UK consumers are increasingly turning to short-term credit services from online providers. The entrepreneurs behind these businesses say that, rather than being a reaction to tightening supplies of credit and cash, they represent the evolution of a lending market that has stopped listening to its customers.
Jorma Jokela founded online microlender Ferratum in his native Finland in 2005. The previous year, at the age of 24, he had sold a recruitment business that he founded when he was just 18.
The service allows customers to borrow small amounts – the average loan is around 160 euros – for up to 30 days. Users apply for the loan online or through a mobile phone.
"We make a loan decision in about four and half minutes. The customer will get the money within 10 minutes," Jokela told CNBC.com.
With just under a million customers in 16 countries, Ferratum entered the UK market this summer.
"The UK market is full of old-school lenders, and that is important, because we will take a big market share from the old-school lenders," Jokela said.
Wonga, founded in 2007 by Errol Damelin and Jonty Hurwitz, has been doing just that for nearly four years now.
Their company's name is a London slang word for cash, and their brash, simplistic advertising on the capital's transport system – as well as their enormous annual percentage rate (APR) - which, theoretically, can be higher than 2,500 percent - have attracted considerable attention and criticism.
On wonga.com, customers are presented with two sliding bars, labeled: "how much cash do you want"" and "how long do you want it for?" Loans can be as much as 400 pounds ($644) and the maximum repayment period is 30 days. Fees and interest on that maximum would be 125.48 pounds – 31 percent of the loan value.
Borrowing 200 pounds for 15 days would see fees and interest of 35.90 pounds, or 18 percent.
"The APR is a red herring," Damelin told CNBC.com in an interview. Far more important, he said, was the transparency of the service – customers know exactly how much they are going to pay for their short term cash and when they have to pay it back. If customers pay the money back early, they are charged a lower rate – if a consumer takes out a 30-day loan, and pays it back in 15 days, they are charged the rate equivalent to a 15-day loan.
"Imagine if you could do that on mortgages and bank loans," Damelin said.
Traditional Lenders' Complacency
Damelin was working in the software industry when he and his partner came up with the idea for Wonga. He did so, he said, in response to a complacency on the part of traditional lenders and credit card companies.
"They were designing products that weren't necessarily in the customers' best interests. Sometimes they just ripped customers off," he said. "When you are a credit company, you are not looking for somebody who will take your credit card, use it, and then pay it off in full and use it again next month. You lose money on that. You want a customer who goes into a minimum payment scenario and lands up consuming long-term credit at very high interest rates for extended amounts of time."
"We thought that there was an opportunity to use technology and data to deliver much better solutions to customers," he said.
At Ferratum, Jokela agrees. The speed and convenience permitted by the technology, and the transparency of the service differentiate it from traditional credit providers, and from high street payday lenders.
Critics of the services say that they prey on people desperate for cash, and act like loan sharks. Both Jokela and Damelin refute this by quoting their customer profiles and the high refusal rates.
"Our customer average age is 30-32 years, and 70 percent of our customers are full-time workers. It's an understanding that our people have an income, but they are temporarily out of cash," Jokela said.
Ferratum's default rate is around 5 percent. Wonga does not disclose its rate, but Damelin told CNBC.com that it is in the single digits.
Wonga only approves around a third of its loan applications, Damelin said.
Not About APR?
"It's a very mainstream product. Some people look at the APRs and interpret from that that it's a certain kind of customer, but our customers realize that APR is a total non-issue, and that's not what the product is about – it's about solving a short-term cashflow problem in a flexible way," he said.
The Wonga system uses 8,000 pieces of data to compile a picture of its applicants, Damelin said. The cost of operating on that basis means that it is not running on exceptionally high margins, he said, although he would not be drawn on figures.
Both founders said that the inference that the financial crisis had created a gap in short-term credit and opened the doors to lenders of this kind was too simplistic. The credit crunch caused them risk management issues and, in Ferratum's case, slowed its international ambitions.
Both agreed that the rise of their services was more closely related to the increasing customer demand for fast, convenient online services.
"I think customers have got sick and tired about a lack of transparency and being treated in a really condescending way by traditional providers. I think that's a more important trend than the economic environment… Most traditional financial service providers do what they can to not be transparent, because they design products that, if people actually understood them, they wouldn’t want them," Damelin said.
"I think it's a problem that a lot of incumbents share in a lot of industries, you see things after the fact and you say: 'how could it be that Microsoft didn't see the internet coming?' I think banks fall into that category in the same way," he added.