The following article was originally authored by Responsible Finance Chief Executive Jennifer Tankard for the Co-operative Party’s policy pamphlet ‘In Our Interests: Building an economy for all‘, published in January 2017.
The dominance of a small number of large banks in the UK’s financial sector is unproductive, risky and ultimately unfair. It locks many people out of the financial services needed to live an ordinary life.
Championing models of responsible finance, this essay demonstrates the value of greater diversity in the financial sector, and points to policy changes to improve such diversity.
Everyone should have access to a comprehensive package of appropriate and affordable financial products. The last decade has seen significant changes, which make it essential for people to have better money management skills,tools and access to appropriate financial services. These include shifts in employments patterns, with more people becoming self-employed or employed on insecure contracts, an expectation that people will take on more responsibility for managing their finances, such as pension freedoms, and changes to the UK benefits system.
Alongside the challenges facing individuals, many small businesses continue to struggle to access the finance they need to start up, grow and flourish, thus holding back local economic growth. The financial services sector has also become more complex and harder to navigate. And eight years on from the global financial crisis and recession with scandals such as PPI fresh in people’s minds, trust in the financial services sector remains low.
Despite a raft of recent legislation and regulation to encourage competition, the UK banking sector remains highly concentrated and uncompetitive. Certain groups of society, mainly those on low incomes, are either poorly served or not served at all by the main high street banks. As institutions driven by making a return for their shareholders, it is unlikely that these banks will ever provide a range of appropriate and affordable financial products for those on low incomes. These markets are not sufficiently profitable to incentivise them to do so.
The UK rightly claims to be a world leader in financial services. It should also aspire to become a world leader in tackling financial exclusion by improving access to financial services. To do this it needs a more strategic and joined up approach backed by political leadership and a commitment to investment in those institutions that have the skills and understanding to tackle financial exclusion at a community level.
Can competition improve access for everyone?
Over the last eight years, the UK’s financial services sector has seen significant change. Challenger banks, financial technology (fintech) and peer to peer lenders (P2Ps) have, in some financial services markets, created more competitive markets and introduced some diversity in model and product, than previously experienced.
In 2016, By Taavet Hinrikus, CEO and co-founder, TransferWise, predicted that, due to FinTech, in five years’ time, the financial services sector will look completely different with a host of new providers and innovative new services.1 And in ten years, it will be transformed. The government has placed a lot of expectations on competition from new entrants driving this transformation in order to improve access to financial services for all consumers and businesses.
Competition is welcome and has certainly given those consumers and businesses who already have access to mainstream financial services much greater choice. But, the costs of entering the financial services markets are significant, so it is hard to see how, without any incentives, new players would provide services to financially excluded groups who are often (although not always) higher risk. Those FinTech companies that are developing products and services appropriate for those on low incomes have yet to reach scale to provide a universal solution or to demonstrate that their business model is sustainable.
Consumers who are financially excluded and businesses that typically struggle to raise finance are seeing few benefits from this more competitive market.
Can consumer power create change?
There has been an increasing expectation for individuals to tackle their own financial exclusion or to seek more appropriate financial products and services. For example, the recent CMA investigation into retail banking markets (PDF) recommendations made clear the onus was on individuals to drive competition by ‘shopping around’. But there is an asymmetry in the availability of information about financial products and services, with larger players no longer having the capacity to make nuanced decisions about risk as well as becoming more risk averse since the banking crisis. As mentioned above, many financial services and products are not transparent in terms of clearly setting out fees and charges, having plain English terms and conditions and alerts when these change. Placing responsibility on individuals without placing responsibility on service providers to become more transparent will only lead to more people taking out inappropriate products and services and so further fuel the decline of trust in the financial services sector, which remains a significant issue, as a 2015 report by the FSCS shows (PDF).
Financial capability is also critical. The government has placed much focus on school based financial literacy activity to give children the skills they need to build financial resilience. But adults also need access to financial capability skills. Research shows (PDF) that two-thirds of people in the UK feel too confused to make the right choices about their money and more than a third say they don‘t have the right skills to properly manage their cash. And around one in four economically active adults in the UK is functionally innumerate; for example, only 36% of people understand that the term APR relates to payments. This falls further to 31% amongst young people aged 18-34. Research by the Chartered Institute of Payroll Professionals shows that sickness absence cost UK businesses £11.5 billion in 2014 or £380 per employee. The third largest cause of sickness absence is stress and mental health problems, which can be triggered by poor financial health.
This combination of a lack of trust in financial services institutions, low levels of financial capability and lack of transparency in financial services markets all act as barriers to consumer led change.
