Forget Pay Day Loans — Working with Banks on Repayments Through Payroll Deductions Are Better for Consumers
Délber Andrade Gribel Lage, Partner, Zetrasoft UK
Let me start this post by telling you something you already know: Sustainability is key to the success for any business in the current FinTech landscape. Achieving this requires businesses to achieve financial inclusion through the equal distribution of financial benefits and services in the market place.
But there’s also more to that which needs to happen. Inclusion is not just about making a product or a service available to more customers. In many situations, financial providers offer products that become known for the burden that they put on their customers. In other words, bad services are neither inclusive nor sustainable for consumers for the future of banking.
Let’s take personal loans as an example. In the UK, there’s been a 20% increase on average family debt rate over the past four
years. The current debt income ratio of 145% is also expected to rise to 172% by 2020.
Payday loans are the most widely used form of alternative finance. They reach millions of individuals who face a hard time with their financial life, and are not able to get credit from other providers. The problem with this business model is that this type of loan is tackling the issue from the wrong perspective: it is based on the idea that the consumer should pay more as a result of their financial instability.
Interest rates on payday loans can vary, but they usually range from 1000 to 6000% APR, whereas other unsecured personal loans can be found at rates around 8% APR. A simple simulation can tell a lot about the effects of such approach, and show how they do transfer a significant part of the burden of the operation for the end consumer.
Consider a loan of £500, taken for a period of 6 months. With an APR of 1.000% (usual for a payday loan), the customer would have paid £ 1.158.00 of interest, while the same loan at 8% APR would represent an interest of £19.62. It is interesting to see how the customer usually does not see the actual size of the burden that they are taking on an operation like this — probably due to the short term of those loans and to the urgency in having access to those funds.
To promote inclusion, financial technology has to play its role, and create ways for the providers to reach those clients with different tools, and to have alternative venues where they can find additional layers of reliability than those already available.
There is a new proposition out in the market: the possibility of deducting repayments for loans directly from the salary of an individual. Some platforms are integrating payroll systems of companies to financial institutions’ ones, and by doing so they enable the latter, at the individual’s request, to access updated information about their salary and their ability to pay. Moreover, since these customers are willing, up to certain limits, to deduct the payments directly from their wages, they are giving financial institutions access to their salaries and ultimately the assurance that loans will be paid.
Financial providers also benefit with this model in other ways. They face lower transaction costs and risks and can offer better deals to consumers. In turn, these customers get access to credit they wouldn’t otherwise find, and can even think of credit consolidation to help get their credit history back on track and achieve greater financial stability in the long term.