Retail banks are not doing enough to address the needs of a financially isolated section of the UK population increasingly reliant on payday lenders, argue Jens Baumgarten, Alex Graham and Chris Peacock

Since the late 2000s there has been a steep increase in the demand for short term credit. And since 2008, prices have increased at 17% compared with 9% growth in earnings, leading to a substantial squeeze on consumers’ real income.

A swarm of "payday lenders" have emerged to meet this demand, offering simple application processes – and extortionate rates. Industry leader Wonga has experienced breathtaking growth during this period, from sales of £19m in 2009 to £315m in 2013.

In 2013 alone, an estimated 1.6m individuals took out high-cost short-term loans worth £2.5bn . Ease of access and aggressive marketing have altered the consumer perception of payday lending; from ‘lender of last resort’ to the immediate choice when ends cannot be met.

With four-figure interest rates, it is not surprising that the industry has attracted scrutiny. The FCA’s proposals to cap fees are expected to go some way to reducing the cost of borrowing. However, retail banks must also act to halt the growth of this financially excluded sector – and now is the time to do it.

Banks have so far held back from entering the payday lending market, owing to concerns over reputational damage. Until recently, US pillar bank Wells Fargo introduced a "Direct Deposit Advance", with a $1.50 fee for every $20 lent – a payday lending product in all but name. The product was withdrawn in February 2014 owing to stringent new regulation.

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Ultimately, banks have struggled to meet the emerging needs of a significant minority. A growing portion of the population have grown increasingly out of touch with their bank and now view payday lenders as their first port of call when they get into trouble
Banks need to follow a two-pronged strategy to re-engage these customers before it is too late.

1. Provide access to interactive budgeting tools that offer pre-emptive guidance
While the idea of online budgeting tools is not a new one, Simon-Kucher & Partners believes much more can be done to truly help those customers perpetually living on the edge. Effective budgeting tools should:

– Identify areas where customers can cut back on spending, enabling those who have become entrenched in their overdrafts to build up a safety buffer.

– Ring-fence funds for the payment of rent and bills as soon as the salary is paid, so that customers always understand exactly how much they have to spend every month. In a recent study conducted by Simon-Kucher & Partners, 42% of respondents felt that banks could really set themselves apart by offering a service that "automatically sets aside money for direct debits."

– Analyse spending trends and notify customers when they are in danger of over-spending, enabling them to adjust their patterns.
Providing these tools would help mitigate the need for a payday loan, enabling banks to deepen customer relationships and shore up customer advocacy amongst those who are disenfranchised.

2. Help customers currently on the brink of payday lending by proactively offering alternative products
While banks already offer products such as overdraft extensions and personal loans for debt consolidation, banks need to do more to proactively engage customers considering payday lending as an option, by offering them alternatives.

A lack of awareness concerning which products customers are eligible for, and a reluctance amongst these consumers to approach large, daunting retail banks for financial help, means that many do not take full advantage of the services available to them at their own bank.

These services such as temporary overdraft extensions or personal loans to consolidate debt are often far less costly than payday loans, and can ultimately help customers regain control of their finances.

As the payday lending landscape changes, banks need to be on the front foot in addressing what has become a clear consumer need. For too long banks have been wary about entering this market, leading to a growing segment of consumers who have become increasingly isolated from their bank. By offering services that engage these customers, banks stand to broaden the relationship into savings products and ultimately mortgages.

Rather than turning their backs, banks are in a position to offer a genuine helping hand.

Jens Baumgarten, Partner at Simon-Kucher & Partners, Alex Graham, Senior Consultant at Simon-Kucher & Partners and Chris Peacock, Consultant at Simon-Kucher & Partners