Recent case proves Australia still committed to leading the world in consumer financial protection
Last week the Federal Court found that payday lenders, Fast Access Finance Pty Ltd breached Australia’s consumer credit laws with its diamond purchase contract business arrangements in a case brought shortly after Australia’s world-leading payday loan protections came into force in 2013.
What is a payday loan?
Payday loans, so called because they are short-term and repayment of the loan is typically due on the borrower’s next payday originated in the US in the mid 1990s and rose to prominence in Australia in the early 2000s after the first payday lender set up shop in Australia in 1998. Due to the increasing demand of consumers unable to access other forms of credit, in the year between 2000 and 2001 the number of monthly payday loans in Australia grew by a whopping 640 per cent.
Payday lenders typically charged high interest rates for speedy access to cash, sometimes stretching into equivalent annual rates of 500 per cent or more of the original loan amount.
Due to the susceptibility of low-income consumers unable to access other forms of finance to the lure of payday loans, in 2013 Australia amended national credit legislation to protect vulnerable consumers, leading the world in consumer finance protections.
What did Fast Access Finance do?
ASIC alleged and the Federal Court accepted, that Fast Access Finance’s business model with diamond purchase contracts were deliberately constructed to obscure the true purpose of the transactions, which was to satisfy the consumer’s need for fast cash and Fast Access Finance’s desire to profit from lending the money.
Under the diamond purchase contract model used by Fast Access Finance, a consumer seeking to borrow $500 would ‘purchase’ 4 diamonds at $250 per diamond deferring paying the $1,000 purchase price to be paid in future instalments. This transaction was combined with a diamond sale contract, signed at the same time, ‘selling’ those same diamonds back to Fast Access Finance $125 per diamond, with the customer receiving $500 but incurring a $1,000 debt to Fast Access Finance and paying a dollar for each dollar borrowed.
The Court has not yet imposed a penalty, but may demand up to $1.1 million for each contravention of section 29 of the National Credit Act.
How does Australia compare?
ASIC became the national regulator of consumer credit in July 2010, with the commencement of the National Credit Act and amendments to the National Credit Act proposed in September 2011 and taking force in 2013 introduced additional provisions for small amount loans (payday loans) to address concerns about risk of consumers falling into a debt spiral (eg several small amount loans, refinancing existing loans before they’re paid out, or increasing credit limits on existing loans).
A ‘small amount loan’ is a loan where the amount borrowed is under $2000 the repayment term is between 16 days and one year (loans with repayment terms of 15 days and less have been banned since March 2013)
From 1 July 2013, only the following fees can be charged on small amount loans:
- a monthly fee of 4% of the amount lent
- an establishment fee of 20%
- Government fees or charges
- enforcement expenses, and default fees (the lender cannot recover more than 200% of the amount lent).
As early as 2011, there was bipartisan agreement in Australia that consumers of payday loans are among the most vulnerable credit consumers, often taking out small amounts with high interest ‘to make ends meet’ and should be protected through the national credit regime.
UK and Europe
European Union countries difficult to get a gauge of size of market, but many EU countries have criminal usury statutes on their books that prohibit high interest lending.
As of January 2015 the UK enacted a cap on payday loans seeing a limit of 0.8 per cent interest per day, £15 limit on default fees, and a cap on total costs of 100 per cent of the amount borrowed. At 0.8 per cent interest per day, UK borrowers pay approximately 24 per cent interest per month, roughly equivalent to the scope of protection under Australian law that have a monthly rate of 4 per cent and allow a 20 per cent establishment fee.
Payday lending in the United States is extremely resilient to regulation, with vastly different regulatory regimes in different states and recent court decisions in favour of payday lenders finding US banking regulators applied ‘backroom pressure’ unfairly on payday lenders in recent crackdowns.
This hasn’t gone unnoticed in popular culture, with the topic of payday loans and predatory lending featured in an episode of HBO’s Last Week Tonight with John Oliver last year. Illustrating the prevalence of payday lenders, Oliver noted that there are more payday loan outlets in the US than Starbucks or McDonald’s and efforts to clamp down in different states are fraught by lenders quickly finding loopholes like Arizona lenders switching to car title loans when payday lending was outlawed, or Ohio lenders registering as ‘short-term mortgage lenders’ to escape regulation.
Pay day lending is such a big business in the US that in just under a one-mile stretch of the Atlanta Highway in Montgomery, Alabama, the sixth-poorest US state, there are 14 payday lenders charging interest at annual rates of as much as 456 per cent, more than 35 times higher than the average fixed-rate credit card.
To combat this problem, earlier this year proposal by Consumer Financial Protection Bureau outlined sweeping prevention and protection measures to dramatically reduce payday lending, but they’re in the very early stages of what promises to be an intense lobbying fight. It also presents a fairly unique situation in the US where an agency seeks to regulate an industry by proposing laws without first being approached with a congressional mandate.
While fair access to credit is vital to financial mobility and found in a 2012 Social Impact Report to be one of the three key measures of financial inclusion, there is a fine balance to be reached where consumers eager for financial mobility aren’t exploited.
It’s clear that ASIC and the payday lending protections are far from toothless and Australia is committed to its role as a leader in consumer financial protection.