Justin Welby, the Archbishop of Canterbury, famously told the founder of Wonga, the online money lender, that he intended to “compete it out of business.” Two years on and Wonga is still in business and charging up to 1,500% APR.
Some of its less well-organised and funded competitors have dropped away, as a result of regulation limiting the terms of their loans and the amounts they can charge rather than competition from the Church of England. But a quick Google search reveals dozens of sites prepared to advance small sums over short periods at rates of interest a hundred times and more greater than those charged by the mainstream banks.
At the same time illegal loan sharks, whose business model relies more on intimidation than on credit checks, have not disappeared. There are regular prosecutions resulting in jail terms for offenders, yet still the number reported to official helplines continues to rise.
What these few facts indicate is that there is a continued demand for credit – often small sums for short periods – and that those who because they have low earnings or poor credit histories are denied access to bank loans, overdrafts or credit cards are prepared to pay enormous sums in order to get it.
Sometimes they run huge risks. Failure to repay on time can lead to penalty fees and punitive extra interest payments which can lead to the outstanding debt escalating to unmanageable proportions. Occasionally it ends in tragedy.
It is against this background that a year ago the Carnegie UK Trust brought together a group of people to look at the problem and suggest solutions. Their report (available here) will be presented and discussed at a David Hume Institute seminar on March 14. The event is free to attend, but registration is necessary (here).
The investigation which led to the final report has been a learning journey for many participants (myself included). Middle-class horror at rates of interest in the hundreds of percent, has to be tempered by the realisation that administering a lot of small loans is dauntingly more expensive than a few big ones. Credit Unions (which are much more constrained by regulation than payday lenders on how much they can charge) and Community Development Finance Institutions (CDFIs) struggle to meet demand and be financially sustainable.
Simply believing that the problem can be solved by abolishing the profit-motive (ie the Archbishop of Canterbury’s approach of establishing more credit unions and CDFIs) is not a complete answer.
The cost of credit
Scotland has a thriving credit union sector, providing relatively low-cost credit for their members. They are by far the largest community lenders to those who are financially excluded and a lot is being done to help the sector expand, but as the report points out, the sector has historically found it difficult to deliver small, short-term loans of on the scale that is required.
The average cost to a credit union to deliver a £500 loan is £108, whereas the maximum income it makes is £68.00, resulting in a shortfall to the credit union of £40.
CDFIs also face challenges and there is currently only one in Scotland which is focused on personal lending. The report says:
Establishing a sustainable, long-term business model, which does not rely on grant funding, has proven to be highly challenging for CDFIs across the UK. This is arguably the most pressing issue that must be addressed if the sector is to be in a position to expand exponentially in order to deliver affordable credit products to many more people across Scotland.
So what is the solution? The report is understandably reluctant to point to easy answers and quick wins, but does highlight some positive developments. Public investment, both at the UK level (such as the Department of Work and Pensions Growth Fund) and locally, via council guarantees, loans and grants to CDFIs or Credit Unions can help. But there is also a role for private investment by banks and other commercial bodies.
If solutions are to be found, no single institution, public or private, national or local, can do so alone. Partnerships are needed.
The report makes 18 recommendations under four headings:
- Leadership – improving the recognition and status of affordable credit in Scotland and providing a focal point for activity
- Development and Investment – bringing new resources and supporting the mechanisms by which CDFIs and credit unions can develop and grow, enabling them to build their infrastructure and reach many more customers
- Partnerships – brokering new relationships between public service providers, commercial partners, charitable organisations and CDFIs and credit unions
- Insight – enhancing our understanding of how people access credit.
Banks, community lenders, advice agencies and civil society organisations can all do more to promote the importance of affordable credit – both internally and by working together to communicate these messages more widely amongst policymakers, practitioners and the general public.
There has never before been a coherent, shared, cross-sector approach to advancing affordable credit in Scotland. Such approaches have been delivered in different local authority areas, but never previously at a Scotland-wide level. The establishment of such a co-ordinated, partnership approach can increase the strategic priority being attached to this critical issue; help avoid duplication of efforts between different actors working on different but similar initiatives in different locations; improve sharing of best practice and learning from each other; and provide new opportunities to tackle big issues at scale.
This post first appeared on the David Hume Institute site and is reproduced here with permission
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