Has Wonga gone mad? Yesterday he effectively written off £ 220million owed to the payday loan by 330,000 borrowers over 30 days overdue in paying off their debt. It might seem like a drop in the bucket in the financial sector, but £ 220million is a huge amount for Wonga. To put it in perspective, that’s five and a half times the company’s annual profits and more than 11 times the amount recently inflicted on it by the Financial Conduct Agency (FCA) for sending bogus letters to individuals. debtors.
As if that weren’t enough, 45,000 late customers will not have to pay interest. All this followed an announcement yesterday that its profits had fallen by more than half and that in the future the company would be a smaller and less profitable company.
From a distance, this seems like a crazy business decision. Why would a payday lender send such a large Mea culpa? It looks like a mafia boss forgetting all the “favors” he had done to members of the local community. But Wonga’s plan to write off the debt is not an irrational decision. Nor is it a business that suddenly finds its soul. It is simply a smart business strategy.
By canceling these debts, Wonga clearly hopes to improve the image of the company. It will no longer look like a rapacious enterprise preying on the poor. He now hopes to be seen as a new age capitalist with a conscience. But – perhaps more importantly – the company will get rid of the regulator. We must also remember that much of the debt canceled by Wonga would have been sold to debt collection companies at a very favorable price.
Loan sharks would blush
In the past, Wonga has been in the crosshairs for directing what looked like a loaner racket. He was charging interest rates that would make a loan shark blush. This was dressed in the advertising costume featuring slightly batty puppets, presumably designed to appeal to the company’s target market. It has also marketed itself as an online high-tech company located in the heart of The tech city of London. Despite this beautiful facade, many commentators noted that the company had come up with a rogue business model that was legal, but many members of the public saw it as illegitimate and unethical. Even the Archbishop of Canterbury weighed in the debate.
It is clear that Wonga tried to defend himself against criticism. He has found clients who are willing to speak positively about his services. Despite this public relations campaign, public suspicion persisted. These criticisms are not unfounded. There is an abundant academic literature showing many of the problems associated with payday loans. American research found that the average payday loan is $ 375, but the average amount of interest paid on this loan is $ 520. Payday lenders clearly target the poor, and often those people from ethnic minorities.
Part of the reason is that traditional banks have abandoned many poorer communities because they have closed branches and centralized services. This was largely motivated by the continued consolidation of financial institutions from a series of smaller institutions serving particular audiences into a small number of larger organizations serving a large number of average clients.
Poorer communities have been particularly affected by the decline in nonprofit financial institutions such as credit unions that traditionally lent to the poor. In the poorest communities, payday loans are often used in place of social security payments. They often leave the poor trapped in debt cycles, causing personal misery and hampering economic activity in these communities.
These concerns have led to an international crackdown on payday lenders. In the United States, 14 states have banned payday lenders. The Australian states of New South Wales and Queensland have established a maximum annual percentage rate (APR) by 48%. In the UK there is no maximum APR and little legislation to restrict the industry. Traditionally, payday lenders have been subject to “light” regulation. It was only during the past year that the Financial conduct authority started to get tough with the industry. The result of this was a fine of £ 11million and today’s voluntary agreement with Wonga.
Wonga’s management clearly hopes that its debt cancellation could help improve the company’s image. Other payday lenders may remain in the sights of regulators. But it is far from certain that the structural problems underlying the growth of the payday loan market have really gone away.
Banks continue to close branches, tighten loans and leave the poorest areas. At the same time, nonprofit financial institutions such as credit unions remain a shadow of themselves. The result is that many of the poorest communities have access only to marginal institutions such as payday lenders. At the same time, consumers continue to be called upon to “prime the pump” of the economy through personal loans. Today, people take out loans for everything from housing to education to daily consumption. This leads to a strange sort of privatized Keynesianism, whereby individuals assume the debt that the state once supported.
The result is an individual debt that is still high in the population. The difference, of course, is that businesses and high net worth individuals pay next to nothing for their loans. The middle classes are now paying unprecedented levels for their loans to repay their homes. In contrast, the working class is forced to turn to payday lenders who continue to pay thousands of percent to pay off a weekly grocery store.
A recent study on payday lenders in the US state of Wisconsin suggests some ways forward. The authors of this study suggest that if a regulator is serious about stopping the spread of payday loans, then it should try to create incentives for the growth of nonprofit financial institutions such as credit unions that cater to generally to the poor. They also point out that banning payday loans does not necessarily solve the problem. In states where payday loans are banned, traditional banks began to offer overdraft services that looked a lot like payday loans. The way the products are labeled is important.
Clearly reporting not only the APR, but also the total cost of borrowing to customers, can force customers to think twice before taking a high interest loan. But careful regulatory oversight can also make a difference. For example, South Carolina, which closely monitors the databases of payday lenders, has been able to drastically reduce the practice of refinancing loans.
Forgiving 330,000 borrowers for their debts can help ease the burden on many people. It might also help start to change Wonga’s image from being what looked a lot like a rogue lender to a responsible citizen. But fixing the problems with payday loans will likely require much more structural action.