It is amazing that the UK has a tiny market for Credit Unions when other markets, particularly the USA, is domianted by them. Why is this? And why are we trying to create more banks when Credit Unions offer a great alternative that is already on our doorstep today?
In a guest piece mainlywritten by Neil Burton of Earthport, Chris and Neil investigate the current state of affairs.
An article in the FT recently suggested that it has cost UK banks – the largely taxpayer-owned ones – some £1.5 billion so far, in their attempts to separate out retail branches. This is being done to overcome the ‘too big to fail’ challenge.
Compare that with the £38 million recently granted for the UK Credit Union Expansion Project. Credit Unions provide basic banking services; but are constrained in their activities such that they are, in retail banking terms, ‘too small to succeed’.
For example, the amount a Credit Unin (Credit Union) can charge for a short-term loan is capped at 2% per calendar month, with a view to increase to 3% next April. At 2% a short term loan is a loss-making proposition, when you take into account the set up and management costs. Even at 3%, which translate into 42.6% per annum, it’s marginal.
Noticing an opportunity, entrepreneurs have stepped in. Wonga, the leading short-term loan provider, has seen considerable success. £150, repaid after 18 days, would incur interest and fees of about £34; which equates to near 6000% APR. Though regulators require that APR be clearly displayed, it can be ‘fundamentally misleading’. Short term loans are just that: short term. It’s a little bit like when your friend asks to borrow some money and you say, “here you go, and pay me back next week with a pint”. If you borrow £50 from your friend, and the pint next week costs you £5, then you’re paying more than 1% interest per day, the charge that Wonga applies.
So payday loan firms are very short term loans, and they do just that thing well. In fact, some people say they prefer Wonga loans to bank loans, as the Wonga loans are absolutely clear in what they charge and there are ‘no hidden fees’. That is why 90% of its customers would recommend Wonga to a friend, significantly higher referral ratings than for other providers of financial services.
In fact, buyers of cheap airline tickets may wish those firms behaved more like Wonga, as Wonga prides itself on transparency. Upfront, it lets you know how much you’re being charged and then it is up to you whether or not you choose to pay those high fees.
But people do not like high fees, and see it as robbing the poor to make them poorer. For example the Archbishop of Canterbury, Justin Welby, dislikes such high fees.
He told Wonga’s CEO Errol Damelin that the Church would try to force Wonga out of business by helping credit unions compete. It subsequently emerged that the Church’s pension fund has a small investment in Wonga, via an investment with a venture capital firm (surely a candidate for own goal of the year).
One of our MP’s has been quoted as having said she supported the Church’s approach, but that ‘it’s just a shame this issue is being addressed by civil society rather than by government’. This definitely should show that competition is the best antidote to regulation.
The wider issue here is that technology has changed everything. More people can be reached, more efficiently, with a wider range of services.
Without Faster Payments, Wonga couldn’t deliver funds quickly, 24 x 7. Mobile phones can reach places that banks can’t. Big data analysis enables customer needs to be better understood and targeted. Technology has made the market bigger; because banking is the biggest consumer of technology. In fact, we're witnessing the fastest ever shift in banking thanks to technology.
A bigger market means there’s more space and more of a need for alternative providers.
Banks are not charities. They have shareholders and investors to satisfy. They incur massive costs and risks from regulations that force difficult choices as to which markets and segments to support (international remittances, for example).
Near-bank providers, such as building societies, peer-to-peer loan providers, Authorised Payments Institutions and credit unions could fill some of these gaps, especially where they have a lower cost base and different business models than the traditional banks.
In the UK, Credit Unions are often perceived as providers of basic banking services to the relatively less well off.
According to WOCCredit Union, Credit Unions have a mere 2.5% market share in the UK. Contrast that with the USA, where 45% of the financial market is served by Credit Unions. In a Q3 2012 US survey conducted by Aite Group, 20% of US consumers with a checking account indicated a credit union was their primary financial institution.
Equally other markets have a very successful Credit Union sector, such as New Zealand where the local Association of Credit Unions claims to be the sixth largest financial transactor by volume, and provides a 24/7 real-time continuum of core banking and payments processing services so its members can pick and choose the solutions they require.
There are several areas where these, and other ‘alternative’ providers of finance might be well placed to help with is financial inclusion.
First, a forthcoming EC Directive on Financial Access seeks to make it a right for EU citizens to be able to get a payments account, if they want one.
There are 58 million EU citizens who don’t have payments accounts, about 1 in 7 adults. Although many high street banks offer basic banking services, it’s not something they promote heavily, but two a thumbs up from moneysavingexpert.com: Barclays Cash Card and the Co-op Cash Minder.
Second, another opportunity will come with the launch of Universal Credit in October, although this does have some issues.
According to Citizen’s Advice, a UK charity, 90% of the people targeted by the government to e beneficiaries of the scheme think they will be unable to cope in some way. This is because the scheme is not set up to be that flexible, for example beneficiaries will be paid monthly instead of fortnightly. There are also concerns that beneficiaries may turn to short-term lenders in order to avoid being penalised for a failed direct debit, which is both costly and damaging to their credit history.
And third, the UK’s account switching programme will enable consumers to switch accounts not only between banks , demand for which is very low, but also to alternative providers, such as the Credit Unions.
The challenge here is that these institutions are poorly placed to help, with only 22 UK Credit Unions offering a functional transactional account. In fact, most run on a shoestring.
By way of example Sheila Bersin MBE, the powerhouse force behind the Halewood Community Credit Union, travelled to a recent event in London at her own cost – there are no expense budgets, let alone bonuses - in order to lobby for a share of the £38 million being offered by the government to assist alternative financial providers. Funds her Union desperately require if they are to automate their operations.
Without automation, credit unions can’t appeal to a broader customer base; without a broader base, they can’t amortise fixed costs; and if they are forced to run at high cost, they will always be condemned to serving only those parts of society that banks don’t want to reach.
Is the £1.5 billion well spent in disassembling the unbroken parts of the big banks?
Or would the underlying problem be better addressed by encouraging more competition?
Perhaps if a little more were directed to helping the subscale credit unions, building societies, e-money issuers, authorised payments institutions, and challenger banks, we might get more innovation, more choice, and less systemic risk.
Oh yes, and more challengers to the banks, which is supposedly what the government really wants.
Again, a space to be watched and tracked, and one where all constituencies – society, the church, the government and the institutions themselves – will all be hoping achieves the right outcomes.