Payday lending: a social ill that needs a social bond

The demise of brought the payday lending industry back into the public consciousness. With socially minded investors scrambling to find assets, this industry seems ripe for intervention via social financing.

  • By Lewis McLellan
  • 25 Sep 2018
Email a colleague
Request a PDF

In Colorado, a proposition to cap retail interest rates at 36% APR (a significant reduction from the average of 129%) is gathering steam. It would be the 16th state to impose such a cap.

Payday lenders have garnered a reputation as predatory and exploitative, charging brutally high interest rates to those least able to afford them, and taking money straight from their bank account to meet their debts. 

Along with overdraft fees, it is a classic example of the way our financial system seems to punish poverty.

From time to time, the tabloids fill up with horror stories of people borrowing a few hundred pounds to fix a car, allowing them to get to work, and running up thousands of pounds of debt, which they have no hope to paying back.

Along with Colorado’s latest attempt to cap rates, there are occasional calls for the product to be banned, usually from politicians looking for a piñata out of which they can beat some good will. But the predatory reputation is perhaps not entirely fair.

Payday loans fulfil a role as a lender for those with credit scores too poor to obtain better rates. Banning the product outright cuts off a source of emergency financing to the otherwise unbanked, pushing them into the arms of unauthorised lenders who really are scary.

Such loans have a default rate of 10%-20% and, accordingly, lenders have to charge high interest. They are profit making enterprises, of course, but look at Wonga. The business is clearly not the usury gravy train it is frequently portrayed to be.

But whether or not you think payday lending is the ultimate expression of vulture capitalism, or a lifeline to otherwise unbanked credit risks, the fact remains that the product frequently leaves vulnerable people left in an untenable financial position.

Social bonds, bonds in which the proceeds are used to finance projects with social benefits, could be a means of alleviating the worst of the negative consequences of payday loans. 

Social bond borrowers could use the process to purchase payday loans portfolios at a discount, and offer debt relief or generous restructuring arrangements.

Those with the infrastructure to do so, likely banks, might also be able to offer advice and help the debtors rebuild credit ratings (although there would have to be strict controls in place to address the moral hazard entailed in cross-selling).

It can be difficult to motivate investors with a story of social progress in somewhere like the Netherlands or Germany, despite the fact that so many SRI borrowers and investors are based there. But payday loans are an emotive topic involving the most vulnerable in society.

Part of the problem with SRI financing is that many social projects are an uneasy fit for bond financing. Many of the most socially beneficial projects are not revenue generating exercises and would find it difficult or impossible to get financing via a green bond, since they are not able to offer a return on investment. That leaves the "bonds" looking like a carefully repackaged donation.

But the sale of loans portfolios is an established capital markets operation and could certainly be slanted to offer a social benefit, tracked through easily quantified metrics — an all-important quality of a potential SRI asset.

There are challenges. Given the default rates, it is unclear what kind of debt relief would be possible before the operation became unfeasible and, of course, no social bond investor is going to be particularly excited about offering debt relief to a teenager who imprudently dropped £400 on a new Xbox.

Social financing is difficult. Helping people can be expensive and risky and the way is often fraught with unintended consequences. But if capital markets are serious about allocating capital to do good in the world, payday loans are worth a try.

  • By Lewis McLellan
  • 25 Sep 2018

All International Bonds

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 JPMorgan 199,466.05 906 8.12%
2 Citi 187,892.62 783 7.64%
3 Bank of America Merrill Lynch 161,014.35 666 6.55%
4 Barclays 149,926.07 598 6.10%
5 HSBC 123,946.37 656 5.04%

Bookrunners of All Syndicated Loans EMEA

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 Credit Agricole CIB 23,615.79 92 7.83%
2 BNP Paribas 22,783.99 94 7.56%
3 Bank of America Merrill Lynch 17,426.11 50 5.78%
4 JPMorgan 15,739.03 45 5.22%
5 UniCredit 13,730.87 76 4.55%

Bookrunners of all EMEA ECM Issuance

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 Morgan Stanley 6,981.75 31 10.38%
2 JPMorgan 6,507.99 41 9.67%
3 Goldman Sachs 5,684.90 28 8.45%
4 Citi 4,430.10 34 6.58%
5 UBS 4,205.38 21 6.25%