Proposal for Loan Guarantee Fund for Credit Unions

By Kezia Dugdale MSP

The Context The Payday loan market in the United Kingdom is booming, currently valued at between 2 and 2.2billion to the economy last year. Thats a likely side-effect of the recession and the credit crunch affecting high street retail bank lending. The consequence is around 8 million payday loans last year provided by Payday lenders companies which exist online and on the High street which specialise in high interest short term lending. The APR for Payday loans is usually in 4 figures and can peak at 4000% for some online productsi. A recent OFT investigation has exposed a substantial amount of non-compliance in these companies and 50 of the biggest lenders, which make up over 90% of the market, are currently being investigated for their poor practiceii. Both the SNP and Labour Party support the need for a cap on the cost of credit, a proposal recently rejected by the UK Government. Whilst the case for tighter regulation continues, it is possible and arguably desirable for the Scottish Government and Local Authorities to seek to mitigate the effects of these Payday loan lenders. There are means by which this can be done through the planning system, through money advice services and social advertising budgets, but there is also a need to ensure that people living in Scotland have access to credible alternatives to Payday loans. Such an alternative must be affordable and accessible. Credit Unions, already well supported by the Scottish Government, are ideally placed to provide such a service but need more support to do so. Can Credit Unions offer Payday Loans? Yes and some of the larger credit unions already do. ScotWest led the way with their Fast 500 productiii. Capital Credit Union followed with their Swift 500iv. Blantyre Credit Unionv recently revealed the success of their Payday loan product. They were able to demonstrate that their payday loan product had been taken up by 2900 clients. The difference between those 2900 loans being taken out through a Credit Union, where interest was capped at 26% APR versus a Payday loan lender lending at a far higher rate was worth 500,000 in terms of saved interest over the period. That was 500,000 back in the pockets of recipients, likely to be spent within the local economy. Crucially, those 2900 clients had now amassed 113,000 of savings between themvi, demonstrating the long term benefits of Credit Unions. The payday loan had not only addressed a financial need but worked as a bridging tool to recruit Credit Union members and promote more thrifty, ethical and sustainable financial habits. However, it is very difficult for a credit union to make a payday loan product sustainable since charging an ethical rate of interest does not generate a substantial income over a short period. Competing with a short term lending product would likely require substantial investment.

The real question is whether consumer demand is for the short term nature of payday loans, or their instant and easy access. If it is instant access which consumers value more, then Credit Unions could be prepared to enter that market with a more affordable product which spreads payments over several months provided the credit union had some comfort that other members savings were not at risk if a lot of instant loans went bad. The Proposal A loan guarantee fund that would allow Credit Unions to lend to riskier clients on the basis that the risk of default was born by the Scottish Government instead of the Credit Union. The Scottish Government would allocate a sum of money to the scheme and interested Credit Unions could register against the scheme. When they meet clients who fall just short of their own affordability criteria, they use this scheme to underwrite the loan. If it goes bad, the Government pick up the cost. Objective To provide accessible and affordable same day credit to Scots who struggle to access credit from High Street banks. To reduce the risk Credit Unions face from defaulters. To build membership of Credit Unions and therefore both enhance the financial education of Scots and promote better capacity to save.

The Audience? The current Payday Loan market. Citizens Advice Scotland tell us that around 75% of people who access Payday Loans are in full-time paid workvii. The majority are male and under 35 and 30% own their own homes. Has it been done before? Yes. It builds on the best of the DWP Growth Fund model: The objective of the DWP Growth Fund was to raise levels of access to affordable credit by building the capacity of third sector lenders (mainly credit unions) to serve financially excluded households. In doing so, the Growth Fund aimed to disrupt the role of high cost credit in the lives of borrowers. The Labour government set out its strategy to tackle financial exclusion in its Report Promoting financial inclusion, published at the time of the 2004 Pre-Budget Report. The report included measures in three priority areas access to banking, access to affordable credit, and access to free face to-face money advice. One part of its work was to establish a 36 million growth fund to support the coverage, capacity and sustainability of third sector lenders. The fund was administered by the Department of Work and Pensions. Grants were made to third sector lenders to fund additional lending to those who are financially excluded, i.e. loans without the normal prerequisite of savings required by credit unions (although not CDFIs), and also the capital to finance the loans given. viii

Was it a success? Broadly yes. The 36million fund led to 405,134 loans being approved between 2006 and 2011. The average loan value was 428 and the total value lent was 175,351,444 across the United Kingdom. In Scotland specifically, 26,215 loans were made totally 10,723,644 ix. At 7% of all loans that is lower than what you would expect a proportionate allocation to total. The DWP commissioned an Evaluation study which said the Growth Fund had disrupted this particular client groups likelihood of taking out high interest loans. Furthermore 29% of applicants that had never previously saved now operated savings accountsx. The scheme put substantial sums of money back in the pockets of low income people due to savings in interest payments. Money spent in the local economyxi. The Evaluation report lays this out clearly: The Growth Fund was found to have reduced the interest paid by Growth Fund borrowers on their lending by reducing the interest rate paid on borrowing and shortening the period over which borrowers repay their debts. Total interest savings are estimated at between 377 and 425 per borrower. Based on the 318,000 Growth Fund loans made to the end of September 2010, this means that total interest savings of between 119.1million and 135.1million were available to individuals and households in the local communities served by the Growth Fund, of which between 41.3m and 48.9m represented interest rate savings.xii

