The Danish government made a new regulation concerning the short term loans also known as personal- and payday loans. The new “Kviklån” agreement is an initiative from the Danish government to help the consumers who are not financially literate to avoid overwhelming debt. The new regulation will be in effect 1. July of 2020.
The new regulation has 6 main areas which should help the consumers of Denmark:
- First is the annual percent return (APR) is limited to 35%.
- Secondly, any company issuing loans with an APR bigger than 25% is prohibited from any form of marketing of the loans.
- To support the 2 other limits, a ceiling has been put on how much the consumer is required to payback. As many companies were making a lot of profit from late fees and extreme rates (on late loans) the consumer is now only required to repay at maximum the double size of the loan.
- The government has gotten a total of 60 million DKK (8 million Eur) for debt consulting in the period 2020-2023.
- Private persons also have to obey these rules. This means that private individuals cannot make non-registered companies lending at extreme rates.
- Lastly, the government wants to educate in the primary and secondary schools to make the youth financial literate.
The Danish minister of business affairs Simon Kollerup states that Denmark now has the strictest regulation in Denmark for short-term loans. In the notes, they even state that they hope to take this kind of regulation to the EU.
The first 3 is the only that affects the P2P lending market, as the 3 last areas concern education and consulting of people.
The Danish government regulation means a maximum APR of 35% and the borrowers will ultimately only have to pay back double the loan amount. This will lower the return of the lending companies. Borrowers are now required to be of better quality if lending companies should remain profitable. Which makes it questionable if Danish loans will remain on P2P lending platforms.
There are many aspects of this new regulation from both the lending companies and the borrowers. In the following sections, I will discuss with you why this may have an impact on your P2P lending portfolio.
On the popular P2P lending platform Mintos loans are found from Denmark with +200% APR. The loan originator Sun Finance only offers an 11,5% return for the investors. This gives an indication of how little the lending company actually profit from the high-interest rates. While we don’t have the actual profit margin by the loan originator, I will presume it is narrow due to the “low” interest rate provided to the investor.
Lending companies use the high-interest rates to cover for the bad borrowers. This way the good borrowers “pay” the interest for the bad borrowers and the lending doesn’t lose money. While the loans are risky there are studies showing that lending companies have an average return on investment of +34%. The study showed that lending companies only lose 10-12 cents on the dollar when the loans are unpaid.
The above-described study also shows the pressure the Danish lending companies will face. If the average return on investment for the short-term lending companies is 34%, and the APR will be restricted to 35% the return on investment will significantly drop unless the lending companies change their overall business model.
Borrower and Lending Ethics
Currently, Danish loans can have an APR of up to 800%, which makes a loan of €100 cost €800 in interest per year. However, short-term loans only last 1-3 months, however, the €100 loan will still cost €66 per month in interest (with an 800% interest). This is obviously obnoxious from a borrower’s perspective. However, if the day-to-day money is very limited it might be necessary on some occasions.
From the lending company perspective, the high-interest rates are made as an evaluation of risk. This means if the borrower has 800% the lending company sees it highly unlikely that the borrower will repay the loan. Therefore, to secure profits from the borrowers they have to issue high-interest rates to cover for the other bad borrowers.
Based on the article from responsiblelending.org (USA) the default rate is approximately 6% on payday loans. The article is from 2001 and might be outdated. If this is also true in Europe the high-interest rates are highly unethical.
Stated from the previous sections, the lending companies will see pressure to maintain their high profits from lending. The lending companies are currently lending left and right with no regrets. On many Danish “kviklån” sites you can take out loans of €1.600 with no security or prechecks. Taking Vivus.dk as an example they have a fixed borrowing rate of 243% with an APR of 814%. The borrowing rate is the interest the borrower pays per year, and the APR is the expense rate of the loan paid per year. Therefore, the consumers cannot go for the advertised borrowing rate, as the APR is always higher.
With the new regulation on 35% APR, the lending companies are most likely forced to focus on higher-quality borrowers. Meaning borrowers with better financial situations. Personally I like the regulation made, as the lending companies are plenty profitable. Looking at the loan originator Simbo from Mintos, they had a revenue of 60 million DKK (€8 million) with just 14 employees. That is a very respectable revenue with just 14 employees. Following the financial statement from the regulation is in effect will help us understand the impact of the new regulation.
How to React as a P2P Lending Investor
There is no reason to panic or withdraw from all Danish loans as a P2P lending investor. However, it is important to keep in mind that the lending companies can only take 35% in APR, where it has previously been over 800%.
The benefits from the lending companies might still give them the initiative to offer investors a reasonable interest rate while keeping the 35% APR. Another scenario could be that the Danish companies simply make companies in other countries to avoid the Danish law. This could potentially make the returns unaffected.
If you want to be out of the Danish originated loans before 1. July 2020 you have to make sure that you adjust your auto-invest settings on the various platforms (Mintos and Fastinvest, amongst others). Since the law will apply from 1. July 2020, the lending companies are allowed to lend with the rates as currently until 1. July, thereafter the loans have to be of 35% APR or lower.
The new regulation from the Danish government on lending companies can have several outcomes. Currently, it is unknown what effect it will have on the lending companies and P2P lending investors. However, it will for sure lower the financial burden that the borrowers obtain with such loans.
The regulation is the ethically correct thing to do. The question is whether the lending companies can sustain the lower interest rates for profits and if they will continue to have P2P lending investors fund the loans, for relatively high interest in return. The lending companies might make a 180 in their business model and start to do background checks on their applicants, to make sure the borrowers are of higher quality.
For the investors, there is not much to do, other than withdrawing from Danish loans or accept there might be a lower interest in return.