High-Cost Consumer Credit Review

High-cost Consumer Credit Review

Submission from the Association of British Credit Unions Limited

Contact details

Mark Lyonette – Chief Executive [email protected] Tel: 0161 819 6997

Abbie Shelton – Policy and Communications Manager [email protected] Tel: 0161 819 6994 www.abcul.coop

ABCUL’s Response – High-Cost Consumer Credit Review

Introduction

We welcome the opportunity to respond to this consultation. As the main trade association for credit unions in England, Scotland and Wales, ABCUL represents around 70% of credit unions, which in turn provide services to over 80% of British credit union members. At the end of June 2008, credit unions in Great Britain were providing financial services to 655,000 adult members1 and had £429 million out on loan to members. The majority of loans made to credit union members are unsecured.

Credit unions are financial co-operatives that are owned and controlled by their members. They offer ethical, not-for-profit, inclusive financial services often in competition with high-cost lenders.

Credit unions are a small part of the unsecured loans market in the UK, but their significance is growing as the sector grows and as other lenders put a squeeze on smaller, shorter term loans that often form a large proportion of the loans that credit unions make available to their members.

Credit unions are unique in the UK in having a legal ceiling set on the amount of interest they can charge on loans. This was increased from 1% a month on the reducing balance to 2% a month on the reducing balance in 2006. This was in recognition of the fact that it is very difficult for credit unions to sustainably lend small amounts of money over short periods of time at the previous maximum interest rate.

The Credit Unions Act 1979 sets down in statute the objects of a credit union; these are four-fold:

1. The promotion of thrift among members; 2. The creation of sources of credit for the benefit of members at a fair and reasonable rate of interest; 3. The use and control of their members’ savings for their mutual benefit; and 4. The training and education of members’ in the wise use of money and in the management of their financial affairs.

Although the Credit Unions Act is to be amended in the coming months in order that the movement can grow more easily, these founding principles and capped interest rates are to remain at the core of the credit union ethos and way of working.

Credit unions are authorised and regulated by the Financial Services Authority and comply with FSA rules including those on Treating Customers Fairly.

Credit Unions and Financial Inclusion

Because of credit unions’ ethical practices and not-for-profit model, in addition to the fact that many are based in local, low-income communities, they have consistently been placed centre stage in Government’s Financial Inclusion Strategy and Action Plan.

1 Figures from unaudited quarterly returns provided to the Financial Services Authority

ABCUL’s Response – High-Cost Consumer Credit Review

Credit unions are tasked with extending the reach of affordable credit and are supported in doing so by the Financial Inclusion Growth Fund, which provides capital for on-lending through credit unions and community development finance institutions (CDFIs). This fund is administered by the Department for Work and Pensions (DWP) and, after the addition of £18.75 million in this year’s budget, has provided almost £100 million to extend the reach of affordable credit.

In addition to this, ABCUL and two of our member credit unions are delivery partners for the FSA’s ‘Moneymadeclear’ money guidance pathfinder which provides people with impartial money guidance to improve consumer confidence and decision making. Both the Government and the Conservative financial services white papers have pledged their support to rolling this service out nationally and ABCUL are committed to promoting further engagement of credit unions with the service as a means to better complement our statutory responsibility to promote financial capability within our membership.

In the course of these inclusive activities, our members consistently come into contact with financially excluded, vulnerable individuals and those that are most likely to use high-cost credit. Furthermore, credit unions are often called upon to assist those who fall into difficulties through excessive and inappropriate use of consumer credit.

The nature of credit unions, their centrality to Government’s financial inclusion strategy and their commitment to promoting sound finances within their membership puts them in a unique position to comment on the nature of the high-cost consumer credit market.

Summary of Response

1. Understanding Consumer Behaviour • High-cost credit users, because of the nature of the market and their circumstances, do not approach credit decisions in the same manner as users of mainstream credit. Restricted options, greater consideration of affordability of payments, poor financial capability and the nature of high-cost credit offerings characterise their approach to credit. Because of these factors alternatives to standard consumer protection measures need to be considered. • APR is ineffective as a comparison of high-cost credit and an alternative system based on the Total Cost of Credit, should be considered.

2. Understanding Lender Dynamics • The banking crisis has led to many high cost lenders pulling out of the market or closing their doors to new business. Those that remain have taken the opportunity to move back ‘up-market’ sometimes to those previously served by mainstream lenders. Despite households wanting to borrow less in difficult economic times there is the real potential to create a credit vacuum at the lower end of the market. This should be a cause for concern as it may give rise to an environment in which scams may flourish and where consumers have less and less legal choices. This review is a very welcome attempt by Government to understand the changes in this market.

