Payday Lending – Digital Finance Analytics (DFA) Blog

DFA Highlights Payday Lending Is Driving Australians Into Debt

DFA provided data from our household surveys to inform an important report “The Debt Trap” released by more than 20 agencies helping consumers with their financial pressure. Our research, based on our rolling 52,000 households reveals that more households are using short term loans to try and manage their budgets, but many get trapped into debt. This is important given the rise in mortgage stress across the country.

The report also contains case studies which bring home the risks involved.

Worse, the recommendations from an earlier Government review are apparently in a holding pattern, and as a result more are being sucked in due to Government inaction.

Finally, the rise of apps and online lenders is making is easier for desperate households to get caught up with high cost short term debt.

Here is the official release.

Over 20 consumer advocacy bodies from around the country have released new data revealing that predatory payday lenders are profiting from vulnerable Australians and trapping them in debt, as they call for urgent law reforms.

The Debt Trap: How payday lending is costing Australians projected that the gross amount of payday loans undertaken in Australia will reach a staggering 1.7 billion by the end of 2019. It also found that:

Over 4.7 million individual payday loans were taken on by around 1.77 million households between April 2016 and July 2019, worth approximately $3.09 billion.
Victoria is the state leading the country with the highest number of new payday loans
Digital platforms are adding fuel to the fire, with payday loans that originate online expected to hit 85.8% by the end of 2019.
The number of women using payday loans has risen from 177,000 in 2016 to 287,000 in 2019, representing a rise to 23.13% of all borrowers. Close of half are single mothers.

The report was released today by over 20 members of the Stop the Debt Trap Alliance – a national coalition of consumer advocacy organisations who see the harm caused by payday loans every day through their advice and casework.

Read the full report here [PDF]

“The harm caused by payday loans is very real, and this newest data shows that more Australian households risk falling into a debt spiral,” says Consumer Action CEO and Alliance spokesperson, Gerard Brody.

“Meanwhile, predatory payday lenders are profiting from vulnerable Australians to the tune of an estimated $550 million in net profit over the past three years alone.”

Brody says that the Federal Government has been sitting on legislative proposals that would make credit safer for over three years, and that the community could not wait any longer.

“Prime Minister Scott Morrison and Treasurer Josh Frydenberg are acting all tough when it comes to big banks and financial institutions, following the Financial Services Royal Commission. Why are they letting payday lenders escape legislative reform, when there is broad consensus across the community that stronger consumer protections are needed?”

The Alliance is calling on the Federal Government to put people before profits and pass the recommendations of the Small Amount Credit Contract (SACC) review into law. This legislation will be critical to making payday loans and consumer leases fair for all Australians. There are only 10 sitting days left to get it done.

“The consultation period for this legislation has concluded. Now it’s time for the Federal Government to do their part to protect Australians from financial harm and introduce these changes to Parliament as a matter of urgency.”

The Fall Of Pay Day?

There have been some interesting developments in the short-term lending market in the UK recently. The Financial Conduct Authority in the UK recently published data on the so called high-cost short-term credit (HCSTC) market. HCSTC loans are unsecured loans with an annual percentage interest rate (APR) of 100% or more and where the credit is due to be repaid, or substantially repaid, within 12 months. In January 2015, The FCA introduced rules capping charges for HCSTC loans.

Just over 5.4 million loans originated in the year to 30 June 2018, and that lending volumes have been on an upward trend over the last 2 years. Despite some recovery, current lending volumes remain well down on the previous peak for this market. Lending volumes in 2013, before FCA regulation, were estimated at around 10 million per year.

These data reflect the aggregate number of loans made in a period but not the number of borrowers, as a borrower may take out more than one loan. They estimate that for the year to 30 June 2018 there were around 1.7 million borrowers (taking out 5.4 million loans).

The market is concentrated with 10 firms accounting for around 85% of new loans. Many of the remaining firms carry out a small amount of business – two thirds of the firms reported making fewer than 1,000 loans each in Q2 2018.

For the year to 30 June 2018, the total value of loans originated was just under £1.3 billion and the total amount payable was £2.1 billion. Figure 2 shows that the Q2 2018 loan value and amount payable mirrored the jump in the volume of loans with loan value up by 12% and amount payable 13% on Q1 2018.