Local government can play a powerful role
Local government is in a unique position with local knowledge that can help inform local policy. Communities with a clearly defined access to finance or financial inclusion strategy have a more robust and coordinated community finance sector. For example:
- Sheffield Money: A partnership of responsible finance providers, credit unions, advice agencies and FinTech firms set up to tackle the use of high cost credit in Sheffield was launched by Sheffield City Council as part of their Fairness Commission. While this initiative is still in its early days, it is an innovate model bringing together existing organisations in a strategic way.
- Glasgow: As part of Glasgow’s financial inclusion strategy, the council developed Scotcash, a responsible finance provider, to provide an affordable alternative to dependence on high cost credit in Glasgow. Since launching in 2006, Scotcash is now an independent and sustainable organisation tackling financial exclusion in Glasgow.
- New York City: An international example of the city government creating an incubator for a range of organisations that tackle poverty, which together provided a “triage” of interventions. As a result, New York City was one of the only cities in America to reduce its poverty rate since the year 2000.
The case studies above demonstrate the potential for mayors and local authorities to tackle financial exclusion in their communities when they are given a wide-ranging remit and leadership opportunities. This combined with bank lending disclosure data can give local areas the ability to understand local need and respond with an effective strategy.
Responsible finance providers reaching markets others can’t reach
Accessing financial services and products can be complex and so there is a need for transparent pricing, plain English terms and conditions and alerts when changes are made to these. Integrating money management tools into products and services is one option, for example, Ffrees and the Change Account both allow customers to manage their money more effectively. Responsible finance providers have a key role to play in supporting customers to improve their financial capability skills while also providing access to appropriate financial products and services.
Responsible finance providers provide access to bank account and credit facilities to those who cannot access them elsewhere; they re-invest profits to deliver economic and social benefits; treat customers fairly, with clarity and transparency about the costs of borrowing, lending only to those who can afford to repay and ensuring customers get the best deal and the best outcome; and providing a personal service, with decisions made by people for people. Responsible finance providers are driven by a social mission, and so are different to other financial institutions in the market in terms of the outcomes they seek. They are also quality-assured and professional, meeting all Financial Conduct Authority requirements (FCA) and complying with the Responsible Finance Code of Practice.
The UK has longstanding infrastructure in place for a financially included society: a strong banking sector, an alternative finance sector, innovation improving the delivery and cost of financial services. But so far, these factors have not functioned as an ecosystem or an inclusive and diverse financial services system. Given its strengths in the banking sector, the UK should aspire to become a world leader in financial inclusion. Central and local governments could incentivise this by adopting the following actions:
- Responsible Finance Fund: Undercapitalisation of the responsible finance sector has long been identified as a significant constraint to growth. The creation of a dedicated government-backed Responsible Finance Fund – in the region of £150 million – would unlock significant private sector investment (typical leverage is 1:3, which would equal a total of £600 million). In the US, the government invests $200 million annually into a CDFI Fund. The CDFI Fund has been an important force in allowing CDFIs to operate sustainably by providing them with equity and is cited as one of the major milestones in achieving their $45 billion loan book.
- Duty on large employers to provide financial capability for employees: A healthy and scaled up supply side for affordable credit is important for consumers and businesses that cannot access finance from the mainstream. But financial education and literacy play a big role as well, ensuring that consumers are informed and understand their options. We suggest a duty on large employers to provide financial capability and literacy training for their employees.
- Banks’ ‘duty to serve’: We recommend drawing on the USA’s Community Reinvestment Act, which would (a) require banks to disclose their lending (which some do now on a voluntary basis) and be held to account by an independent regulator as to whether there is discriminatory lending activity; (b) require banks to invest in responsible finance providers as a way of demonstrating they are reinvesting into communities from which they take deposits.
- High cost credit levy: A levy should be introduced on all forms of high cost credit, such as payday lenders, retail store cards, home credit, white goods, etc., which will fund financial inclusion activity.
- Proportionate regulation: We recommend ensuring that regulation is appropriate and proportionate. Small social lenders, such as responsible finance providers and credit unions, are regulated by a regime that is designed for mainstream banks. Parts of this regulatory burden, such as the Approved Persons Regime or the Senior Managers Regime, can be disproportionate and are a barrier to growth in the sector, and directly reduces the resources available to support financial inclusion.
- Reform of UK payments: Access to the UK payments system should be widened to ensure more competition in the financial services sector, and for small scale lenders like credit unions and responsible finance providers to affordably access payments services.