Monthly Archives: February 2014

How to build alternatives to payday lending

We posted here last week about our new report on whether it might be possible to build an organisation to take on the payday lenders and, as the Archbishop of Canterbury put it so graphically, drive them out of business.

Whatever the solution is, the problem of corrosive high cost/short term lending is increasingly obvious.  And not because there is no market.  It covers a market that was once served by the big banks at one end and the loan sharks at the other.

It is a problem not because clients of payday loan companies are being given loans.  It is a problem because the expansion plans of the companies require those clients to get into difficulties, to roll over their loans, and to continue to leach money in ever greater amounts to the companies.

The implications for the individuals are bad enough.  It is also a disastrous scenario for the local economies of the poorest neighbourhoods.

But it does beg the question of what a reasonable political platform ought to be on payday lenders, especially now that the government has agreed to regulate them and cap their total charges.

It is a difficult question because the credit union movement, important though it is, is only geared up in a few places to compete.  There also needs to be some institutions covering that market or the loan sharks with the baseball bats will be back.  So what should your average political party do, say the Liberal Democrats, for example?

This is what should probably go in their manifesto:.

1.  Real time regulation.  This is the way it is organised in most US states, mainly by a company called Veritec.  Without that real time regulation, clients are able to take out multiple loans with different companies and the loan companies are able to interpret regulations as they like – some already don’t count the first loan rollover.

2. Gear up the credit unions.  The government is already gearing up the credit unions, but this needs to concentrate on the biggest ones like London Mutual, which between them might be able to organise a short-term loan portal that is easy to access and use – and does not destroy lives.

3.  Experiment with crowdfund platforms.  We need to experiment with a range of different social enterprise or crowdfunding models, for different segments of the market, especially with linked debt advice services for those in difficulties – and with the overall objective of getting people out of long-term debt, not digging them further in.

4.  Offer welfare loans through the welfare system. The old social fund loans for furniture were provided through the benefits system.  There is an opportunity here for the welfare system to provide emergency loans, at reasonable cost, and to take payments out of benefits – perhaps in partnership with the biggest credit unions.

5.  Get the big banks to build the infrastructure.  See our other report about how the big banks need to help pay for a new local banking infrastructure that is capable of offering services to those people and places they no longer want to serve.

6. Plug the demographic gaps.  We now have detailed postcode lending data from the big banks and it needs to be used to find the places which are suffering the most from loan sharks or payday lenders – nurses and service personnel for example – and to prioritise alternatives there.

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Are payday loans depressing poor neighbourhoods?

There is a central moral conundrum at the heart of the payday loan phenomenon, as our report Can You Imagine an Ethical Wonga? sets out.

It is that payday loan companies are designed to help people through what are intended to be unusual and temporary periods of financial difficulty.  Long-term and repeated use of payday loans is seriously expensive.

Yet the business plans of most payday loan companies envisage growth.  Their business purpose, and the purpose of their investors, is to maximise their profits – and this is bound to be at the expense of some of the poorest families and the most vulnerable places.

So it is time we looked at the issue of what growing payday loan companies means for the local economies in the poorest neighbourhoods.

The profits of the top ten payday loan companies in the UK were about £194 million, according to the Bureau of Investigative Journalism.  It is not clear how much the profits of the other 230 or so payday loan companies are, but the same report suggests that the turnover of the top ten is about 55 per cent of the total, which suggests that about £400 million a year is being extracted from the some of the poorest areas of the nation.

This will be an under-estimate because it excludes the money extracted to cover basic costs.  It is also a suggestion of what the figure might be, which is a reason for more research to pinpoint the amount being extracted more precisely.

If that is so, it is a serious problem, given that the way that money stays circulating in the most impoverished areas, from local business to local business, is a vital element in their economic resilience.  If there is an economic vacuum cleaner on the high street, it means that what enterprises survive locally will be that much less viable, and the neighbourhood that much more dependent on benefits and grants.

The loan companies point to the amount of money they are funnelling into the poorest economies.  But more research is needed about the long-term impact on the poorest local economies when the borrowers are expected to pay back the loan, but find the equivalent of 5,000 per cent annual interest as well.

This matters because the money flowing through a local economy is one of the few assets poorer neighbourhoods possess.  Increasing the length of time that money stays circulating locally can increase people’s wealth.  Finding more ways that it can leak out will make them more dependent.

At the heart of this idea is the theory that maximising the use of the money already flowing through the economy, so that it is passed from local business to local business before it flows away, and can increase the economic impact without necessarily requiring new money.

