The Financial Inclusion Centre

Our long-awaited evaluation of London Mutual Credit Union’s payday loan scheme has been published today. The report demonstrates that not only does affordable short term borrowing through a credit union have the potential to be an effective way of diverting borrowers away from high cost lenders and give borrowers welcome flexibility about how to repay but also shows that even with the current interest rate restraints, such a product can be financially viable and sustainable in the long term.

Our research measured the success of the pilot project, examining actual performance over its 12 month lifetime, profiling of the new and existing borrowers together with their attitudes and behaviours towards payday loans and finally assesses subsequent patterns of financial service usage amongst new members to help determine the actual cost implications of delivering such a payday loan product. We hope that it provides the credit union sector with valuable insight and evidence that will encourage more affordable short-term lending products to be developed and launched.

Key headlines:

• A total of 2,923 payday loans with a value of £687,757 were distributed over the course of the year-long pilot to 1,219 different borrowers.
• Applicants liked the option of repaying payday loans over a longer repayment term. Just 29% of loan applicants wanted to borrow over the traditional one month term, with the majority (59%) opting to repay over three months.
• Just over a quarter of all those borrowing during the pilot were new members, specifically attracted into the credit union by the payday loan product. A total of 331 new members joined in order to take out a payday loan – on average they borrowed fewer times (1.8 loans compared to 2.6) but loaned higher amounts (£249 compared to £226) compared to 888 existing members.
• Delinquency levels appear to be relatively low with 6.3% of all LMCU payday loans being at least one month in arrears compared to 28% of all payday loans across the industry being rolled over, as identified by the Office of Fair Trading (OFT). Arrear levels amongst new members (12% of loans) are over twice the level of existing members (4.8%).
• By borrowing through LMCU instead of high cost payday lenders, the 1,219 who borrowed during the pilot have collectively saved at minimum of £144,966 in interest charges alone, equivalent to almost £119 per borrower.
• If the 7.4million and 8.2million payday loans taken out in 2011/12 from high cost lenders had been through a credit union alternative, we estimate that between £676 million and £749 million would have been collectively saved.
• Before accessing their first LMCU loan, 74% of surveyed borrowers had taken an average of 3.2 over the 12 months before their first payday loan from LMCU. Worryingly, 17% of these had taken six or more loans.
• Payday lending through a credit union is an effective way of diverting borrowers away from high cost lenders – over two-thirds of surveyed users would be unlikely to borrow from other payday companies again.
• Crucially, new members do go on to utilise and benefit from accessing other financial services offered by the credit union:
  • LMCU membership actually encourages recent joiners to build financial resilience with almost £18,000 accumulated by the 331 new members during the pilot – a £53 average saving level per member.
  • Almost a quarter of all new members opened a current account with LMCU
  • New members were initially attracted by access to short-term borrowing but over 40% of all new members who have been with LMCU for at least six months then went on to take out a longer term loan, which increases to 52% with at least nine months of membership.
• The ‘loss leader’ model adopted during the payday pilot is financially viable in the long-term taking into account the additional income from subsequent longer term borrowing by new members. Projecting the additional income generation levels amongst those new members who have been with LMCU for at least nine months across all new members, the payday loan pilot would actually realise an overall profit of at least £8,950 or £3.06 for every loan given, making the model financially sustainable.

The full report can be found here and the summary version here.

With social housing residents already far more likely to be marginalised from mainstream financial services and continuing to experience financial difficulties in this tough economic environment, social housing providers are implementing a raft of financial inclusion initiatives.   

Most social landlords already recognise that partnerships with local credit unions are a pivotal part of this strategy. Delivering access to financial services by offering a safe and easy way to develop a savings habit, access to affordable credit channels, options to operate transactional bank accounts and support with money management can generate significant benefits for both residents as well as their businesses.

With the prospect of the greatest reforms to the welfare system in over forty years on the horizon, an even greater focus has been put on credit unions and how they can help overcome some of the significant resulting challenges.

