Payday lenders have lessons to learn from credit unions
A cap on interest is the first step to transforming predatory lenders into responsible ones.
We know we have come a long way when Iain Duncan-Smith says, "for too long now predatory lenders have been plaguing the homes of vulnerable people." But what does his government intend to do about it? Not a lot so far.
Admittedly, if there was to be an interest rate cap on the loans dealt out by predatory lenders, then they would just find ways around it, like loading up administrative fees and charges elsewhere. So what then? A cap on the total cost of credit is what we should pine for today, placing a cost ceiling on how much a loan, inclusive of charges and administrative fees, would be to a consumer.
The benefits to a person taking out loans would be unprecedented.
Since the "Big Bang" – the sudden deregulation of the financial markets back in the 1980s – policymakers have been loath to right the wrongs of market irresponsibility with anything other than mere guidance. The same must be said of the credit market. At an official level, we require responsible lending, but it is all self-regulated. This has to change.
However there is one financial product that does have, imposed upon it, a legal cap. That is a loan from a credit union. Currently a credit union cannot lend at more than 26.8 per cent interest. This has always been the main pull of a credit union’s appeal – it can lend at a low interest, and offers advice and encourages savings as well.
The first credit union in the UK 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 in their paper on the relationship between credit union objects and cooperative philosophies point out, it probably wasn’t the first credit union as such, as 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 modeled.
Political support for the institutions didn't occur until the 1980s/1990s as they started to become part of local and central government discourse on tackling poverty and disadvantage. In the late 1990s/early 2000s, the Association of British Credit Unions (ABCUL), the sector’s largest trade association, decided to encourage credit unions to be a bit more like a business, 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 perfectly 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 modernization, 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 has said that the sector is not financially sustainable. This might suggest that with continued funding, in the amounts that it has been coming, 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 I think it is rather modest – especially given 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.
One of the 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 find the convenience of the loans, from their doorstep, very satisfactory indeed. 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.
Credit unions should enjoy continued investment, and in the last few years have received far more than £18m, so a lower rate home credit service could be feasible. This is guaranteed to get people to join credit unions, and signposts a more creative approach to modernisation.
If we want better credit unions, interventions like this one are the way forward. The stock answer that credit unions, as they are, will help wean people off high-cost credit is simply not good enough.
Tags: Payday Loans