The average loan value in the year to 30 June 2018 was £250. The average amount payable was £413 which is 1.65 times the average amount borrowed. This ratio has been fairly stable over the past 2 years. A price cap introduced in 2015 stipulates that the amount repaid by the borrower (including all charges) should not exceed twice the amount borrowed.

Over the past 2 years the average Annual Percentage Rate (APR) charged for HCSTC has been consistent, hovering around 1,250% (mean value). The median APR value is slightly higher at around 1,300%. Within this there will be variations of APR depending on the features of the loan. For example, the loans repayable by installments over a longer period may typically have lower APRs than single installment payday loans.

In the UK, the North West has the largest number of loans originated per 1,000 adult population (125 loans), followed by the North East (118 loans). In contrast, Northern Ireland has the lowest (74 loans).

Borrowers between 25 to 34 years old holding HCSTC loans (33.4%) were particularly over-represented compared to the UK adults within that age range (17.5%). Similarly, borrowers over 55 years old were significantly less likely to have HCSTC loans (12.2%) compared to the UK population within that age group (34.8%). The survey also found that 60% of payday loan borrowers and 45% for short-term installment loans were female, compared with 51% of the UK population being female.

61% of consumers with a payday loan and 41% of borrowers with a short-term installment loan have low confidence in managing their money, compared with 24% of all UK adults. In addition, 56% of consumers with a payday loan and 48% of borrowers with a short-term installment loan rated themselves as having low levels of knowledge about financial matters. These compare with 46% of all UK adults reporting similar levels of knowledge about financial matters.

But now the top PayDay lenders are out of business. In August 2018, Wonga, once the biggest payday lender in the UK collapsed and now administrators for the lender have revealed that 389,621 eligible claims have been made since Wonga’s demise. Despite being vilified for its high-cost, short-term loans, seen as targeting the vulnerable, it became a household name and was enormously successful until stricter regulation curtailed its, and other payday loan companies’, lending.

It collapsed in the UK following a surge in compensation claims from claims management companies acting on behalf of people who felt they should never have been given these loans. So far, the compensation bill is £460m, with the average claim £1,181.

Another lender, The Money shop closed earlier this year.

Now QuickQuid, UK’s largest payday lending firm is to close with thousands of complaints about its lending still unresolved. QuickQuid’s owner, US-based Enova, says it will leave the UK market “due to regulatory uncertainty”.

QuickQuid is one of the brand names of CashEuroNet UK, which also runs On Stride – a provider of longer-term, larger loans and previously known as Pounds to Pocket. The UK’s Financial Ombudsman Service said that it had received 3,165 cases against CashEuroNet in the first half of the year. It was the second most-complained about company in the banking and credit sector during that six months.

Back in 2015, CashEuroNet UK LLC, trading as QuickQuid and Pounds to Pocket, agreed to redress almost 4,000 customers to the tune of £1.7m after the regulator raised concerns about the firm’s lending criteria.

More than 2,500 customers had their existing loan balance written off and more almost 460 also received a cash refund. (The regulator had said at the time that the firm had also made changes to its lending criteria.)

“Over the past several months, we worked with our UK regulator to agree upon a sustainable solution to the elevated complaints to the UK Financial Ombudsman, which would enable us to continue providing access to credit,” said Enova boss David Fisher.

“While we are disappointed that we could not ultimately find a path forward, the decision to exit the UK market is the right one for Enova and our shareholders.”

So this could be the twilight of the PayDay industry in the UK, as better education, and other lending options, plus tighter regulation bite.

Meantime in Australia its worth reflecting that proposed changes to SACC loans here (Small Amount Credit Contracts) have not progressed despite an earlier investigation, and we will be talking about the impact of this inaction in a later post.

Given the pressures on households here, we are concerned that more will reach for short term loans to tide them over, despite the high costs and risks from repeat borrowing, all made easier still via the proliferation of online portals. The debt burden on households is high and rising.

