No more PPI means higher interest costs for unsecured loans

Was the decision to prohibit the joint sale of PPI with unsecured loans justified? PPI or payment protection insurance has become a financial service associated with large pay-outs by the banks, windfall payments received by many bank customers and far too many unwanted phone calls. While much discussion has unsurprisingly focused on the nearly £14 billion pounds of PPI customer redress paid out in the last 3 years, the effect on this decision on the cost of  unsecured lending is also significant.   

A joint study by academics from Bangor University and the University fof Hull addresses this concern through examining whether PPI cross-subsidised loans.  The research by John Ashton from Bangor and Robert Hudson from Hull universities showed that customers are in fact now paying higher interest rates for unsecured borrowing following the changes implemented in 2010.

Dr Ashton of Bangor University Business School likened the previous system to buying peanuts from a hotel minibar, explaining that: “Customers choose a loan, generally based on the cost of the loan repayments, irrespective of the PPI costs, just as a hotel customer would opt for a hotel with cheaper rooms, knowing the price of minibar sundries could be artificially high. Problems arose with PPI as, while most customers are aware minibar treats can be overpriced, knowledge as to the costs of PPI services was not universally understood. This lack of customer information enabled firms to raise PPI premiums and employ profits from PPI sales to significantly reduce the cost of unsecured lending prior to 2010.”  

Dr Ashton continued:: “While customers clearly overpaid for PPI when borrowing in the past, this did reduce the interest cost of unsecured debt. Without PPI the interest costs of unsecured debt will be higher.”  

The examination considered data from Moneyfacts PLC for interest rates of unsecured lending offered with PPI or otherwise for three amounts of unsecured personal borrowing (£1,000, £5,000 and £10,000). The data were recorded monthly for 14 years, from January 1998 to December 2011 for 219 unsecured personal lending products offered by 104 banks, providing a comprehensive and diverse sample of UK banks offering unsecured loans. The study accommodated the influence of other important factors including redemption payments, arrangement fees, existing customers, the use of direct debits, the form of distribution and the maximum term of the loan. The study is published this month in the academic journal The International Journal of the Economics of Business.

Publication date: 27 February 2014