Bad news for the Archbishop of Canterbury: in competition Wonga disappearing, which is Justin Welby’s stated ambition for credit unions, is not going to be easy.
The payday lender‘s 2012 financial results confirmed how far Wonga has come in six years. After-tax profits rose 36% to £ 62.5million and four million loans totaling £ 1.2 billion were made to more than one million customers. The company is on the rise.
How was it done? Wonga’s business model appears to have four key elements. First, the company rejects two-thirds of applicants as bad credit risks. An effective credit risk assessment kept default rates last year at 7.4% – a rate that would dishonor a traditional lender but is easily tolerable for Wonga at its astronomical interest rates. It’s also why Managing Director Errol Damelin can casually offer to help Welby give credit unions a boost. Damelin, you can be sure, will not offer to hand over the algorithms that are at the heart of Wonga’s system.
Second, Wonga is, let’s face it, a clever operation that gives its customers what they want. Quick loan processing is not a trick traditional banks have mastered. Whether you view many of Wonga’s clients as desperate or ill-advised, the company has clearly identified an appetite for instant loans.
Third, Wonga is an extraordinarily capital efficient company. Damelin boasts that the company only makes £ 15 net profit per loan. It sounds small, but the bottom line is that the company renews its capital several times a year. So the ‘same’ £ 200 could earn £ 15 six or seven times in the space of 12 months. This is what produces financial statistics that leave traditional lenders in the dark. Wonga’s return on equity is approximately 30% and after-tax profit margins are 20%.
The fourth characteristic is one that – rightly so – infuriates critics of Wonga. It is the presentation of the business of borrowing at high interest rates, even for a short period, as a fun daily activity undertaken by ambitious people. The ads are humorous and Damelin reports that his typical customers are “young, urban, digital and with a very high proportion of smartphone owners”.
Of course, sometimes some borrowers will have reasonable economic reasons to take out a short-term loan at high interest rates – avoiding overdraft fees, for example. But, according to Damelin’s description of his clients as members of the “Facebook generation,” most would be better off cutting back on spending or joining the world of mainstream finance.
No more fooling them, you might say. Well, yes, but society should also protect the interests of the victims of the growth of payday loans – the already over-indebted who get even further into trouble by becoming addicted to short-term loans. There is a clear rationale for putting a cap on the amount that payday lenders can charge. A 50% to 60% interest rate limit seems reasonable to limit revolving loans.
Certainly someone in the financial or government establishment should be interested in the boom in easy access payday loans. At the very least, Wonga and his ilk, through their cheerful ads, undermine anything the new regulator says about the importance of financial education to avert the next crisis.