Yet Another Inquiry Into Payday Lending And Beyond

The Senate will review the regulatory environment surrounding payday lenders and consumer leasing businesses and also buy now, pay later schemes such as Afterpay. The scope will likely also include debt negotiation firms and credit repair agencies, who offer “services” which are unregulated and often costly.

Given the high and rising levels of household debt and mortgage stress, and the fact that this area is not caught within the current Royal Commission, it makes sense for it to be examined, assuming appropriate regulatory intervention follows.

This is the latest in a string of reviews which seem to go nowhere. After the previous inquiry, the Small Amount Credit Contract and Consumer Lease Reforms bill from 2015 would have introduced a cap on leases equal to the base price of the good plus 4 per cent a month and only allow leases and short-term loans to account for 10 per cent of a customer’s net income. The recommendations were broadly accepted in 2016. But five ministers and more than 1000 days later, nothing has changed. People are getting more into debt, and the growth in the alternative lending sector continues.

We estimated the cost of this inaction in an earlier post.

Since the Government released the report of the Independent Panel’s Review of the Small Amount Credit Contract Laws in April 2016, three million additional loans have been written, worth an estimated $1.85 billion and taken by some 1.6 million households.

In that time, around one fifth of borrowers or around 332,000 households, were new payday borrowers.

Payday Pain Still Grips

Since the Government released the report of the Independent Panel’s Review of the Small Amount Credit Contract Laws in April 2016, three million additional loans have been written, worth an estimated $1.85 billion and taken by some 1.6 million households.

In that time, around one fifth of borrowers or around 332,000 households, were new payday borrowers.

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We also know that over a 5-year period around 15% of payday borrowers will get into a debt spiral which leads to events such as bankruptcy. On that basis, an additional 249,000 households have been allowed to enter a debt path which leads to this unfortunate end. A larger number fall into other family or relationship issues when borrowing from this source.

Digital Finance Analytics was asked by the Consumer Action Law Centre to complete custom modelling using data contained in our rolling 52,000 per annum household surveys, focussing in on the question of the quantum and impact of delays in the proposed legislation relating to the sector.

Specifically, we estimated the incremental damage done to households in terms of the value of loans taken since the final review was published on 19th April 2016, as well as some observations as to the characteristics of borrowers over this period.

The data presented is this paper is somewhat indicative, in that we made a number of reasonable assumptions to support our findings.

The survey remains as statistically robust sample (aligns with the most recent ABS census data).
We have extrapolated 2018 figures on the current run rates per month.
We have not tried to overlay the potential before and after impacts, had the proposed changes been made to payday sector, but we have considered the mix and impact of loans taken during this time.
We use the term “payday loans” to refer to those loans made within the SACC (Small Amount Credit Contract) legislation, so this excludes medium term loans and other personal credit facilities.

The Current Size of the Payday Market

We continue to see some growth in the payday sector overall.

In 2016, the total loans written (loan flows) were in the order of $736 million and based on projections for the full year 2018, this will rise to $925 million. However, because payday lending is by nature short term, the incremental value of $189 million is not the full measure of loans written in the period. We will estimate this later in the paper.

Of note is the significant increase in online origination, with 83% of loans now accessed via a web site on a mobile device or another computing device.
The other important factor is to note the switch in types of customers being attracted by these services. As a result of tighter controls on loans to Centrelink recipients, and the rise in online services, the mix between those we classify as financially distressed (those with immediate financial needs and no alternative) and financially stressed (those with financial needs, with alternatives, but who reach for payday loans as a simple, quick and confidential alternative) has increased, and is facilitated by greater online access.

Since 2016, the total loan flows have risen by $191 million for financially stressed, but the value of loans to distressed households has remained static. But again the net value of loans does not tell the full story.

The Number of Households with Payday Loans

Value apart, the other perspective is the number of households taking payday loans. Since 2016, the number has risen by 149,000 households. Of that 13,000 are classified as distressed households and 136,000 are stressed households.

This once again reflects the refocussing of the industry of those in financial pain rather than distress. Within these numbers we note a continued rise in the number of women accessing payday loans. The number of women using payday loans has risen from 177,000 in 2016 to 226,000 in 2018. This represents a rise to 22.18% of all borrowers.

Within the women segment we see a large number of one-parent women accessing payday loans, representing 40% of women.

