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Cracking down on payday lenders will hurt the poor

1 July 2013

Payday loans and pawnbrokers are a common feature of the nation’s high streets today, as they have been for centuries.  Recently however they have experienced something of a boom. Now they are also going online and increasingly advertising their products on TV. One company in particular – Wonga – has become something of a household name.  All of this has provoked calls for the sector to be regulated or even outlawed.

Now we have a summit and a lot of public statements from politicians to the effect that the activities of payday loan companies are uncompetitive and against the public interest. This kind of policy agenda is wrong on a number of grounds.

It would firstly be wrong in itself, as it would prohibit a voluntary transaction between consenting adults that does not cause direct or immediate harm to anyone, and certainly not to third parties. In economic terms such action would also be misguided and would harm the people it is intended to help, the poor.

Most attacks on payday loans and pawnbrokers cite truly eye-watering rates of interest but this is deeply misleading. The figures cited are for Annualised Percentage Rates (APR) but these only truly apply if the loan is repaid over a long period of something close to a year or more.

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In fact, loans from payday lenders are almost always paid off over a very short time period (typically days or one to two weeks) so the actual amount of interest paid is nothing like that suggested. Loans of this kind are not for large purchases or for servicing over a long period –  they are intended to provide needed cash in the very short term. They are a mechanism for letting very poor people (and others as well) get needed short term liquidity.  This is done on the basis of the only kind of security many poor people have, future income from employment, or personal possessions.

As such, short term lenders such as payday loan companies are very valuable and their absence would make short term cash-flow problems much more serious and harmful than they otherwise need be for many people. If cash is needed in the very short term to meet a utility bill, for example, far better that the liquidity be provided in the short term and the bill be paid than that somebody have their power cut off or be put on a punitive payment schedule that would last a lot longer.

Evidence shows us that bans and restrictions can often make a difficult situation more difficult still. For example, interest caps in France and Germany saw financial breakdowns –  such as bankruptcy – rocket to five times the UK’s level amongst people with debt troubles.

Even more likely, the demand for these kinds of loans would remain but would now be met by truly unsavoury characters. If you want to help loan sharks and low life money lenders then restricting legitimate firms such as Wonga is the way to go.

Politicians are sending out very mixed messages. They want to limit lending from companies such as Wonga, but simultaneously complain that major banks are not lending enough to relatively risky small businesses. It would be a grave error indeed to credit politicians with the wisdom to determine what interest rates should justify what loans.

Dr Steve Davies is Education Director at the Institute of Economic Affairs

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  • TheQuick LoanShop

    Short-term loans are debt instruments which help in providing instant cash. As the name suggests these loans are given on a short-term basis. These loans unable an individual to get their next payday, if financial urgency puts a threat on their normal budget.

  • Jennifer Underwood

    Many consumers complain that payday loans have high interest rates and that payday lenders are loan sharks. I don’t understand such statements because payday loans are not just ordinary personal loans. These loans intended to help people in emergency, when there is an urgent need of money. And you can borrow money only for relatively short term. But the most important is that cash advance loans are available for people with bad credit. If you have a good credit then you just don’t need these loans and can you loans with lower interest rates.

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  • Thomas

    Ask the poor not to take the eye watering interest rate for the loan from the pay day lender.


  • Fergus Pickering

    What would be a proper rate of interest for a loan without any collateral made to someone with no prospects who is known to be improvident? I’m just asking.

    • David Webb

      Fergus, you have just set out a case for lending to someone who no sane person would lend to UNLESS they had continual payment authority to empty their bank account at will….

  • itdoesntaddup

    The government has its own captive payday lender that offers it low start loans a.k.a. QE from the Bank of England. Perhaps that’s why they think it’s OK to have payday loans for the poor.

  • Alex

    I have more sympathy with the article than most commenters. The fact is that these companies are obviously meeting a need. If that need cannot be met legally it will be met illegally, with far worse results. To portray the lenders as evil exploiters is just silly; they are lending small amounts for short periods to high-risk borrowers; it would be suicide for them not to charge high rates. And adding regulations will simply push up those rates.
    The long term answer is to examine why people are in this situation.
    1. By improving numeracy and financial planning
    2. I believe that a major reason for people using food banks is late payment of benefits. Is this also an issue making people need payday lenders?

    3. Has the credit union idea been damaged by over-regulation?

  • Colin

    Try running up an unauthorised overdraft with a “reputable” lender and see what happens.

    Ever wondered why Payday Loan Companies weren’t an issue before now? The reason they’ve rocketed to the centre of the universe in terms of revulsion (mostly driven by people influenced by the banking lobby), is because they’ve filled a gap left by the high street banks – namely that they’re actually lending to people. More recently, some of these companies have started lending to small and medium sized businesses – this has rattled the banking industry and they’re now fighting back.

    Whilst the banks have been busily using tax payer’s money to rebuild their balance sheets, the personal balance sheets of many, many tax payers are in ruins. Whilst some of these payday loan companies look to be nothing short of corporate loan shark operations, most of them are well run, very legitimate and are filling a niche. A niche that the political/media complex will never need to avail itself of.

  • WillyTheFish

    This article can, perhaps, be best described as an anagram of ‘carp’.

  • David Webb

    There is a basic unfairness in the contract that provide for absurdly high charges and interest, and allow bank accounts to be emptied without notice, despite their being in many cases legal questions over the amount owed.

  • Smithersjones2013

    Oh dear someone call waste collection another Liberal is spouting garbage again. Have they no pride?

  • Matthew Blott

    Only a member of the lunatic fringe could come up with this swill. Fraser Nelson likes to think of himself as a mainstream conservative and despite warning signs such as his eulogising of Sarah Palin I was prepared to give him the benefit of the doubt. The fact that nutty articles like this make regular appearances suggests Mr Nelson is firmly camped in the right-wing funny farm.