The Campaign to Protect Rural England (CPRE), for example, suggests that spending £10 in a local food outlet is actually worth another £25 to the local economy, as it gets re-spent locally several times (a local multiplier of 2.5); and they also report that local food shops can employ three times as many people for the same amount of turnover as a large supermarket.

If this is the case, it matters that money is leaking out to payday loan companies.  Unsuccessful places leak out income very quickly.  That is what makes them unsuccessful, because it is not the total amount of money that is important here.  It is the diverse ecosystem of businesses, and maybe even the diversity of people that matters – because they can keep money circulating:

  • The original research by the New Economics Foundation on the local multiplier effect showed that every £10 spent with the organic vegetable box scheme was worth £25 for the local area, compared with just £14 when the same amount was spent in a supermarket.
  • A study in a Chicago neighbourhood showed that a dollar spent at a local restaurant yielded a 25 per cent greater economic multiplier effect than at a chain restaurant.
  • Another study in Maine showed how, for every $100 spent with 28 locally-owned businesses, $58 returned to the Portland economy.
  • Closer to home, a study of the Lincolnshire Co-operative Society found that every pound spent in a co-operative store changes hands five times, at diminishing levels, until the final penny leaves the local economy.

The implications of this for the local economy are profound.  It means that sustainable economic success requires a diverse range of locally-owned businesses which trade with each other. It also means that, if a financial institution sets up which drains the economy of the money circulating, then the economy will suffer.

It won’t just be the person paying back the loan.  Payday loan companies may be depressing the poorest places.

Why bank failures can be a success

Let’s leave aside for a moment the new Barclays bonus bill of £2.4 billion, which is not just evidence that the big banks continue as dysfunctional as ever – it is also money which, in London at least, is being recycled into property prices, imprisoning the next generation in whatever rents the landlords wish to charge.

More on this in my book Broke: How to Survive the Middle Class Crisis.

But, as I say, let’s leave it aside for now, and concentrate on another piece of financial news today: a credit union on the Isle of Thanet has gone under.  Wantsum Credit Union has closed their doors.

This is not good news for the members, who have saved £100,000 there.  But what is fascinating about it is that they will get their money back within seven days.

This is not exactly bailing out Lehman Brothers, but it is brisk by UK standards and it is important that it should be.  Because one of the side effects of a diverse local banking system is that some new banks will fail, and must be allowed to do so – without compromising other institutions and without vast systems which spend years spinning out the process.

Bank failure resolution is therefore one of the most important new elements of the new entrepreneurial local banking culture we so badly need.

For the past three generations, we have been governed in the UK by a regulatory policy that regarded failure as unthinkable, and preferred not to allow any new banks to make failure virtually impossible.  That is what now has to change.

Why aren’t there more building societies?

You only have to look at the results of the government’s Funding for Lending scheme to realise there is a problem.

Despite being able to draw down low-cost finance under the government’s borrowing umbrella, the banks have reduced their lending by £12 billion since the scheme has introduced, according to a new report by Phillip Blond’s think-tank Respublica.

The figures underline the basic difficulty: the big banks no longer want to be in the market for lending to SMEs, however much they are beaten and cajoled by politicians to be there.

They no longer have the infrastructure to lend in that market.  They have no local intelligence and the alogarithms they use, by way of risk software operated at regional level, tend to rule out most loans.

There is the problem in a nutshell.  Despite all the rhetoric, the big banks don’t want to do it.  That is why Project Merlin failed and it is why the results of Funding for Lending have been so unspectacular.

What I hadn’t realised until I read the new Respublica report, Markets for the Many, is that the Funding for Lending figures for building societies are completely different: they increased their lending by £15.7bn during the same period.

The problem is that regulation prevents them lending to SMEs.  It isn’t surprising, in those circumstances, that loan rejection rates to SMEs in the UK are twice as high as they are in Germany and France.

Markets for the Many suggests lifting those restrictions on building societies and to look urgently at remutualisation legislation.

This is sensible, though since the disaster of the building society demutualisation in the 1990s (see my book Broke: How to Survive the Middle Class Crisis for more), the building society market is very strange – one whale (Nationwide) survives alongside many minnows.  It may be that SME lending would only apply to one building society in practice.

Respublica’s other big idea – that building societies should be allowed to buy the new TSB bank, carved out of Lloyds – would certainly apply to them alone.

What is strange is that even the most fervent advocates of building societies seem to have given upon the idea of starting new ones.  The Building Societies Association website is not encouraging.

What is encouraging is that Respublica is closely involved in this debate, which goes to the heart of the key to rebalancing the UK economy – providing an effective local lending infrastructure that can use local deposits as local investment.