ABCUL’s Response – High-Cost Consumer Credit Review

• ‘Innovative’ organisations such as BrightHouse (rent-to-buy) and Richmond Group (credit brokerage), adopt creative measures which allow them to avoid the scrutiny that more straightforward high-cost credit companies receive despite offering services that have the potential for considerable consumer detriment.

3. Quantification of consumer detriment found in relation to high-cost credit and the development of appropriate remedies where necessary • The restrictions upon the availability of consumer credit – especially in the high-cost market – are creating a worrying scenario. As the lack of credit increases a vacuum can be created whilst the consumer’s credit needs remain. The options left open to the low-income consumer might consist only of credit unions, CDFIs and illegal, unlicensed moneylenders. Despite good growth in recent years the credit union sector is not yet at a scale where it can provide a comprehensive, competitive offering all over the UK. Credit unions are very concerned about the rates that operate in this sector. Indeed many credit unions see it as major part of their mission to provide an alternative. However in the short term simply imposing a rate cap without a parallel growth in affordable credit could increase consumer detriment. • Therefore Government should continue to support the development of inclusive affordable credit and the regulator should act carefully in order not to enflame consumer detriment inadvertently. • The Government has the potential to facilitate much greater competition and diversity in this sector and bringing forward a major new source of affordable credit through its partnership with the Post Office. ABCUL and Post Office Limited are working together to bring forward proposals in this area.

1. Understanding Consumer Behaviour

The High Cost Credit Market The market for high-cost consumer credit is very different to the mainstream market. Factors influencing the decision to enter this market are generally one or a combination of the following:

1. An inability to access mainstream credit; often due to poor credit history or lack of a bank account and to the nature of the loan needed. Mainstream lenders consider loans for small amounts over short periods not cost-effective apart from via overdrafts and credit cards. 2. Cost considerations – generally consumers consider the affordability of weekly payments over the APR or total cost-to-borrow. 3. Consumer confidence and financial capability – many users of high-cost consumer credit are poorly informed as to the factors they should consider and the alternatives open to them when considering their credit options. 4. The nature of door-step lenders, pawnbrokers, sale and buy back stores and pay-day lenders is that they are quick, easy and convenient to use. They are often the only lenders within manageable walking distance of the poorest areas and may ask fewer questions before issuing credit.2

2 Considerable research has been conducted in this area see: Ellison, A., (2008), Transitioning high risk low income borrowers to affordable credit, (Policis and BERR, UK); Jones, P. A., (2001b), Access to Credit on a Low Income: A Study into How People on Low Incomes in Liverpool Access and Use Consumer Credit (The Co-operative Bank, Manchester);

ABCUL’s Response – High-Cost Consumer Credit Review

5. Availability and flexibility of credit product combined with good customer service is an attractive offering for many.

Credit unions strive to provide services in competition with these but are often faced with difficulties because of poor awareness and financial capability. Steps need to be taken to address these issues and to promote greater competition in this market – a recent campaign in Glasgow sponsored by the city council demonstrates what can be achieved by government backed credit union awareness campaigns (http://www.cucity.co.uk/). As a result of good development work over many years credit unions in Glasgow now serve 1 in 5 (20%) of all adults. This is an important landmark in availability and represents a critical mass on which a wider range of services can confidently be offered.

High-cost credit use often results in a cycle of debt that is difficult to escape and that creates a credit dependency in those that are least able to afford it. Credit unions are regularly approached to provide an escape route from this cycle by clearing debts and providing a manageable and affordable loan in their place.

Although the argument in favour of triple-figure APRs is well rehearsed and developed, it remains the case that those least able to afford it are obliged to pay the most for credit and that it is these charges that create an unsustainable level of debt dependence within their customer base. Too many high-cost credit providers engage in little or no credit control resulting in very irresponsible lending practices premised upon the notion that people with poor-credit histories can still access their service.

Total Cost of Credit One of the concepts that consumers and users of high-cost credit often find difficult to understand is APR. Computed using an extremely complex calculation, APR is very difficult to relate to the reality of meeting a loan agreement. In addition, due to the nature of high-cost credit, APRs are often distorted by the length of the period of loan repayments this can both allow for specious arguments against use of APR as a defence for high-cost credit by credit providers and for consumer’s disregard for what appears an irrelevant figure.

