Usury and soap operas: how lenders profit from least credit-worthy

Having berated the High Street banks, the OFT has now turned its attention to those lenders who deal with high-risk, low-income borrowers. Adrian Ash looks at whether their practices really are unfair.

If you had the misfortune to watch day-time TV in Britain today, you might be forgiven just as in the US, Australia or Canada for thinking there's stiff competition at work in consumer debt.

But not according to the UK government's Competition Commission there isn't. Intervention is needed, it intervention is just what the market in lending to high-risk, low-income borrowers will get.

The Competition Commission (CC) first started playing to the gallery back in April this year. It claimed that in 2004 alone, so-called 'home credit' firms lent £1.5 billion (around $2.6bn) to 2.3 million customers and collected £1.9 billion ($3.3bn) in repayments. Last week, on 30th November, it said it had uncovered the reason for this fat juicy margin: Britain's 'doorstep' lending market lacks new entrants, competing products, and fair competition between the money lenders themselves.

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If only the commissioners would take a 'duvet day' off work, and stay at home on the sofa! There they would find a host of C-list celebrities packing the advert breaks, urging viewers with bad credit histories to pick up the phone and consolidate their borrowings into one 'easy' lump sum.

'Tick, tick get a response in one minute...' as Provident Financial, the market leader, likes to say.

Instead, the CC has decided that the free market between willing lenders and cash-strapped consumers needs a helping hand. Now doorstep lenders those companies helping to keep Britain's low-income families solvent from one week to the next will have to share customer data, publish their offers on a comparison website, and also make sure that debtors who pay early get a 'fair' rebate.

Whatconstitutes 'fair' in consumer credit?

According to the CC's own sums, Britain's home credit customers pay the equivalent of $40 'too much' for their loans on average. That 'unfair' premium has fallen since the spring, it would seem. Back then, the CC's original press release made headlines by claiming that home credit customers paid nearer $50 'too much' per loan...a shocking $9 'too much' for every $100 they borrow.

Its No.1 reason for meddling, however, remains. Profits look excessive. Ergo, the charges must be excessive, too.

'Home credit lenders have been able to earn more than £500 million [nearly $1bn] in profits in excess of the cost of capital in the last five years,' says the Competition Commission. In 2004 alone, the industry is charged with earning more than 26% gross on its lending book. And here, perhaps, is where the home credit providers have invited trouble. For while they have done what the major High Street banks won't and lent small sums to the poorest, least credit worthy consumers they have also maintained their margin. The mainstream UK lending market, however, has cut its prices sharply over the last decade.

Since 1995, the gap between Bank of England base rates and the rates charged on most unsecured lending has shrunk dramatically. The average credit card, for instance, used to charge 16% over base rate; that's now fallen to 12% and below. Overdraft fees have gone from 18% above base rate to only 11% above the Bank of England's official cost of money. Most precipitous has been the collapsing price of unsecured bank loans and borrowing more, as ever, costs less.

The gap between Bank of England base rate and the interest you pay on a loan of £3,500 has gone from 13% to 9%. An unsecured loan of £10,000, however, has fallen in price from 11% over base rate to just 2.2% and falling.

Lower-income families, of course, never got invited to the High Street bank's cheap credit sale. So while the mainstream lenders slashed their prices for better credit risks and new provisions for bad debts looked safe between just 0.2% and 0.4% of their total loan book the 'doorstep' lenders have been left the higher-risk low-income market, pretty much all to themselves.

The home credit market has also undergone a severe consolidation, especially amongst the biggest lenders. The number of 'doorstep' lenders with more than 1,000 agents has fallen from six to four since 1993. Those four suppliers now account for two-thirds of the market. The market leader, Provident Financial plc (LSE:PFG), has around half the total UK market.

And what a market!

The attractions of the sub-prime market

Surveys suggest that four million Britons always run out of money and benefits before the end of the month, according to the BBC. That means the 'sub-prime' lenders are making a packet from a large, growing, and captive market...lending the poorest consumers easy money at rates of up to 64.5% per annum.

'It's unfair,' says the Office of Fair Trading. 'It's uncompetitive,' says the Competition Commission. 'It's just what I need,' say low-income consumers, shut out of today's cut-price loan deals on the High Street.

'To take usury for money lent is unjust in itself,' wrote Thomas Aquinas in 1269. The Dominican monk, in keeping with Aristotle, believed that money was sterile, a unit of account only, and one mandated by law not by nature. Aristotle was writing in ancient Athens; Aquinas wrote in 13th century Paris. But both would have no trouble passing judgment as one of Britain's unelected financial watchdogs today.

Britain currently has no 'usury' legal ceiling above which banks and other lenders cannot bill their customers. But the nation's financial watchdogs are getting truly medieval on 'excessive' rates and 'unfair' charges. Earning 'usury' by lending money is fast becoming a sin once again.

Given that long-term interest rates have only recently turned up from half-century lows, what might this mean for interest-rate policy? The political opposition to anything but falling rates, most especially from the government regulators, is getting louder by the day.

'Credit card default charges have generally been set at a significantly higher level than is legally fair,' decided the Office for Fair Trading in April. 'The OFT estimates that across the industry this has led to unlawful penalty charges currently in excess of £300 million a year...Where credit card default charges are set at more than £12, the OFT will presume that they are unfair...[but] a default charge is not fair simply because it is below £12.'

Okay, the OFT admitted that 'only a court can finally decide whether a charge is unfair or not. It also noted that its own 'view of the law...has not generally been accepted by most of the eight credit card issuers.' But so what? As the Competition Commission goes after the doorstep lenders, the OFT can now smell 'unfairness' in High Street bank accounts, too. Overdraft charges might help keep 'free banking' free if you don't go overdrawn. But NatWest, Barclays, Lloyds and the rest stand accusing of a Great British rip-off.

'Lloyds TSB,' reports the London Times, 'recently changed its overdraft rules so that 8 million customers could be charged as much as £135 for slipping into the red by just 1p...Current-account charges cost customers an estimated £4.7 billion a year...[So now] hundreds of consumers are taking their bank to court on the basis that overdraft charges break consumer law because they are 'disproportionately high'. Banks have tended to settle out of court, which suggests they know that their fees cannot be justified.'

This revolt against 'unfair' banking fees isn't just hitting Britain, either. The Japanese government is currently looking to cap interest rates at 20% per year. South Africa already has a maximum rate of 17%. And late last year, the US state of Alabama ruled retrospectively that the rates charged by 'payday' lenders were 'usurious' and therefore illegal.

Mainstream credit, meantime, just keeps getting cheaper. Even if you accept the official inflation data, real interest rates all over the world remain low. In Britain they've fallen from 3.4% to little more than 1% during the last 10 years.

What might happen first politically...and then at the sharp end of consumer credit if inflation finally shows up in the official measures, and rates have to rise to stem the flood of or otherwise?

Adrian Ash is head of research at