Lessons from Wonga
Wonga was lauded as an innovative and technologically savvy company. It was using fintech, big data and automated decision-making to make high-cost, short-term payday loans. But its business model depended on high-cost loans, repeat customers, weak affordability assessments and aggressive collection activities. This could be toxic for customers and led some into a spiral of debt and financial difficulty.
Wonga is now in administration and investors and regulators need to do more to examine the business models of new breeds of lenders which will rely on Open Banking data. We must not be hypnotised by firms talking about ‘big data’, ‘algorithms’ and ‘AI’. It also seems strange that high street banks are still allowed to charge far more for their unarranged overdrafts than Wonga would be allowed to get away with for its payday loans.
In 2012 Wonga charged 1% interest a day, plus a fixed fee of £5.50. Borrowing £100 from Wonga for a month would cost around £35. But Wonga would also charge additional fees on top – if you needed to roll over your loan for extra time then that would cost a flat fee of £10 plus extra interest. Pay late and Wonga charged consumers a £30 late fee and also carried on charging interest on the outstanding balance of the loan. This meant that a consumer who was late paying a 28 day loan would actually end up paying back £180, including charges and interest.
By 2012-2013, the UK had the second largest payday loan market in the world (after the US). £2.8 billion of payday of loans was being given every year, gaining payday lenders around £1.1 billion in interest and charges. Wonga was the largest payday lender accounting for around 30%-40% of the market. Wonga advertised on TV and sponsored Newcastle United football club.
Robert Peston reported that its technology was world class.
“Wonga has written algorithms, computer programs, which determine whether you deserve to be given a loan in seconds, from looking at details about you and your behaviour, such as what email service provider you use and whether you have bothered to look at the company’s terms and conditions”
Its all about the business model
Most payday lenders said that they were providing short-term loans to people. But actually, to make money, their business model relied on repeat customers. They made hardly any money to people who took out one off loans. Wonga and other payday lenders made most of their profit from consumers taking out repeat loans and then rolling them over and topping them up.
Following pressure from Parliamentarians the FCA introduced a cap on the cost of payday loans. The price cap on High Cost Short-Term Credit (HCSTC) came into effect on 2nd January 2015. HCSTC is defined in FCA regulation as being a loan where the Annual Percentage Rate is greater than 100%, is provided for a term shorter than 12 months and is not a doorstep loan, bill of sale loan or overdraft. The price cap contains three elements:
- An initial cost cap of 0.8% of the outstanding principal per day on all interest and fee charges during the agreed loan duration and when refinancing.
- A cap for those in default of: an aggregate total of £15 on fixed charges, interest at the same rate as the initial cost cap calculated per day on the outstanding principal and any fixed default charges.
- A total cost cap of 100% of the amount borrowed applying to all interest, fees and charges. Therefore, the maximum anyone could ever pay on an individual loan in interest, fees and charges would be 100% of the original principal.
Stopping aggressive collections practices
Whilst the major focus was on the charge cap it was arguably a little noticed change to the rules on collections practices which had a bigger impact on the business model of the payday lenders. Wonga and other payday lenders had used what was known as Continuous Payment Authorities (CPAs) to collect repayments on loans. This involved taking a consumer’s debit or credit card details and taking repayments in the form of a card payment. Unlike Direct Debits, CPAs do not appear on your internet banking system. Before 2013, it was also harder to cancel as some banks were refusing to cancel CPAs when asked by the consumer.
Payday lenders used these CPAs to undertake aggressive debt collection. For example, if you owed them £250, they would try to take the entire £250, they would then try and take £200, £150, £100, £50 and £20. If that didn’t work they would try again the next day or a few days later. Consumers would find their bank accounts cleaned out. Usually, even if a consumer couldn’t afford to pay their loan back immediately then at some point their wages or benefits would be paid into their bank account and immediately taken by the payday lender.
The new rules limited the number of times a CPA could be used to two for each loan and stopped payday lenders from using them to take part repayments.
The FCA also clarified requirements for payday lenders to assess the affordability of the loans. This was in terms of the risk to the customer of not being able to make repayments:
- as they fall due over the life of the credit agreement, and within a reasonable period in the case of an open-end agreement
- wholly out of income, unless the customer has clearly indicated an intention to repay using savings or other assets
- without the customer having to borrow to meet the repayments, or being unable to meet other financial commitments, and
- without the repayments having a significant negative impact on the customer’s overall financial situation
Wonga checked 7,000 pieces of data
Remember all of the talk from Wonga about analysing 7,000 pieces of data. Well that apparently didn’t include whether their customers had any outstanding payday loans from other lenders. It often didn’t include checking expenditure. The only way lenders can check whether a loan is affordable is to consider both income and expenditure.
