It looks at the role credit exclusion plays in the growth of unlawful lending, the circumstances of people borrowing, and the harms caused in the process.

Illegal loan sharking is notoriously difficult to study, and there are problems when it comes to estimating its scale. Research on the topic relies on self-reporting and not everyone using an illegal lender is likely to be forthcoming.  Nevertheless, several recent studies have tried. Last year the Centre for Social Justice (CSJ) estimated that 1.08 million (2.5% of the population) were in this position. This is over 800,000 more than was estimated by the FCA’s 2020 Financial Lives survey, and the FCA’s latest survey, conducted in May 2022, and published today, does not indicate any increase in that figure. Whilst the FCA notes (p.50) that "Claimed use is, however, likely to understate the real level of use", there are clearly wide variations in the estimates such that we simply do not know how many people are using illegal lenders at this point in time.

Fair4All Finance’s study is qualitative. It doesn’t attempt to estimate the number of people using illegal loan sharks, or how many lenders currently operate. What it does is improve our understanding of how these lenders exploit people’s hardship and vulnerabilities. Through in-depth interviews the report paints a detailed picture of the tactics used to draw people into borrowing money illegally, and to enforce repayments. It also looks at the lives of the people using illegal lenders, giving an indication of what causes them to use loan sharks in the first place.

The 287 people interviewed in their study are unlikely to be representative of all illegal moneylending borrowers, because we cannot be certain of the correct sampling that would be required to achieve this. However, the testimonies provided by the study participants indicate a close link to poverty and over-indebtedness.

A precarious nation

The UK has a problem of inadequate, and often insecure, incomes. In the same month as the Fair4All Finance report, the APPG on Poverty published a report concerning the (in)adequacy of the social security system. In it they quote estimates from the Joseph Rowntree Foundation (JRF) concerning the cost of essentials. For a single-person household, these amount to £120 per week. For couples that rises to £200. These exceed the amounts awarded to these households on Universal Credit, which are £84.86 and £133.22 respectively. Under 25s are penalised further: £67.22 per week for a single-person and £105.50 for a couple.

Analysis by the Centre for Research in Social Policy shows that for a working age couple in 2008, out of work benefits provided 42% of what was needed for a minimum acceptable standard of living. By 2022 that had fallen to 29%.

The cost-of-living crisis is deepening.  Although millions of public sector workers are set to be given a pay rise of, on average, 6% (7% for police officers), this still represents a real terms pay cut. The squeeze on incomes leaves many with unenviable options: cutting back consumption, falling into arrears with bills, borrowing, and/or defaulting on existing credit agreements. This has a  devastating impact on the poorest. The Bank of England estimated in 2022 that the very poorest 10% spend 90% of their gross income on essentials. This will be worse now.

According to JRF, 7 million households cut back spending on essentials since 2022, including food and heat. Low-income families fall behind on payments by an average £1,600. 1.3 million households use credit to pay for essentials, and 2 million households owe money to high interest lenders.

And, Citizens Advice recently reported a rise in the number of people it sees with negative budgets – where, even after income has been maximised and costs cut back, there is insufficient income to meet essential needs. The number of people in this position has doubled in the last two years.

A problem of credit exclusion?

In our view, these cost-of-living pressures are the most likely explanation for any increase in the use of illegal lenders.  Fair4All Finance instead focus on credit exclusion as a possible driver: “mainstream credit refusal is one key triggering factor shared by those borrowing from illegal lenders”.

Whilst Fair4All Finance are careful not to “draw national conclusions from [the] small sample”, they do hint at a possible causal connection between reduced access to regulated credit and illegal money lending activity.

In support of this argument they note a reduction in the supply of legal sources of credit for people on low incomes; for example that the provision of home credit (door-to-door-moneylending) has reduced to fewer than 100,000 loans per quarter, from 400,000 per quarter in 2019. In part, this has been due to the introduction of proportionate regulation stopping lenders from exploiting customers.

However, the period has also seen an increase in the use of unregulated Buy Now Pay Later products. In addition, as the FCA's latest Financial Lives Survey reports (pp.190-191), very few people turned down for regulated credit subsequently turn to an illegal lender:

"Of the 2.9 million adults who were refused a credit or loan product...under half (45%) were unable to get the credit they needed at all. One in ten (10%) were able to get credit from an alternative supplier, 10% were able to get a similar product but with different terms and conditions, and 7% had to pay extra.