Yet, harnessing the potential of credit unions has not always been straightforward for social housing providers, particularly for larger landlords spread over diverse geographical areas. Gaps in the national coverage of credit unions have left large swaths of residents without access. But more importantly, the hugely contrasting individual service and product offers and varying quality of credit unions make it impossible for landlords to offer a consistent and minimum standard of service to every resident.

This has left many struggling to effectively co-ordinate a myriad of partnerships with a handful of credit unions and sometimes questioning the sustainability and value of the arrangements.

It is in this context that the Financial Inclusion Centre has been working closely over the last year with Affinity Sutton Group. As one of the largest and leading housing associations operating in over 100 local authority areas, they were keen to assess the different options for a more sustainable and productive approach that can deliver benefit to all their residents.

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The UK remains mired in the fall-out from the unprecedented and devastating financial crisis which began in 2007/08 and continues to beset our financial system and economy. That much is recognised but what we have perhaps not faced up to is just how economically severe and socially damaging the aftermath of the crisis could be in the long term unless we pull together to develop policies to meet the critical economic and financial needs of UK households.

The seeds of the current crisis were sown long before the actual financial crisis appeared to hit us out of the blue. Moreover, a crisis of this severity would have had a huge impact on the economy and society even at the best of economic times. But what makes this crisis so damaging for UK households is that we entered the crisis in such a vulnerable and unprepared financial state with record levels of household debt driven largely by the crazy distorting effects of the UK property market, record low savings ratios and pension provision, rising bills for the cost of health and social care, huge disparities in wealth and income between households, the regions, and the generations. In other words, our national financial resilience was extremely low. As ever, the national picture conceals wide variations with disadvantaged households and communities most vulnerable to external shocks.

The challenge now in the age of austerity is to develop credible economic and financial policies to help UK households: i) urgently build financial resilience and in the long term, ii)create secure financial futures, and iii) meet their housing needs. There is no question that these are major economic and financial challenges in themselves. But we are optimistic that the actual policy challenges can be overcome. The UK is still a prosperous nation with plenty of untapped potential financial and human resources – even if the resources are in in the wrong place or not being used productively.  However, the real problem in the age of austerity is the emergence of a nasty strain of the politics of envy, blame and resentment which makes the necessary collective, consensus long term decisions harder to reach.

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A theme we keep returning to at the Centre is the worrying growth in payday and other forms of subprime lenders and the impact this has on vulnerable households and communities. We like to see successful businesses but, unfortunately, this is one consumer sector where the more successful it is, the worse it can be for certain communities.

It would now seem that the Office of Fair Trading (OFT) is taking a more intrusive approach to investigating payday lending firms (see http://www.independent.co.uk/money/loans-credit/payday-loans-firms-raided-by-watchdog-8201373.html).  This is to be welcomed but it must lead to urgent action and controls placed on some of the more predatory activities in this sector.

As with any policy response, the robustness of a regulatory intervention must be proportionate to the detriment caused by an activity. But it is very worrying that so far the debate around subprime lending seems to focus on shallow, narrow consumer protection issues. Consumer protection is of course important but this narrow regulatory paradigm is far too limited to understand the wider socio-economic impacts of subprime lending on vulnerable households and communities.

The growth in subprime and payday lending not only leaves many vulnerable households overindebted and exposed to unfair and aggressive practices, it undermines households’ efforts to build financial resilience and create secure financial futures, it extracts resources from disadvantaged communities and undermines the ability of community lenders such as credit unions to provide access to fair and affordable credit to more consumers.

It follows that, if policymakers, regulators, and consumer activists fail to understand the wider public policy impacts on households and communities, then the policy and regulatory response will be far too tame to deal with the problems.

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The financial crisis, and the response to it, raises a number of important issues over and above the narrow economic impacts described in the previous blog.

Firstly, we badly need a new policy paradigm and social policy model to properly evaluate the impact of this new economic reality on different households.  Narrow economic paradigms and limited quantitative models do not help us fully understand the wider financial, economic, social, psychological, cultural, and generational effects of major crises and policy responses.

