Neither a borrower…
My heart goes out to the unfortunates who are driven into the clutches of pay-day lenders; and it warms to the Archbishop of Canterbury who wishes to mobilise the Church’s support for credit unions to compete the loan sharks out of existence. But what does my head say?
Several years ago a charity which helps vulnerable people obtain justice (helping them in court proceedings for eviction and repossession, often for trivial arrears) asked me to cast a banker’s eye over the accounts of one prominent business active in this area. Ideas floating around at the time included not only credit unions but legislation in favour of capping interest rates etc. I was saddened by what a few minutes with the accounts and a spreadsheet told me.
It’s easy for the affluent to turn their back on this problem. As children we feel better when our parents explain that if we individually gave away everything we had, that, spread over the world’s needy, would make no difference; and when, confronted by itinerant beggars, we are told that we should not give them money because that will only encourage them to remain homeless, that too allows us to travel comfortably to our air-conditioned offices and get on with the business of making money for ourselves. Our consciences are cleared by the occasional gift-aided donation to something respectable. And when we’ve amassed a large enough sum, we can make everything all right by giving to a museum (who will put our name on the wall). And if the talk of 5000% APRs still niggles, we can brush it aside with idle, ill-informed speculation about what sort of mental illness or fecklessness puts people into the position of needing such support.
But the reality is that poverty comes in as many unhappy ways as would keep Tolstoy in business. There are people who simply have the misfortune of needing money, often in quite small amounts, and have nowhere else to turn. Some of them are able to pay these sums back quite quickly – when their monthly pay arrives. But there will be others who can’t. And some who won’t.
The problem is that, once the criteria of eligibility for conventional banking are not met, it can be difficult for lenders to work out who will default; and inevitable that provision be made for unrecoverable amounts. The stubborn fact is that the arithmetic of margin-based lending simply doesn’t accommodate significant levels of write-off. But the real (and I suspect for many readers unexpected) killer is the costs of collection, negotiation, rescheduling, court appearances etc. This is simply a cost of doing business of this kind. It can be streamlined with volume and slick management. But the smaller the individual loan the larger these administration costs will appear when quoted as an APR. If you lend someone £1m, you have an admin. burden; if you lend him £100, that is a burden the borrower must bear (if your operation is to run profitably). And if the cost is £20 for a 30-day loan, you get to an APR of 9000%. One description sounds obscene; the other sounds perfectly fair given a reasonable estimate for the work involved.
So can credit unions provide the answer the ABC wants?
They can certainly help some borrowers; but let’s be quite clear how. They depend upon three key, and rather limiting, features. Firstly, although the interest rate charged to borrowers is capped at a far lower level than commercial pay-day loans, they depend upon most of the administration being provided for free, by volunteers. Second, they are funded by deposits from members of the union, who receive interest of what is left from borrowers’ repayments after bad debts and unavoidable administration costs (one presumes at least that the Church will not be charging rent on the space they licence for their use); their capital may be protected by the financial services compensation scheme, but they are taking an unremunerated business risk in the deposit rate they accept. (At today’s interest rates of course that sacrifice is smaller than when I last looked at this, and this may help the ABC’s cause.) But most important, the model depends upon selection: selection of eligibility for borrowing that will necessarily exclude quite a lot of people who don’t belong to the parish, community or other group they target. They are the ugly children left in the orphanage.
For all of these reasons I think it unlikely the Wongas of this world have much to fear from the ABC. The real problem is that these people are poor. It is rare that their need is genuinely temporary; the poverty they face is chronic. They need grants, not loans. (Vince Cable needs to understand that most of the SMEs the banks won’t service are in the same position: they need equity, not debt, and the German model of a bank-funded Mittelstand he holds up used to be cited in textbooks as what was wrong with the German financial system. Our banks do not need the burden of equity risks for debt rewards.)
Credit unions help only by providing charity disguised as lending, to a narrow segment of the needy. Their cherry-picking, if it reaches a scale sufficient to have any impact at all, may ironically make things work for those that are left outside their safety net. As with insurance, there is a redlining effect: if you end up in the group that includes those that default, your borrowing costs will go up even more to pay for your neighbours’ bad debts.
A civilised society has to think hard about who should bear the burden of poverty (just as it already legislates for what type of discrimination insurance companies may lawfully practice). The problem will only get worse as government austerity measures withdraw central taxation from the equation. I don’t have the complete solution; but I’m not convinced the ABC has either.