This is in stark contrast to males where just 6% are one-parent families.

How Many Loans, and What Value Has Been Written Since 2016?

The final part of our analysis we examined the run rate of loans written by volume and value to assess the impact of the Government inaction since April 2016.

Since April 2016 and June 2018, just over 3 million discrete payday loans have been written, worth in total around $1.85 billion by around 1.6 million households. These loans would have generated something in the order of $250 million in net profit to the lenders.

In that time, around one fifth of borrowers will be new borrowers, or around 332,000 households. We also know that over a 5-year period around 15% of payday borrowers get into a debt spiral which leads to events such as bankruptcy. On that basis, an additional 249,000 households have been allowed to enter a debt path which leads to this unfortunate end. A larger number fall into other family or relationship issues.

ASIC bans director of unlicensed payday lender

ASIC says it has banned Mr Robert Legat from engaging in credit activities for a period of three years following the penalty decision of the Federal Court on 10 March 2017.

The Court had previously found that payday lenders Fast Access Finance Pty Ltd, Fast Access Finance (Beenleigh) Pty Ltd and Fast Access Finance (Burleigh Heads) Pty Ltd (the FAF Companies) breached consumer credit laws by engaging in credit activities without holding an Australian credit licence.

The FAF Companies used a business model which used the sale and purchase of diamonds to provide loans to consumers (the diamond model). The Federal Court found that the diamond model was designed to conceal the true nature of the transaction, which was the provision of credit. As such the FAF companies should have held an Australian credit licence under the National Credit Act.

ASIC found that Mr Legat created and caused the FAF companies to implement the diamond model, which was designed to circumvent the 48% legislative interest rate cap that would have been applicable to the loans. This conduct demonstrated a lack of judgement, integrity and professionalism on Mr Legat’s part and a disregard for the law. ASIC determined that Mr Legat is not a fit and proper person to engage in credit activities.

ASIC Deputy Chair Peter Kell said, ‘The National Credit Legislation contains important protections for consumers. ASIC will take action against people who seek to deprive consumers of these protections.’

Small Amount Credit Contract Reforms in Australia: Household Survey Evidence and Analysis

Last year we published a report on financially stressed households, including coverage of small amount credit contracts, using data from our household surveys.

Now Professor Gill North has published an important academic paper – see this link – “Small Amount Credit Contract Reforms in Australia: Household Survey Evidence and Analysis” which takes the analysis of the survey data much further. Here is the abstract.

A review of small amount credit contract regulation in Australia began in 2015 as mandated under section 335A of the National Consumer Credit Protection Act 2009 (Cth). The review panel sought comprehensive data on industry and consumer characteristics and trends. To provide such evidence, consumer groups commissioned original empirical research using data collected from a longitudinal survey that monitors the financial position and attitudes of Australian households. This data on household use of small amount credit contract loans was extracted for the last decade, allowing detailed analysis of the historical patterns and developing trends. The data indicates that overall demand for small amount short duration credit is growing in Australia, the consumer base is broadening, and the predominant form of lending today is online. Deeper analysis highlights the varying motivations of borrower households and their different stages and levels of financial difficulty. It also confirms the socio-economic, employment, educational and financial disadvantages of most households using these loans and their vulnerability to adverse changes in personal circumstances and negative external shocks.

Cash Converters to pay over $12M following ASIC probe

Following an ASIC investigation, payday lender Cash Converters will refund $10.8 million to consumers who received small amount loans under approximately 118,000 small amount credit contracts. Cash Converters has paid a $1.35 million penalty following the issuing of infringement notices by ASIC.

ASIC has agreed to accept an enforceable undertaking from Cash Converters following concerns that, in respect of small amount loans processed via its online website at www.cashconverters.com.au, Cash Converters failed to make reasonable inquiries into consumers’ income and expenses, particularly in situations where the small amount loan was presumed by the credit legislation to be unsuitable.

In addition, ASIC had concerns that Cash Converters did not take reasonable steps to verify consumers’ expenses in accordance with its responsible lending obligations. Instead of assessing the actual expenses recorded in a consumer’s bank statements, Cash Converters applied an internally-generated assumed benchmark that had no relationship to the real expenses of the individual consumer.

