This blog discusses the issue of problem debt in the UK, highlighting how individuals often underestimate their repayment capabilities and fall into debt due to psychological biases and overoptimistic financial views. It critiques lenders for not considering these human tendencies, and points out regulatory actions against misleading credit advertisements that exploit consumers’ weaknesses.
About 10 years ago, many customers who would regularly take out expensive ‘Payday Loans’ became unhappy with the debt and challenging position they found themselves in. Although many of these loans were irresponsibly provided by lenders who failed to carry out the affordability checks, it wouldn’t necessarily be clear to the customer that the lender was at fault. As one Ombudsman said:
“It feels unlikely that a consumer would say ‘I couldn’t afford this loan, they should not have given it to me’, particularly when they are in a difficult financial situation and desperately need the money. But when you scratch beneath the surface of many complaints affordability is often found to be the root cause of the problem.”[1]
It could be said that blaming a lender for the debt you find yourself in is counterintuitive – if, on the surface, all the lender has done is provide you with credit that you wanted and requested at the time.
Of course, no one deliberately sets out to obtain credit that they will struggle to pay back. But many customers can be overconfident of their ability to repay borrowing and debt, whilst underestimating future spending. This can be described as ‘present bias’ whereby people try to satisfy immediate gratification by consuming now, and paying for it excessively later[2].
Research has shown that people have a tendency to view their own financial position more optimistically than others in the same boat:
‘Very few in the sample considered their outstanding balances on credit products as debt. Debt was a ‘dirty’ word describing other people with problem debt. In contrast their own position and portfolio of credit products was viewed optimistically. If they were making their minimum payments then they could be assured that they were in a sound financial position. This was particularly true of those in the earliest stages of their credit journey’[3]
We are only human. And that means we can be subject to different biases and counter-productive mindsets when making financial decisions:
‘Behavioural research shows us that consumers are not the economically rational ‘super consumers’ our models might predict. Regardless of capability or vulnerability, all consumers experience situations that challenge them or might cause them harm.’ [4]
– The Financial Conduct Authority
Opinions vary on who is ultimately at fault for the amount of debt there is in the UK, or for that matter, how bad it is to borrow in the first place. But it is fair to say that companies who lend and provide financial services should take account of people’s challenges and biases when making financial decisions.
‘It is not surprising that the growth of ATMs and immediate borrowing possibilities offered by credit cards and store cards in the last few decades has coincided with reduced saving and mounting debt. There is a psychological trap set by offering credit cards with no frontloading of charges, it appears costless to consumers who by and large do not anticipate that their desire for immediate gratification will result in penalty fees and debt repayment at high interest rates.’[5]
The way that credit cards are advertised and promoted can be revealing. Do they play upon people’s desire for instant gratification? Such practices would be especially unethical for customers who have had previous problems with overspending and consequent debt on card accounts.
The Advertising Standards Authority made a ruling (November 2022) against an advert for a credit card, on the basis that it made light of a consumer’s spending and racking up debt – against a backdrop of a poor credit history:
‘…we considered the statements, “I just got my credit card and you better believe I’m getting ready to go shopping right after this” and “[I]f you guys are worried that you’re not going to get accepted for a credit card because you don’t have good credit, don’t worry because I got accepted and my credit score isn’t the best”, were likely to be understood by consumers to mean that the woman had a poor credit history, but nevertheless was continuing to use credit for non-essential purchases and was not worried about the consequences of obtaining further credit.’[6]
In a more recent case, the Advertising Standards Authority ruled that a lender’s advert could not be broadcast again in its current form, because of the manner in which their loans were promoted for consolidation purposes:
‘The ad stated that consumers who had previously encountered difficulty accessing credit could pay off existing debt with the advertised loan – which had an APR of 99.9%, as stated in the superimposed text. We considered the ad was targeted at those who may have had pre-existing debts, or who had struggled accessing credit because of a poor credit score. We noted the APR of the loan was 0.1% lower than that of a high-cost short-term loan, and considered that if the interest rate was lower than a consumer’s current rate of interest, they likely owed money to a high-cost short-term lender, making them particularly vulnerable.’[7]
Whose problem? Unfortunately, it is the consumers themselves who have to suffer the consequences of poor financial decisions leading to debt. But lenders have a significant responsibility to take account of cognitive biases and vulnerability when making lending decisions, and when promoting their credit products.
[1] https://www.financial-ombudsman.org.uk/files/1759/payday_lending_report.pdf
[2] https://www.fca.org.uk/publication/consultation/cp18-12.pdf
[3] https://www.fca.org.uk/panels/consumer-panel/publication/20221108_final_draft_panel_position_paper.pdf
[4] https://www.fca.org.uk/publication/corporate/our-future-approach-consumers.pdf
[5] https://www.fca.org.uk/publication/research/fsa-crpr69.pdf
[6] https://www.asa.org.uk/rulings/trendybuzz-a22-1160243-trendybuzz.html
[7] https://www.asa.org.uk/rulings/everyday-lending-ltd-g23-1182809-everyday-lending-ltd.html