Beware the promise of salary advance schemes

Apps allow employees draw down some of their monthly pay packet in advance

High energy and food prices are particularly bad news for people who live from one payday to the next. In the UK, about 22 per cent of adults have less than £100 (€118) in savings, according to a government-backed survey. In the US, about 20 per cent of households say they could only cover their expenses for two weeks or less if they lost their income, according to the consumer protection regulator.

In this context, many employers are keen to do something to help their staff become more “financially resilient”. One increasingly popular idea is to partner with companies which provide “earned wage access” or “early salary advance scheme” products.

As well as the risk of becoming trapped in a cycle, if you are paying a flat fee per transaction the cost can soon add up

These companies connect with an employer’s payroll to let employees draw down some of their forthcoming pay packet in advance.

The companies usually charge a fee per transaction (generally £1-£2 in the UK) which is paid by the employee or the employer. The products are largely unregulated because they are not seen as loans. They are proliferating in the UK, the US and a number of countries in Asia, such as Singapore and Indonesia.

Revolut, the UK-based banking app, has also entered the market, telling employers it is a way to "empower employee financial wellbeing, at no cost to you". Revolut offers this service in Ireland also, as does Azucko, an app developed by Kerry-based debt management group, Prima Finance.

Data is scarce, but research company Aite-Novarica estimates that $9.5 billion (€9bn) in wages were accessed early in the US in 2020, up from $3.2 billion in 2018.

In a world where many employers don't offer ad hoc advances to employees any more, these products can help staff cope with unexpected financial emergencies without having to resort to expensive payday loans. Some of the apps like UK-based Wagestream, whose financial backers include some charities, combine it with a suite of other services such as financial coaching and savings. There is also value in the clear information some of these apps supply to workers about how much they are earning, especially for shift workers.

But for companies which don't offer these wider services, there is a question about whether payday advances really promote financial resilience. If you take from the next pay cheque, there is a risk you will come up short again the following month.

Data from the Financial Conduct Authority, a UK regulator, suggests users take advances between one and three times per month on average. While data shared by Wagestream shows 62 per cent of its users don't make use of the salary advance option at all, 20 per cent tap it one to two times per month, 9 per cent tap it four to six times and 9 per cent tap it seven or more times.

As well as the risk of becoming trapped in a cycle, if you are paying a flat fee per transaction the cost can soon add up. The FCA has warned there is a “risk that employees might not appreciate the true cost” compared to credit products with interest rates.

Against that, Wagestream told me frequent users weren’t necessarily in financial distress. Some users are part-time shift workers who simply want to be paid after every shift, for example. Others seem to want to create a weekly pay cycle for themselves.

Wagestream users on average transfer lower amounts less often after a year. The company’s “end goal” is that all fees are covered by employers rather than workers. Some employers do this already; others are planning to as the cost of living rises.

Regulators have noticed the market but haven't got involved yet. In the UK, the FCA's Woolard review last year "identified a number of risks of harm associated with use of these products", but didn't find evidence of "crystallisation or widespread consumer detriment". In the US, the Consumer Financial Protection Bureau is expected to look again at the question of whether any of these products should be treated as loans.

A good place to start for regulators would be to gather better data on the scale of the market and the ways in which people are using it.

Employers, meanwhile, should be wary of the idea they can deliver “financial wellbeing” on the cheap.

Companies that believe in the value of these products should cover the fees and keep an eye on the way staff are using them. They could also offer payroll savings schemes to help people develop a financial cushion for the future.

Nest, the UK state-backed pension fund, has just concluded an encouraging trial of an “opt out” approach to employee savings funds.

If employers don’t want to go down that road, there is a perfectly good alternative: pay staff a decent living wage and leave them to it. – Copyright The Financial Times Limited 2022