For the small amount loans that were likely to be unsuitable because of the consumer’s circumstances, ASIC was concerned that Cash Converters failed to assess the loans as unsuitable for the particular consumers and subsequently entered into them in breach of the credit legislation.

Cash Converters has paid penalties totalling $1.35 million following the issue of 30 infringement notices by ASIC, under the National Consumer Credit Protection Act 2009 (National Credit Act), where ASIC had reasonable grounds to believe that Cash Converters failed to assess small amount loans as unsuitable, and entering into those unsuitable loans, when the loans were presumed to be unsuitable under the credit legislation.

Under the Enforceable Undertaking accepted by ASIC, Cash Converters is required to:

refund eligible consumers $10.8 million in fees through a consumer remediation program overseen by an independent expert who will report to ASIC; and

engage that same independent expert to review its current business operations and compliance with the consumer credit regime and report to ASIC

‘ASIC is seeking to protect financially vulnerable consumers, many of whom are recipients of welfare payments, from falling victim to unsuitable payday loans.” said ASIC Deputy Chairman Peter Kell. “Payday lending is a high priority area for ASIC, and we will continue to pursue lenders who do not follow their responsible lending obligations.’

Consumers who had two or more small amount loans in the 90 days before taking out another small amount loan through Cash Converters’ website during the period 1 July 2013 to 1 June 2016 should expect to be contacted in due course with information about their refund.

Consumers will no longer be charged direct debit fees for payday loans

Following an independent review of payday lending laws, ASIC has taken steps to ensure consumers are not charged direct debit fees when taking out a small amount loan.

This new rule will apply to any payday loan provided from 1 February 2017. It is facilitated by the repeal of interim ASIC Class Order [CO 13/818] Certain small amount credit contracts.

Loans that commence before 1 February 2017 will continue to operate under the existing rules and third party direct debit fees will be able to be charged on those loans.

Background

On 1 July 2013, restrictions were introduced for small amount credit contracts (SACCs) that limit the fees and charges that consumers can be asked to pay. Cost caps apply to establishment fees and monthly fees (both of which are subject to maximum limits based on a percentage of the adjusted credit amount), default fees and government fees and charges.

In response to a Government request, ASIC made Class Order [CO 13/818] on an interim basis to allow the charging of direct debit fees by third party companies in certain circumstances.

In August 2015, to fulfil a statutory requirement under the National Credit Act, an independent review panel (the Panel) was established by the Government to examine and report on the effectiveness of the laws relating to SACCs. Two phases of consultation were undertaken during the course of the review, with the Panel considering written submissions together with holding roundtables and bilateral meetings with interested stakeholders.

The Panel’s final report released in March 2016 included a recommendation that “Direct debit fees should be incorporated into the existing SACC fee cap”. The then Minister for Small Business and Assistant Treasurer, The Hon Kelly O’Dwyer MP, when releasing the final report, stated that, “The Government is supportive of ASIC acting on this recommendation when it considers it appropriate”.

As a result, ASIC has now repealed [CO 136/818] and after consulting stakeholders has provided a 12 month grandfathering period to ensure a smooth transition for both consumers and industry. This means that for loans which commence from 1 February 2017, third party direct debit agencies will no longer be able to charge consumers a fee when processing a repayment on that loan. Third party agencies, who have entered into an agreement with consumers for a loan which commenced prior to 1 February 2017 will continue under [CO 13/818] to be able to charge consumers a fee when processing a repayment on that loan.

Further information and relevant documents:

Class Order [CO 13/818]

ASIC Credit (Repeal) Instrument 2016/1067 (registration pending)

Media release of the Hon Kelly O’Dwyer MP, the then Minister for Small Business and Assistant Treasurer: Small amount amount credit contract report released (19 April 2016).

SACC Lending Market Evolving Fast

We have updated our Small Amount Credit Contract (SACC) models to include data to end September 2016. SACC is of course the new name for what were pay day loans, before the last round of regulatory changes. In fact we are still waiting on Government for their response to the review which was completed earlier in the year.