Mr W borrowed from Wonga 27 times between December 2010 and January 2013. Mr W’s first loan was for £85 (£90.87 with interest). Next month, he borrowed and repaid £36 (£46). Three months later, he borrowed and repaid £114 (£137.18). He then continued to borrow monthly for the next two years. The amounts varied, but they increased to £630 (£792.20). His monthly income was only £950 and Wonga didn’t obtain information about his expenditure or other credit commitments. The size of these loans together with the interest meant that it could be seen that Mr W was effectively trapped in a spiral of debt. The FOS ordered Wonga to refund the interest and charges paid on loans numbered 3 to 27.
[Wonga] has accepted that the checks it made with the credit reference agency did not allow it to check whether Mrs J had other current payday loans at the time. Wonga also accepts that it did not ask Mrs J anything about her monthly expenditure as it says it requires information that can be independently verified. in August 2011 Mrs J took her third loan with Wonga but had already borrowed £983 from three different payday lenders earlier in that month. In September 2011 Mrs J took out both a top up and new loan with Wonga, as well as borrowing £635 with two other payday lenders that month.
It also appeared that Wonga’s technology didn’t always document what actually happened and how it checked whether the loans were affordable. In response to another complaint:
Wonga has told [the FOS] about the checks that it normally performs. It has explained a number of criteria that, if met, would result in a loan application being declined. And it has also shown us some screens that it has recently added to gather information about a consumer’s income and normal monthly expenditure. But Wonga hasn’t been able to show us the checks that it actually performed on Miss S’s applications, or any results that these generated.
Wonga also appeared to not conduct adequate affordability assessments when lending to repeat customers. The first loan granted might have been affordable but the constant repeat borrowing might not be. Remember that Wonga made more money from repeat borrowers than one off customers.
Wonga gave 94 loans over two years to Miss W, who was on benefits and had an income of between £600 and £700 a month. The FOS found that only the first three loans were actually affordable.
Bullet style payday loans can be a fundamentally harmful product
The bullet style payday loan (where you borrow for around a month and then pay the entire amount back in one payment) has been found to be a potentially harmful product. These loans may help the consumer in the month they are taken out, but often the repayment and charges will cause larger financial difficulties down the road, leading to consumers being less likely to meet essential payments and exceeding their overdraft limit. Some US States have banned the product and instead required lenders to only offer longer term loans with the amount repaid in instalments – with a strict charge cap and limiting the total value of loans which can be given to one customer.
Banks still charge more for unarranged overdrafts than Wonga did for payday loans
Even if Wonga does go out of business there will still remain toxic and expensive payday loan type products provided by high street banks in the form of unarranged overdrafts. The FCA is currently considering what further action it might take. Will it rely on disclosure of information to consumers or learn the lessons from its successful regulation of payday lending and impose a cap on unarranged overdraft charges?
Open Banking leaves the way open for toxic business models
Open Banking will allow consumers to share their banking data with third parties. This will allow new business models to be developed which will monitor the amount of money in a consumer’s bank account and lend them money when they are approaching their overdraft limit and then take money back out again in repayments once they receive their salary or benefits. This sort of Auto-Wonga business model will become increasingly common in the market. The worry is that this business model is that it can be used to circumvent the controls introduced by the FCA for payday lending and High-Cost Short-Term Credit.
- These new Open Banking enabled overdraft services could be structured to be exempt from the FCA’s payday lending charge cap.
- Lenders will also not be subject to the same restrictions on use of CPAs to conduct aggressive collections activity – indeed as they will have constant access to the consumers bank account they will know exactly when the consumer gets paid and could use this information to conduct aggressive collections as soon as money appears in the account.
- Lenders will only have to assess the affordability of the overdraft style loan once when the initial credit limit is granted and not every time it is drawn down by the consumer.
Lessons from Wonga
The lesson which Wonga should teach us is that we need to look more at the business model of consumer credit firms. Investors need to do more to understand how lenders treat their customers. Did investors in Wonga actually ask any questions about Wonga’s business model? Or were they hypnotised by talk of big data and algorithms?
The FCA was quick to take action when it took over regulation of consumer credit on 1st April 2014. But Wonga had been operating since 2007 and is now being deluged with complaints from consumers about its past practices. This has led to their administration and consumers will have to join the list of creditors and may not get redress.
 CMA report, para 2.8