One in five (19%) who were declined said that they had to borrow from friends or family as a result, 16% cut back on spending, 14% raised money by selling something, 10% saved up until they had the money they needed, and 8% used savings. One in ten (9%) said being declined resulted in their defaulting on another loan, bill, or payment, and 2% said, as a result, they turned to an informal/unlicensed (ie illegal) moneylender."

Great care should therefore be taken before drawing causal links. Illegal money lending is complicated. Loan sharks often operate in their target areas for years, and there are several other factors which need to be considered, including increased deprivation and poverty arising from a reduction in social security protection.  Reports of an increased use of illegal lenders have coincided with big changes to welfare policy. For example, the benefit cap has lowered social security payments pushing many into hardship.  We have also seen the ‘localisation’ of Council Tax Support and the discretionary Social Fund which reduced support for those on low incomes.

Greater use of sanctions and deductions from benefits may also be playing a part. The APPG on Poverty reported that almost half (45%) of households on Universal Credit (UC) “have deductions from their income due to debt repayments, averaging around £14 per week, the majority of which are repaying government debts (e.g., UC advances).” This is pushing people into hardship. Over half (57%) of those on UC referred to food banks have debt deductions. Areas with the highest rates of deprivation, also have the highest rates of deductions.

Wider changes in the labour market, including the rise of the gig economy also need to be considered.

As the The Financial Conduct Authority (FCA) noted in 2017:

“Many of the factors we identified as likely to be significant in the prevalence of unauthorised lending fall outside the immediate regulatory remit of the FCA. This includes social and environmental factors identified as possible drivers of the circumstances that lead consumers to use this type of lending.”

Finally. the question also arises as to whether people borrowing from illegal lenders are ‘credit excluded’ or over-indebted, as well as how these interact with each other.

Over-indebtedness as a potential driver

Debt problems are clearly on the rise. As Debt Justice reported earlier this month, there are now 12.8 million adults weighed down by debt - an increase of two-thirds since 2017.

And Fair4All Finance themselves report that people being refused credit and using illegal lenders: “held larger total amounts of debt, with two thirds having over £3,000 of debt worth of total debt, within which nearly half (45 %) had over £5,000 of debt. Over half (54%) of those not refused credit had self-reported as holding under £1,000 of debt”.

It appears to us that people being refused credit before using illegal lenders have, in many cases, exhausted their legal credit options (i.e., are over-indebted rather than ‘excluded’).  

For example, as the CSJ found:

“Victim data shows that those who have borrowed from illegal lenders are also often mired in debt to regulated or legal creditors … data show that two-thirds of victims in 2021 owed debt to a regulated or formal creditor and almost 45% have priority debts.”

Rather than illegal lending being driven by a ‘credit vacuum’, it appears to us to be caused by an over-extension of high-cost credit leading to debt problems and, ultimately, to over-indebtedness. We have previously reported on how illegal moneylending in Japan, for example, grew alongside an expansion of high-cost credit.

This is all to say that the problems described are unlikely to be solved by an expansion of affordable credit alone. Both Fair4All Finance and the CSJ advocate increased investment in credit unions and Community Development Finance Institutions (CDFIs) as a response to the threat of increased illegal lending.   Whilst CfRC has long advocated for greater investment in this sector, and our own evaluation of the Fair For You Food Club indicates that these can play a role in reducing illegal lending, we consider much more will be needed.

With many reported victims of loan sharks already highly leveraged with debt, it’s unlikely that even well capitalised credit unions or CDFIs would lend to people owing so much money on other credit products. Less likely mainstream banks. And, we should note that many - including the CDFI, Scotcash - have recently collapsed.

CfRC position

In our view, there needs to be a greater focus on the risks of over-indebtedness leading to illegal lending use.  People using high-cost credit often enter a spiral of increasing indebtedness, which finally results in credit exclusion. Recognising this link requires policy solutions relating to insolvency reform: widening access to debt-write offs and a genuine ‘fresh start’ is urgently needed.  So too greater funding for community-based debt advice services.  But illegal lending isn't only a credit and debt problem: we need to recognise that government policy is increasing hardship. There is plenty that government can do to stop people turning to illegal lenders. Addressing rising poverty levels must be one of them.

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