We published detailed analysis of the market last year. The report “The Stressed Finance Landscape” is available here. Our model is based on responses from our household surveys, and we also overlay economic growth factors and other data, to estimate potential future growth.

So looking at the new data, our first observation is that growth in SACC loans (under $2,000 and 1 year) is significantly faster than personal credit as reported by the RBA personal credit data. The overall value of these SACC loans is still small, under $1 billion compared with the $145 billion for personal credit (cards and personal loans).

However, the growth in SACC loans appears to be directly linked with the rise on online usage, as more lenders, and borrowers go digital. We think about 70% of new SACC loans were originated via the online channels. We are also expecting the momentum to slow, as market participants tweak their business models and players leave, or enter the market.

One clue is the mix of households. We identify households who have no choice but to use SACC loans (financially distressed) and those who choose to use these loans for convenience (financially stressed). The mix is changing, with more financially stressed using SACC, whilst distressed households are static, and we think will reduce over time, as lenders change the focus of their business models. In a nutshell, the new focus of the industry is convenient loans to more affluent households, rather than those struggling to make ends meet, and probably on Centrelink payments.

The final clue is that the larger proportion of households with digital capabilities are those stressed, not distressed, so there is strong alignment with online origination. We conclude that it is online which is changing the game. This has profound implications for those seeking to work with households under pressure financially and how digital offerings should be regulated.

SMEs need protection from online Payday Lenders

From TheBankDoctor. In 2015, online SME lending in Australia was around $250m, up from a zero base two years ago. Growth will continue exponentially and online SME lending will become a significant alternative source of funding for Australia’s SMEs.

Online lenders perform an important role by lending to thousands of SMEs that would otherwise struggle to attract support from a bank. I am a big supporter of this sector but am concerned that many SMEs don’t understand what they are getting themselves into when they borrow from some lenders that could be more accurately described as SME payday lenders to SMEs.

These concerns together with suggestions as to how the interest of SMEs could be better safeguarded were summarised in this recent article in Fairfax Media. The full version follows:

Its not until they have repaid the loan that cash strapped, time poor and financially inexperienced borrowers finally work out how much they have actually paid in fees and charges to some online lenders. You need to have a very good business to make a profit while paying up to and even beyond 100 per cent but this is what many unsuspecting SME borrowers find themselves up for.

As an example, a NSW based wholesaler took a $20,000 loan for a period of 8 months and agreed to pay it back at $161 per day for 171 days. The total amount repaid including fees was $27,531 representing an annual rate of 115 per cent.

Perversely, the lenders charging the highest rates are able to grow their businesses the fastest. By charging higher rates, these lenders can afford to:
• Spend more on advertising which drives more leads and therefore sales.
• Pay higher brokerage and commissions (up to and even beyond 4 per cent) to introducers who then become attached because it’s easier and more profitable to refer everything to one big lender.
• Offer wholesale investors and lenders better returns thereby attracting more funds to feed the ever expanding machine.
• Take on riskier loans because there is a bigger buffer to absorb losses.
Lenders that have achieved rapid growth are seen as more credible which attracts partners, investors, introducers, media as well as borrowers. Meanwhile the lenders that charge more reasonable rates face the prospect of being left behind. These players tend to be smaller, newer and have lower profiles. They are professionally and financially committed and are passionate about the role the industry can play in helping small business owners achieve their goals.

The SME online lending market is already crowded with more than 25 operators all with similar websites offering quick and easy solutions to the financing needs of small business owners. But with some of the lenders it’s not easy for a borrower to readily answer three simple yet critical questions:
• Is this the best product for my needs?
• How much is it really going to cost me?
• Could I get a better deal elsewhere?
For instance, if it’s going to take time for the benefits of a new investment to kick in, a loan that requires you to commence principal repayments on day one may only exacerbate your cash position.

And the way many loan agreements are structured and worded makes it difficult to work out the total cost of borrowing which in turn means it’s nigh on impossible to tell if another lender would offer a better deal. In such circumstances the natural tendency is to go with the recognised name or the one that your broker or advisor recommends and these are often one and the same.

