According to the Financial Inclusion Taskforce 1.75 million adults in Britain do not have access to a transactional bank account - 7.7 million accounts are without credit facilities and a further 9 million people are without accounts that allow access to mainstream credit. Credit cards have dropped in circulation by 1 million since 2011. PwC calls this the mid-life crisis of the credit card, which is currently seeing a contraction in use as the banking industry faces heavy competition from other financial products. This is all in spite of the rising cost of living, job losses, underemployment, and the lack of a real wage increase for many workers.
What this reality has not been matched with is access to cheaper and better forms of lending. Credit union membership in the UK is around 2 per cent of the population, even with government funding and modernisation attempts. Compared to 24 per cent membership in Australia, 44 per cent in the United States and up to 75 per cent in Ireland, this does not bode well.
So how are people getting by? We have seen a rise in the use of payday loans – an expensive financial product that has been widely criticized in recent times for the amount they charge borrowers. A report in the Guardian in 2011 showed that some payday lenders were charging what they called 60 times the “true cost of a loan” – compared to a loan by My Home Finance, a not-for-profit organisation set up by the government and the National Housing Federation in 2010, which charges a representative APR of 69.9 per cent.
Payday lenders often compare their prices to unauthorised bank loans, which can end up being comparably expensive, to give their product some justification. But compared with the average authorised overdraft charge, payday loans are expensive.
Moreover, the diagnosis here is not quite as simple as to simply say ‘avoid those loans’. Many people are priced out of enjoying mainstream credit, while living costs rise and wages are static. We should be demanding answers – not least from the banks - as to why so many people find it difficult to get to the end of the month without help from payday loans.
Sadly, such loans are the only alternative for some people. Research by R3 has shown that 60 per cent of people who took out a payday loan have regretted the decision afterwards. Indeed as I show in my book, “Loan Sharks: The Rise and Rise of Payday Lending”, payday loans can very often be detrimental to an individual, and the companies themselves know it. In the book I have set out why the industry needs better, stronger regulation and why I believe such financial products must be avoided.
I also attempt to bust many of the myths that exist. For example some well-meaning people have hastily assumed credit unions can fill in where payday lenders are operating. But unfortunately this is far too simple. From conversations I have had with credit union trade associations and other credit union professionals, lending to the same people as payday lenders will not be easy, and will take a drastic reconfiguration of their model. That is not to say, however, that this cannot be achieved.
Credit unions have played a very important role, despite not being widely known about in the UK. The first credit union in Britain was likely to have been born out of the first properly documented cooperative institution, which was in Rochdale in 1844. As Ann-Marie Ward and Donal McKillop point out in their paper on the relationship between credit union objects and cooperative philosophies, it probably wasn’t the first credit union as such (the unions grew out of less formal savings groups), but certainly it was the most successful of the day on which many others were subsequently modelled.
Political support for these institutions didn't occur until the 1980s and 90s as they started to become part of local and central government discourse on tackling poverty and disadvantage. In the late 1990s and early 2000s, the Association of British Credit Unions (ABCUL), the sector’s largest trade association, decided to encourage credit unions to function a bit more like businesses, so as to encourage middle-class savers and shift the image of being the "poor person’s bank".
Credit unions have been subject to many levels of so-called 'modernisation'. In the Blair years there was a commitment towards more funding for credit unions, which was consistent with the "third way" appeal to a savings culture assisting with welfare, such as the savings gateway and the child trust fund.
Unions received a great boost from the Department for Work and Pensions (DWP) in 2011, receiving a funding package of £73m for a modernisation, but given that only 2 per cent of the UK population is a member of a credit union, something is missing the mark.
A recent report commissioned by the DWP said that the sector is not financially sustainable. This might suggest that with continued funding at current levels, credit unions cost more than they are worth. I take a different view. It is not how much they cost in funding that is the problem, but how the money is spent. When I asked Sally Chicken, Chairman (Volunteer) at Rainbow Saver Anglia Credit Union, how to make credit unions more appealing to a greater amount of people, she told me:
We are already very appealing to people once they have heard of us, so we really just need a good loud marketing campaign, I don’t understand why ABCUL is so against a national marketing awareness campaign… in the US there are still such public information radio ads, even though there is already high awareness. We need to use modern media in a better way, radio, TV, even Facebook.
