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High-cost credit market failure, major government investment needed

July 20, 2017

There is a market failure in the provision of credit for financially vulnerable people who have to borrow to meet their essential costs, according to a major new report - ‘The high cost of credit’ by StepChange Debt Charity.

Over one million people in the UK are using high-cost credit to cover their everyday household essentials. Half of this group are using it to pay for food and grocery shopping, a third for fuel and water bills, and a quarter to cover housing costs1. At present, the products available to this group often pose significant risk of trapping people in cycles of persistent borrowing which push them into deeper financial difficulty.

The charity is calling on the Government to follow the example of successful initiatives in the US and Australia, by introducing or underwriting the development of a new low and no interest loan scheme. This would provide safe, suitable and affordable credit to adequately meet the needs of those who have to borrow to cover everyday living expenses.

Are community lenders and FinTech the answer?

Community lenders such as credit unions and community development finance institutions (CDFIs) and FinTech solutions have all been championed as alternatives to high-cost credit. But the evidence shows that there is a major gap between the estimated £3.5bn demand and the £0.5bn supply that community lenders are able to provide 2.

Credit unions currently don’t have the scale to be the whole answer to the problem. At present the total credit union loan book is just 10% of the size of the commercial high-cost credit market 3. They can also find it difficult to lend to the more ‘high risk’ vulnerable borrowers who are using high-cost credit for essentials, around 50-80% of credit union loan applications are turned down 4.

CDFIs tend to serve more vulnerable groups and there are question marks over whether they have sufficient reach. There are currently only a few across the country that specialise in lending to individuals. The clear indication is that credit unions and CDFIs alone cannot fill the provision gap for high risk ‘survival borrowers’.

Commercial providers and new FinTech employer based loans are also constrained in who they can lend to and tend to exclude more higher-risk borrowers. In order to meet the needs of this group it is essential to find another way to manage the risk other than price. This however is unlikely without some form of government backing to attract other investors and sources of funding to mitigate the risk of potential losses.

Lessons from the US and Australia

In Australia, Good Shepherd microfinance provides a range of programmes for those on low incomes including a no-interest loans scheme (NILs). This started as a local scheme in 1981 and following significant funding from the National Australia Bank and the Australian Government has become a nationwide scheme that helps over a 100,000 people a year. With average repayment rates of 95% percent 5, the scheme provides evidence that low income borrowers are not necessarily higher risk if the product has affordable, sustainable repayments built in.

In the US, CDFIs in particular have benefitted from access to substantial long-term funding at both state and federal level. A layer of funding provided by governments can act as a form of loan guarantee scheme which helps cover lenders for a degree of customer default. Calls for such a scheme have been backed by a CDFI trade body, the Community Development Finance Association.

Laura Rodrigues, Senior Public Policy Advocate at StepChange Debt Charity, said: “Without significant support from government in the form of a renewed Social Fund or through the provision of major capital backing for a no interest loan scheme, financially vulnerable households who need to borrow will still be left with financial products which don’t serve their needs and risk pushing them deeper into hardship.

“The expansion the community lending sector and expanded provision by mainstream lenders would all be welcome and needed steps. However the gap between supply and demand means that what’s needed are bold and innovative ideas.”

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