It’s amazing and fascinating to see how financial engineers have made a simple discipline of finance into a complex mechanism. This whole financial innovation revolves around the needs of people and corporations. Payday lending business that first started in the US for people to borrow a small amount of money for a short time period, has now become popular in many parts of the world, including the UK. The UK’s payday lending industry is valued at around £2.2 billion and many household avail payday lending services to deal with their end of the month short term monetary needs. Here in this article, we intend to look at the payday loan industry from the inside and explore the inner working of a payday lending business.
Short Term Financial Needs
Do you turn thrifty during the end of the month? Most people would answer in affirmative when asked this question. The reason for their thriftiness is their account balance. Well, as we mentioned earlier that financial innovation revolves around needs of people, payday loans solved this problem of many salaried individuals. Now any employed person can instantly borrow money online from payday lenders and meet his/her short term needs.
Collateral? What Collateral?
On looking upon the mechanics of the payday loan industry one could quite rationally deduce that it is a very risky business. The reason is that the payday lender faces 100% exposure at default (EAD). This is because there is no collateral that could be sold at a fire-sales value to cover the losses. Well, the case is quite the contrary. The payday lender never lends huge sums of money to a single borrower i.e. his concentration ratio is always low and the number of borrowers are high. Thus, according to the law of large numbers, even if some of them might default or are unable to pay on time, a huge number of them will actually make timely payments and the business will be profitable.
Why are Interest Rates of Payday Loans Too Damn High?
You could only ask this question if you haven’t studied finance in college. Those who’ve studied would remember that interest rate is made by adding various risk premiums to the risk free rate or the LIBOR. As we’ve mentioned earlier that these risks are present in payday loans since no security is kept as collateral additionally these loans are extended to the borrowers without conducting their thorough credit check. Thus, the risk premium charged to account for such risks makes the overall interest rate to be very high.
Is There a Watchdog Appointed Over These Loan Sharks?
First of all, payday lenders are not loan sharks they are in the industry to do business not to rob people. Secondly, yes, there is a regulator appointed to monitor the payday lending industry. In the UK, Financial Conduct Authority (FCA) regulates payday lending business and ensures that it operates without any hiccups or scams. In order to operate as a payday lender in the UK, a formal authorization from the FCA is needed. All payday lenders operating within the territory of the UK also have to follow the following rules and regulation imposed by the FCA:
- Per day cost of borrowing should not exceed 0.8 percent of the borrowed amount.
- If the borrower fails to honour its financial obligations then a payday lender could only charge him a penalty of £15 per day and not more.
- The maximum amount that a payday lender can legally recover from the defaulter is twice the amount that he had borrowed and not more under any circumstances.
A Contrarian’s View of Payday Loans
A well-regulated industry with a justified interest rate. That’s one way of viewing things, now let’s look from a critiques lens. The one biggest drawback of borrowing from payday lenders is that, though they do not look your credit worthiness before extending you the loan, but if you are unable to pay back the loan on time it will adversely affect your credit rating.
The APR rates are justified but you don’t need to be a financial engineer to conclude that the rates are abnormally high and thus the very idea of payday loans do not seem to be a viable option if one has to borrow money for long term.
A Helicopter View of Payday Lending Industry of the UK
Payday lending is popular in the UK. This fact can be proved by looking at the figures. According to a research conducted by The Centre for Social Justice, around 7 million Brits avail the payday loan facility. Also, more than 40% millennials avail payday loans or use pawn shops to deal with their end-of-the-month financial issues. This surely proves that there is a huge demand for such financial services. There are many payday loan retailers located all around the UK however; most Brits choose to avail loan online. This is why it has become imperative than ever before to compare the rates and terms of all the online payday lenders. If you too are looking to avail a payday loan then visit quiddicompare to find out the lender that offers funds at a minimal rate. We at quiddicompare provide our users with the facility to compare all the well-known, reputed and trustworthy payday lenders and their APR rates. Visit our website today to find out the lender that best fits your requirements.