The lenders we are talking about here are online balance sheet lenders that fund loans off their own balance sheet using a combination of debt and equity just like any other business. This is not an issue with Peer to Peer platforms because here the rates paid by borrowers are largely determined by what third party investors are prepared to offer so P2P rates are much more transparent. Borrowers on P2P platforms just need to be sure they understand what fees they pay (up front and on-going) to the platform.

It seems some online lenders exhibit the same skewed priorities they criticize banks for – purporting to look after the little people but in reality looking after themselves at the expense of the little people. Yet poor bank behaviour is much more likely to be exposed because banks are highly regulated public companies whose actions are closely scrutinized by regulators, ratings agencies, analysts, the media, politicians and possibly also in the not too distant future by a Royal Commission. Plus there is a degree of self-regulation for example the Australian Bankers Association‘s Better Banking Program that is being lead by reputable and independent third parties. The same cannot be said for the online lending sector where unlisted, unscrutinised and largely unregulated relatively new businesses are all seeking to stake their claim in the huge SME borrowing space.

This is a nascent market and in time borrowers and introducers will become better informed about the merits of alternative offerings. So what could and should be done to safeguard the interests of SMEs? Should they be afforded similar protection as consumers or should we just refer to “caveat emptor” and allow market forces to shape the sector over time?

It’s a balancing act but both regulators and industry participants should do more to safeguard the interests of borrowers and build the reputation of online lending as a reliable and trustworthy alternative source of finance. For instance it would be easier for borrowers to gain confidence regarding the total cost of borrowing if:
• All the fees and charges imposed were presented on an Annualised Percentage Rate (APR) basis. APRs are not without limitations but they do enable borrowers to make apples with apples comparisons.
• Lenders were required to use consistent terminology and plain language in all agreements.
In addition borrowers should be informed of any payments made to brokers and introducers and any other relationship or arrangement with parties such as shareholders, investors, lenders, partners etc. that could compromise the ability of the lender to act in the best interests of the SME borrower.

The way we are heading it is only a matter of time before a scandal takes place and this will trigger the intervention of bodies including ASIC and the ACCC.

Meanwhile, lenders themselves need to take responsibility for the future of their industry. Progress has been slow to date notwithstanding the endeavours of some, one of whom described the process of getting the players to come together as “like herding cats”.

Individually and collectively online lenders have an opportunity, indeed a responsibility, to improve the financial literacy of small business owners. Transparency is a word that is bandied around a lot in online lending but lenders that only quote daily repayments, advertise rates that are only available to the very best quality borrowers or hand-cuff borrowers in with `lock-in fees are the antithesis of transparent and responsible. Online lenders should also publish details of their loan book such as rates, size, credit quality, term, amount, defaults, enquiry and acceptance rates etc. Some are already doing this to varying degrees but it needs to become the norm not the exception.

External research companies like DFA Analytics, DBM, East & Partners and RFi have started covering the sector. Comparison sites like Finder and Mozo offer basic information but usually couched in terms of “rates starting from…” which really isn’t that much help. Review sites like Trust Pilot offer a platform for borrowers to share their experiences. Interestingly, currently there are more online lenders who don’t use Trust Pilot than who do use it and amongst the non-users are some of the players who charge the highest rates.

It is telling that Google whose corporate motto is “Don’t be evil” is becoming a quasi industry regulator. It is doing its bit to safeguard Australian consumers by banning advertisements from personal payday lenders for loans in excess of 60 days. In the USA Google has banned advertisements for personal loans with APRs higher than 35 per cent. Google might already be considering the steps it could take to safeguard the interests of SMEs in the USA and around the globe.

The lack of transparency and regulation in the online SME lending market has allowed some high priced lenders to achieve impressive growth rates but at what cost to small business borrowers? In addition, their conduct exposes the entire sector to reputational harm. For online lending to become a trusted, permanent and significant alternative form of SME finance borrowers need to be able to readily tell if the loan they are considering best suits their needs, what its true total cost is and whether they could get a materially better deal elsewhere.

Note: These concerns also apply to the traditional offline non-bank SME finance sector. Many of these lenders have been around for years and charge rates that can be at least as onerous as the most expensive of the online lenders. I recently saw an agreement that bound a small business owner to an APR of 140% on a nine month loan.

Reproduced with permission.