Secondly, while much of the responsibility for the financial crisis can be laid fairly and squarely at the door of financial institutions, we entered the financial crisis in an extremely vulnerable state mainly due to the level of household overindebtedness caused by massive property market overvaluation.  We have simply not come to terms with the distorting effects of the property market on our society – whether in terms of financial vulnerability, propensity to save, pension accumulation and social and cultural norms. To use the cliché, it is the elephant in the room. The obsession with property pervades much of our financial, social and cultural lives and needs to be dealt with or else we are condemned to repeat the mistakes of the past.

Thirdly, some of the groups who have suffered, and will suffer, most in the aftermath of the financial crisis seem to be relatively powerless and invisible – the groups that spring to mind are younger generations and the ‘working poor’ who are in the shadow of the now famous ‘squeezed middle’. They lack a voice in the political arena compared to other more influential groups whose cause is championed by well-resourced campaigning and representative organisations in the media and corridors of power. With this in mind, to counter this imbalance, wherever relevant we will ensure that the interests of these groups are properly reflected in our future work.

Mick McAteer

The Financial Inclusion Centre is launching its new website and will have a regular blog on important new financial issues. This is the first blog – about the response to the Bank of England’s assessment of the impact of Quantitative Easing (QE) on UK households.

The Bank of England yesterday published its analysis of the effects of QE and changes to the bank rate on different UK households.  The analysis contained no real surprises on the ‘winners’ and ‘losers’ given what we already know about the impact of the financial crisis on various households but it is good to the see an attempt to quantify these effects.  What is also no surprise, but no less dispiriting, are the attacks from commentators who seem to be arguing that interest rates should have been higher to benefit specific groups such as those with large high levels of savings.

The financial crisis has unfolded in three phases. First, we had the financial crisis in the arcane financial markets (which few commentators understood the significance of at the outset) but this rapidly and scarily transformed into an economic crisis in the form of a major recession. Now we’re in the third phase – the costs of dealing with the crisis and recession has resulted in a social crisis with ordinary households paying the price in the age of austerity for the behaviours of largely unaccountable financial institutions.

But, as the crisis unfolded, we warned of our fears that the age of austerity would be governed by the politics of envy and blame with commentators castigating policymakers for forcing ‘deserving’, ‘responsible’ savers to pay for ‘feckless’ households who borrowed too much and the weakest in society losing out in the battle for scarce resources against those influential groups in society with the loudest voices in the media and corridors of power.

Much of the focus has been on the balance between savers and borrowers. While there may be many more savers than borrowers, the reality is that most households in the UK have such low levels of savings that higher interest rates would make no real difference to their incomes. If rates were a full 2% higher, the typical UK saver would benefit by 34p a week. The real winners in the savings market would have been the comparatively small number of wealthy households with high levels of savings – but of course the impact on mortgages, jobs, and the economy could have been catastrophic.

Of course, we have every sympathy for the small number of older people who do rely on their savings to top up their incomes but their needs are best met by special targeted measures not by maintaining interest rates at higher levels which would have a devastating impact on many more households.

Looking at the fall-out from the financial crisis (even with QE and low rates) the losers are the poorest and working poor, the regions and poorest parts of London, and the younger/ middle age groups who will be saddled with a legacy of debt that will affect the rest of their lives or whose housing needs will not be met – not much chance of financial resilience and secure financial futures for them in this cold, new economic reality.

We dread to think what the impact would have been on financially vulnerable, overindebted households if rates had not been driven down so dramatically. As our series of reports called Debt and the Family points out, we have the same proportion of mortgages in difficulty as in the early 90s when the Libor rate was 4-5% higher. In certain regions of the UK, greater proportions are in difficulty compared to the 80s/90s when rates were in double figures.

Over the longer term, the winners from recent UK economic trends of past two decades and QE are generally the richest 10%, and many older households – especially in the South East.

Remember that part of reason we now need low rates is the massive overvaluation of property and associated debt accumulation which resulted in a huge transfer of wealth to older, wealthy people much of which was monetised into savings. Once they amassed their wealth, did the minority want to pull up the drawbridge by keeping rates higher than need be? We hope human nature is not so bad.

Mick McAteer