A new discussion paper by the Carnegie UK Trust has set out the need for a range of affordable alternatives to meet the demand for small sum short-term credit – including CDFIs and credit unions.
“Meeting the need for affordable credit” makes clear the need for greater policy interventions to grow the affordable options for those unable to
access mainstream sources of finance. Policy has so far concentrated on restricting current exploitative provision of short term credit. The new tighter regulation of the high cost credit market is estimated there will be a reduction of around £750 million per annum in high cost loans. But the paper calls for policy makers to now turn their attention to meeting this ongoing demand for credit through a range of options.
It highlights the need to understand the high cost credit market and the borrowers who use it. The market has many kinds of credit providers and products, including payday, (both online and retail) home credit lending and pawnbroking (estimated to account for £5 billion worth of loans and serve 5 million customers) as well as rent-to-buy retail credit and catalogues.
But customers are diverse; there are significant differences in the demographic profile of users of different financial products within the high cost credit market. The UK net median income is £17,100. The median incomes for payday customers are £16,500 for online and £13,400 for retail. The lowest income decile in the UK has a net income of £8,800. Nearly 50% of home credit customers are in the bottom two deciles. Around three-quarters of online payday loan customers and two-thirds of retail payday loan customers are in full-time employment, compared to only a quarter of those who use home credit or a third of those who use pawnbrokers.
The paper argues that any solution to the credit gap must therefore provide a range of products which cater for the very different circumstances and demands of different groups of consumers.
One of the obvious challenges of providing an affordable alternative is the cost of providing small sum, short term loans, and the need for higher margins required to cover the higher risk of defaults. The paper states that policy makers should recognise that this type of lending will always be significantly more expensive than mainstream credit products.
The factors that influence customers choice of loan are also important to consider. The Speed of access is often the key factor, and other considerations are affordable repayments – particularly for those who repay in cash on a weekly or fortnightly basis – flexibility, and trust in the lender.
The paper highlights credit unions as a good long-term option. But it stresses that the demographic profile of credit union customers is very different to that of payday loans or home credit, and says it would be a significant challenge for credit unions to adapt and provide for these customers in the short to medium term. The credit union model, the scale of the sector, the restriction on its interest rate, the products on offer and the costs involved in lending present a challenge for the sector in meeting the needs of payday and home credit customers.
The paper argues that it is vital that other players in the not-for-profit arena are considered when formulating solutions.
The paper highlights the greater flexibility of the CDFI model which potentially makes them a realistic and viable option for developing new affordable credit solutions to meet demand in the medium term, though it acknowledges the tiny sise of the sector in comparison to the mainstream.
There are significant overlaps between the CDFI customer base and the home credit segment of the commercial high cost credit market. Similarly to this market, the majority of CDFI customers are female, under 35, have dependent children and live in rented accommodation. However, around two-thirds of CDFI customers are unemployed, compared to a figure of around 10% of customers using commercial providers. The paper argues this means CDFIs would need to make significant adjustments to t heir model to appeal to customers of commercial services. While CDFIs have the flexibility to do this, but financial sustainability remains the key barrier to scaling the sector.
To effectively compete with commercial providers CDFIs would need to significantly increase their scale and diversity of their product range. This would require
- considerable investment to provide the required loan capital to serve a larger market
- significant development capital to build the required infrastructure recruit, train and properly remunerate skilled personnel.
Without commercial support, investment is needed from the public sector, civil society or from financial markets.
The paper concludes with a number of critical policy questions that need to be answered if this challenging and complex issue is to be addressed. It requires long-term interventions, and the widening of the current debate.
“Meeting the need for affordable credit” was written by Niall Alexander, Douglas White and Tara Murphy