How would a Scottish Government scheme differ? The DWP scheme allowed the Credit Union to keep the cash on the basis that it could lend it again, this therefore helped with the capitalisation of Credit Unions. Given the financial envelope that the Scottish Government has to work within, this scheme could operate on the basis that the loans were under-written only. The default rate on the Growth Fund scheme was 4.5%xiii. Assuming money would be lent on the same basis a guaranteed loan fund of 1million could release up to 22million in capital. A more ambitious scheme would follow the example of the Growth Fund and allow Credit Unions to keep the value of the loans so that it can be lent again on the condition that it continued to serve the same client group. The Growth Fund model turned a pot of 36million into 175 million worth of lending. This is an issue for the Scottish Government, and indeed the Minister to consider further. The Maths. We asked an Actuary, supportive of the wider Debtbusterxiv, campaign to explain the difference between loans lent by Credit Unions and those by payday loan companies in stark terms. Table 1 demonstrates the profit that a) Credit Unions and b) Wongaxv make on a 500 pay day loan based on 3 different repayment options i.e. 1 month, 3 months and 6 Months.

Table 1.
Credit Union 1 month 3 months 6 months 500 1.018769265 1.057371263 1.118033989 1.9% 5.7% 11.8% 9.38 28.69 59.02

WONGA 1 month 3 months 6 months 500 1.367582855 2.557766779 6.542170894 36.8% 155.8% 554.2% 183.79 778.88 2,771.09

Table 2 looks at the savings made when you transfer 1000 loans from Payday lenders to credit union alternatives, again broken down by 1,3 and 6 month borrowing periods. Table 2.
Credit Union Wonga Saving 9,384.63 183,791.43 174,406.79 28,685.63 778,883.39 750,197.76 59,016.99 2,771,085.45 2,712,068.45

The figures speak for themselves. Encouraging 1000 people to borrow from a Credit Union rather than a Payday loan company over one month generates 174,406 of savings amongst those 1000 people. If each loan lasted 3 months, instead of 1 month, that sum becomes 750,197.76 and 2.7 million over 6 months. Given that the OFT recently reported that 50% of Payday loan company revenue comes from rolled up loansxvi it is not in any way unrealistic to expect a loan originally intended to last 1 month become a loan over a 6 month period. In fact, the saving could arguably be far higher given the number of one off charges and administration fees charged by Payday loan companies when loans are rolled up and capital increased. Since a loan repaid in full (plus interest) within a few days or weeks is almost never truly affordable, a credit union alternative would charge a much fairer rate of interest and likely spread payments over a longer period. This model of lending helps make the product sustainable at an ethical interest rate for the credit union, and makes the repayments much more affordable for the consumer. What would the benefits be? More money in pockets of low paid workers, which evidence suggests is more likely to be spent in local economies.

Reduced demand on Money Advice Services Reduced demand for Scottish Government administered debt relief schemes Increased financial and budgeting skills More savings held by low income groups.

Is there an appetite for it? One of the critiques of the Growth Fund scheme in Scotland is that it encouraged risky lending by Credit Unions whose ethos was opposed to that type of behaviour. Those concerns still remain and its fair to say that there will always be a divide in the Scottish Credit union movement between those who think Credit Unions should offer short term financial products and those that dont. It therefore follows that there will not be universal appetite for such a scheme amongst Credit Unions. That said many are evolving their own payday loan products at the moment. A scheme such as this would not only increase the development of those products across the country, but increase the number offered and the breadth of the client base also. Lord Freud, the UK Government Minister for Welfare reform recently awarded a 38 million for credit union expansion to ABCUL. A substantial slice of this funding will be used to enhance their IT infrastructure of smaller credit unions which will liberate their ability to offer a variety of alternative productsxvii. Conclusion The Scottish Government has an opportunity here to protect low paid Scots from high interest lenders and the debt cycle which perpetuates from that. In so doing, it can support ethical and sustainable credit unions whilst also encouraging a culture of saving. A loan guarantee fund very much fits with the prevention agenda. A small amount of money spent this way will pay dividends in the form of supporting local economies and reducing arrears and demand on money advice services. Kezia Dugdale MSP for the Lothians 23 April 2012 Notes: Wish to thank Greig Liddell in SPICe for providing background reading. This paper has been discussed favourably in principle with ABCUL, and in particular Frank McKillop.

i ii

http://www.wonga.com/money/is-this-apr-expensive/ OFT Payding Lending Compliance Review - http://www.oft.gov.uk/shared_oft/Credit/oft1481.pdf

iii iv v vi vii

http://www.scotwest.co.uk/bank-with-scotwest/loans/fast-500/ http://www.capitalcreditunion.com/content.asp?section=210 http://www.blantyrecreditunion.org.uk/ These figures were given in evidence to the last CPG on Credit Unions by Blantyre Credit Union. Citizens Advice Scotland report: Payday Loans: Your rights, their responsibilities House of Commons Note Credit Unions 2011 http://www.parliament.uk/briefing-papers/SN01034

viii ix x xi xii xiii xiv xv xvi xvii

Statistics taken from DWP website http://www.dwp.gov.uk/other-specialists/the-growth-fund/statistics/ Evaluation of Growth Fund Scheme 2010 http://www.hm-treasury.gov.uk/d/evaluation_growth_fund_report.pdf http://povertyalliance.org/policy_campaigns/living_wage Para 8.4 ibid. Page 48 ibid. www.keziadugdale.com/debtbusters Wonga was picked on the basis of current dominate market presence. http://www.oft.gov.uk/shared_oft/Credit/oft1481.pdf http://www.abcul.coop/media-and-research/news/view/330