The same DWP report suggests raising the maximum annual interest rate from 26.8 per cent to somewhere in the region of 42 per cent. This is bound to cause gasps. But it is modest by comparison with the finding from the Community Development Finance Institutions (CDFI)'s project My Home Finance that credit unions need to charge 68 per cent to cover its costs alone. In order to avoid necessitating such high charges, and for credit unions to realistically have the capacity to lend to those who are already financially troubled and thinking of using a payday lender (or have done already) then government is going to have to devote more money into its credit union funding packages.
However, this would not be wasted money, provided it is spent the right way. There are three reasons for this. First, lending money to people means that those people will put that money back into the economy, especially given that the reason many people borrow money is to pay for food, bills and other essentials. Second, ensuring credit unions have the capacity to lend more means that individuals' debt profiles will be considerably reduced, particularly if that individual was to turn otherwise to a high-cost credit lender on the high street. And third, reducuing individuals' debt profiles might pave the way for that individual to have the capacity to save and invest more. Spending more centrally, to allow credit unions to lend more and maintain its low level of interest, will save money in the long term and save individuals from the misery of legal loan sharks.
One of the other modernising moves I recommend is for credit unions to offer a home credit service. A regular feature that always comes up in Provident Financial’s annual reports is that the majority of their customers value the convenience of loans on their doorstep. So much so, in fact, people are willing to pay way over the odds for it.
On the face of it, home credit, at a representative APR of 272.2 per cent, seems irrational, particularly given the availability of lower cost loans elsewhere. Taking note of this, the Joseph Rowntree Foundation, back in 2009, published a report assessing whether there could be scope for a not-for-profit home credit provider – taking the best from the industry and seeing whether it could be achieved at a price that doesn't exploit the customer.
The resulting conclusion from the study found that even without profit, at a break-even rate, 129 per cent APR was going to be typical on a loan of £288 over an average 56 week loan, assuming an investment of £18m with the intention of becoming cash-positive, operating without further investment, after five years. This is clearly too expensive.
Credit unions in the last few years have received far more than £18m, so a lower rate home credit service could be feasible. But with the sort of large-scale funding package that I recommend, which will give credit unions more capacity, and bring in improvements that people find useful such as a home credit service, then this is almost certain to get more people joining credit unions.
Another, rather controversial conclusion I have reached, on how to build up better credit unions is to look again at free banking. It has come to our attention again recently that free banking, as a concept, is rather mythical and has always just been cross-subsidised by more profitable elements of banking. This in turn has unfortunately created the incentive (or culture, if you like) of mis-selling other financial products for their loss-leaders. However, it might not come as too much of a surprise to learn that what we call free banking is quietly opposed by ethical lenders such as credit unions.
Though some will take the view, as Phillip Inman for the Guardian did, that paid-for bank accounts are much like a “pickpocket saying he was forced to steal wallets because he was denied other sources of income”, the justification from ethical lenders are that this could reduce the many barriers to market entry for building societies, credit unions and the like.
While the market is already dominated by big banks, it was noted at the KPMG’s 22nd annual Building Societies Database that: “almost half of the UK’s 47 financial mutuals had increased their profit in the year to April 2012, and that they would benefit further from the end of free banking.”
This isn't the first time I've heard something similar. One source who works close to the credit union industry, and who preferred to go unidentified, told me that Barclays' talk of transparent charging structures has made the prospect of credit union modernisation very interesting indeed.
Credit unions have always had such a structure, and if paid-for accounts led to more competition among smaller players then a possible rise in credit union membership in turn increases the chance of them lending more money, particularly to those who are currently having difficulties remaining creditworthy or are thinking about going to a payday lender. However the paid-for model comes with many problems. I would suggest that to make sure those who can least afford to pay for their banking don't lose out, government means-tests current account payments for those on around median income, to ensure only the better-off pay. In doing this, there will be fewer market barriers for smaller financial institutions and ethical lenders. Paying for something like this won't sound attractive, but free banking is a myth and at the moment low-income people are being stunted by unaffordable bank charges. Making wealthier people pay for their accounts can start to reverse this problem.
Of course better credit unions can only be one part of an overall solution. Consideration also needs to be given to restoring crisis loans, overturning cuts to the social fund, addressing the crisis in the cost of living and dealing with the ever-growing pay gap. The campaigning that is taking place against the payday lenders today is not an attempt to ban them outright – this would only cause more problems as a policy in itself. Instead we need to build alternatives and raise awareness about the issue. I hope that my book can contribute to that effort, and to the fight against predatory lending.