  • terregles2

    Prefer the concept of encouraging the public to save a small amount and borrow from their local credit union.

    • OldLb

      I agree. I’m a libertarian. I would rather people did use credit unions. Nothing better than getting together as a group to help each other.

      However, lots on the left need to educate themselves on the cost of providing loans. Even for a credit union, the costs are larger than you might think.

      1. You need staff. The cost of employing them is going to be three times wages as a ball park.

      2. It’s a regulated industry. That means lots of paper work. That means lots of staff.

      So far, you haven’t even got as far as making any loans or taking any deposits.

      Next, there’s the problem of bad debts. Bad debts have to be paid either by those depositing loans, or by charging more interest to those borrowing. At a default rate of 10%, with a 5% borrowing the rate you need to change is 16.7%, and that’s before any costs.

      Next, if its a small loan, the cost of just doing the paperwork is a considerable percentage of the amount borrowed.

      So the biggest cost, yet again, is the state. Next is the problem of people not paying back their debts. That falls on to others. Just like the banking mess, caused by people not repaying their debts.

      There’s a far better way. Cut the state out of the mess. They have by and large caused it.

      Lets return to Beveridge’s original vision. A fund in your name into which you pay money whilst earning. It’s your money, not to be tapped or taxed like Frank Field wants to [In secret]

      For a median wage earner after 40 years, that gives a fund of 627,000 pounds.

      For those who don’t work all the time, its less, but still considerable. The reason is compound interest, and not having money diverted for other things.

      We also need to look at the cost of the DWP. 5% of all the money they pay out goes in their charges. That’s worse than any rip off pension company. An example of the money being diverted.

  • itdoesntaddup

    There is no good reason why a utility company couldn’t indulge in extending repayment on far less onerous terms than a payday lender. Indeed, their bill is probably excessive in the first place.

    Those who get themselves into that degree of liquidity problem probably need rather more than a loan at high rates of interest (that in fact reflect the probability of default): they need to sort themselves and their finances out. Payday lenders offer no such assistance. A visit to the CAB would be more productive.

    • itdoesntaddup

      I’ve a better idea: the expensive utility bill ought to be sent to one of the 396 MPs who just voted in favour of expensive energy for payment. They voted for it.

  • Dogsnob

    “Payday loans and pawnbrokers are a common feature of the nation’s high streets today, as they have been for centuries. ”

    Not quite. Yes they have been in existence in the nation for centuries; but common, no.
    From the mid sixties to the nineties, they were not a common sight. Can’t remember one in my city.

  • MirthaTidville

    There can surely, be no justification, for allowing firms like this to trade on the vulnerable, poor, frightened and desperate for nothing more than usuary gain. Still I dont suppose those who run these rackets have trouble sleeping at nights and there is always someone somewhere who will pop up and try to justify them…

  • Alexsandr

    All lenders should be forced by law to do credit checks on all their loans and send data on new loans to the credit reference agencies.
    They should check on income, seeking evidence that the income is real and not a lie.
    And from this they can check the affordability of the new loan and not make it if not affordable. If they don’t do proper diligence before making a loan then they should not be allowed to use the courts to recover the debt.
    The rollovers just make the situation worse for people, and are not a help at all, but just an escalating millstone.
    No-one should run a business exploiting the vulnerable lending unsustainable debt.

    • telemachus

      The desperate poor with children still need money
      If you deny them you send them to the loan sharks
      Your proposal is a prescription for broken legs

      • Alexsandr

        so sinlge mum gets paid on 30th of each month. She runs out of money on 20th june and borrows £100. pays back £110 on 30/6. But now she is short for July so borrows £120 on 20/7. then she is short for august and so it escalates. But the loan company are happy cos the loans come back. But clearly her earnings dont justify that level of borrowing.

        I fail to see how lending to someone who doesn’t have any discretionary income helps them.

        • telemachus

          Because if you do not she will still crave money and go to the loan sharks with disastrous consequences to her own and her families health
          Unless you wish to put these folk back in the workhouse this is the least worst option

          • David Webb

            Telemachus, you seem to be pro-fraud. Payday lenders ARE loan sharks. Violence, greivous bodily harm etc, by loan sharks is illegal and if the police are aware that someone has been targeted in this way, it is their duty to prevent such violence from happening.

    • FrankS

      You’re saying, in a roundabout way, that they shouldn’t exist.

      • Alexsandr

        well if they are giving loans to people who cant afford them and will be unlikely to be able to replay them, then yes.

  • Niall Cooper

    Steve Davis clearly hasn’t read the latest OFT inquiry into Payday lending, which clearly shows that a very high proportion of loans are NOT paid off in ‘days or one or two weeks’ – but rolled over into further loans – at punitive rates of interest. In fact, most Payday lenders business models currently rely on this – as 50% of their profits come from rollover loans. Shame on the Spectator for publishing such an ill-informed and misleading article.

    • Daniel Maris

      Shame is certainly due since most of the staff will never have had to experience having nothing left in the kitty as payday approaches.

    • Nicholas chuzzlewit

      Yes its terrible but these same borrowers will still need to borrow to make ends meet and at least Wonga etc will not resort to violence and intimidation in the manner of unregulated Loan Sharks. So no, the Spectator is entitled to air a view which just happens to differ from yours.

  • Daniel Maris

    Is there no inquity that the IEA won’t defend. Human trafficking could probably be defended on the same or similar grounds.

    There is simply no way interest rates of 4000% to ordinary people are justified in any context whatsoever. We should have a maximum limit for loans of up to £10,000. The government should subsidise credit unions to provide meaningful support to poor people who experience difficulty managing within budget .

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