Asking borrowers to pay more is not the answer for credit unions

In the wake of changes announced by chancellor George Osborne last week on the amount at which a credit union can charge in interest for one of its loan products, Joseph Wright of Civitas has written a paper entitled Credit Unions: A Solution to Poor Bank Lending? exploring the industry and its rates.

In the wake of changes announced by chancellor George Osborne last week on the amount at which a credit union can charge in interest for one of its loan products, Joseph Wright of Civitas has written a paper entitled Credit Unions: A Solution to Poor Bank Lending? exploring the industry and its rates.

It was realised fairly late in the day that for credit unions to survive they could not simply be perceived as the ‘poor person’s bank’.

Indeed Wright’s paper quotes Rob Cairns, Barrow district CEO, who said with rare honesty in an interview with The Guardian that “We need people who have some spare cash to provide the funding for those that don’t.”

As well as needing more middle class savers, there is a real public purse interest in the increased role of credit unions. For both personal loans and business loans, credit unions can and must undercut the inability of mainstream banking institutions to properly deal with this.

Wright mentions for example Project Merlin – the agreement between the government and the ‘big four’ banks, Lloyds Banking Group, HSBC, Royal Bank of Scotland and Barclays, to increase small business lending.

The two most recent ‘Trends in Lending’ reports issued by the Bank of England have shown “continual contractions in the rate of bank lending to business, and stagnant levels of lending to individuals”.

As Wright correctly points out: “This situation has been further aggravated by new requirements for major banks to increase their capital reserves, encouraging them to sit on any extra funds they can find.”

Of course Wright also addresses payday lenders. While mainstream banking has rolled back its ability to lend, despite some being owned by the government, and the pressure for them to lend to stimulate the economy, payday lenders – who through their sky-high costs for credit draw money away from savings, the high street and investment – have grown their industry from £100 million in 2004 to somewhere between £2-4 billion in 2013.

So how does Wright suppose credit unions can help? He talks about the plan by the DWP to raise the interest rate cap to three per cent a month.

As of last Wednesday this is now the case. Credit unions, which are the only financial institutions in the country to have imposed upon it an interest rate cap, formerly at 26.8 per cent per year (2 per cent per month), can sell loans at 42.6 per cent (three per cent per month) from April 2014.

Is this enough? Wright says no. He concludes on this point that:

“On a loan of £300 for one month, a credit union can charge a maximum of £6 with the 2 per cent cap (providing the loan is paid back in a lump sum at the end of the loan period). Processing plus credit referencing costs for a loan typically cost a credit union £8, sometimes more, leaving the credit union with a net loss of £2 on the loan. Consequently, many credit unions avoid issuing many short term loans to avoid losses. A raise to 3 per cent would allow for only one pound profit on the loan, still leaving poor incentives for credit unions to push the product.”

While I agree in principle that credit unions should be able to make lending to more people easier by raising costs on the charges it makes (it’s not usury since it’s not profit from money lending, in fact it’s a loss-making loan) I don’t think it needs to go up any further than it did last week.

This is because I don’t agree with the principle, agreed on by Wright, that credit unions should have to make returns on its loans.

Though Wright says charging more in interest on a loan still makes credit union loans cheaper than the payday lenders, his conclusions are controversial in that they call for a rise in costs. But my conclusions may look more controversial still at face value.

I feel that before credit unions go ahead and charge even more (like the 68 per cent and beyond that My Home Finance suggested) they should be able to continue the use of cross-subsiding from savings products to finance the loss-making loans.

We’re already on our way to making this a reality. The £38 million expansion fund by the DWP over the next three years should put money aside for advertising and social media to highlight how credit unions are good for both poorer borrowers and middle class savers.

Credit union staff spend more time fighting for funding than finding members so this next pot of money from the government frees their time to make their presence better known.

Also more councils should give credit unions shop fronts to make them more visible to the high street consumer. ‘Jam jar’ accounts should be facilitated for (it’s in the plan), some benefits or the social fund could be paid through them, and more initiatives should be rolled out like that of Glasgow City, where all secondary school children will be given a credit union account with a £10 deposit.

Wright and Civitas have done some very useful research and reached some noble conclusions as regarding the current life and times of credit unions, but asking borrowers to pay more again is not the next step; using the money from the DWP expansion fund creatively is what will work.

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2 Responses to “Asking borrowers to pay more is not the answer for credit unions”

  1. James Richards

    I’m not sure the author has fully understood the typical credit union’s business model. Having worked in the industry for the last ten years, I welcome the decision to allow credit unions to charge more for their ‘sub-prime’ lending. The middle class savers the author mentions are a means to an end (providing greater funds for on-lending). They generate no income for the organisation until their funds are lent. Indeed, each saver is a direct cost to the business. The only income most credit unions have is interest from lending and any grant funding received (usually from local authorities). The DWP money isn’t the kind of direct revenue funding most credit unions need to meet the costs of shop front premises and paid staff and will in any case be given largely to the already sizeable credit unions who can deal with the bureacracy that goes with the funding. Moreover, in order to attract revenue funding from local authorities, credit unions generally have to agree to prioritise serving the ‘hard to reach’ (awful phrase I know) customers that cost the most to address. So unless those loans can to some extent be profitable, credit unions are caught in a vicious circle. Against a background of cuts in local authority funding to all types of third sector organisation, the only long-term solution for credit union sustainability is through a significant increase in their self-generated income. Unwelcome though it may appear, higher interest rates are therefore inevitable.

  2. Carl Robert Packman

    Yes, middle class savers put in their money, credit unions can lend more with it, make their money from the interest charged, ergo they need more middle class savers.

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