One solution to the lack of proper functionality of APR – especially for short-term, low-value loans – is to instead or in addition create a comparative regime using the Total Cost of Credit. This could be represented as a percentage of the principal loan amount:

• A credit union loan of £500 repaid over 6 months at the maximum APR of 26.8% would represent a TCC of £35 or 7% of the loan principal. • A typical home credit loan of £500 repaid over a similar period at an APR of 294.4% comes in at a TCC of £225 or 45% of the loan principal. • A typical payday loan of £200 repaid over one month and at an APR of 1335.5% has a TCC of £50 or 25% of the loan principle. If the loan isn’t repaid in the first month, however, £50 is added for every month the loan goes unpaid. TCC in this instance would double with each month.

and Jones, P.A., Barnes, T., (2005), Would you credit it? People telling stories about credit (The Co-operative Bank, Manchester).

ABCUL’s Response – High-Cost Consumer Credit Review

Given that high-cost credit customers often struggle to conceive of APR as a means of comparing the cost of lending, the TCC system provides a much more effective and comprehensible tool. One of the main considerations that anyone considers when taking out a loan is the amount they are ultimately expected to repay – especially true for those on a low-income.

As a system it removes the opaque nature of APR and translates the true cost of borrowing into a form that is immediately recognisable and which relates directly to the day-to-day business of managing personal finances.

Following the Competition Commission’s inquiry into the home credit market, the Lenders Compared site was set up (www.lenderscompared.org.uk). The idea behind this was to ensure that proper comparisons could be made between lending options available to consumers. The steering group for the site has acknowledged the benefits of comparisons on a TCC basis – this is now the default option on the credit search tool.

2. Understanding Lender Dynamics

High-cost credit and the banking crisis The traditional high-cost credit market in the UK has suffered since the banking crisis took root in 2007. London Scottish Bank, the third largest player defaulted; Cattles, whose ‘Welcome Finance’ and ‘Shopacheck’ brands made up the second largest home-credit business, has closed its doors to new loan applications and Provident Financial, although posting good profits, puts this down to much stronger credit controls, loan rejections and a move upmarket with the advent of their fast-growing ‘Vanquis’ credit card.3 HFC, HSBC’s high-cost credit division, has also closed its doors for trading.

As the international credit markets contract, those legal credit supplies available are increasingly restricted to those markets and organisations that offer opportunities with less endemic risk; this has significantly reduced the amount of credit available to low-income borrowers. Alongside this many consumers have attempted to reduce their borrowing although the extent to which this is possible for many consumers in the high cost credit market is more questionable. The fact remains that if you are using credit to manage your week by week existence rather than for consumer aspiration a contraction in this market may have detrimental consequences.

Government should ensure that it has a clear view of what is happening to the commercial high cost credit sector and the consumer in the current environment. Much Government effort has rightly focused on the need to provide real help for people with mortgages. The impact of the current economic climate on the high cost credit market and most importantly its impact on people on low incomes should not be ignored in the desire to keep people in their homes. This enquiry is a very welcome step towards this.

We also believe that the Government should ensure it is putting sufficient energy into encouraging new entrants and alternatives to the existing suppliers. This is especially important with those vehicles over which it has a great deal of influence. The Post Office represents a potentially hugely significant new entrant into this

3 See http://www.providentfinancial.com/ for the latest Annual Report.

ABCUL’s Response – High-Cost Consumer Credit Review

marketplace. Working innovatively in partnership with the credit union sector they could inject a huge new supply of affordable credit into this arena. Post Office Limited and ABCUL are continuing to work on proposals in this area and would hope that Government would enable an environment which would stimulate greater competition this sector and provide an attractive new offering.

Measures to stimulate competition and market entrants need to be considered as well as continuing support for the credit union and third sector lending sector.

BrightHouse BrightHouse is a retailer of ‘white goods’, electrical goods and furniture. They sell goods outright and, more commonly, via their ‘rent-to-buy’ scheme. This involves the customer signing a loan agreement whereby the customer pays a weekly amount over a period of time after which they own the item outright.

Analysis conducted by Credit Action has shown how a Whirlpool Bluetooth washing machine available from ASDA at £430 is priced at £527.74 by BrightHouse. Via the ‘rent-to-buy’ scheme, the same product is charged at 29.9% APR, and with a weekly payment of £7.59 per week over 156 weeks (or three years) the same product is charged at a total of £1168.44. This equates to a mark-up of £738.44 or 172%. A Nintendo DS games console bought under the same scheme, charged at £6.99 per week over 52 weeks, costs £363.48 a mark-up of £243.50 or 203%. From Amazon a DS costs £119.

The reason for the vastly increased price is the ‘optional’ insurance cover that is added invariably to the loan amount – in-so-doing, BrightHouse can advertise an APR of 29.9% whilst increasing their margin by adding an additional high fee onto the cost of the product for the privilege of utilising their ‘rent-to-buy’ system. This is after the 25% price inflation in comparison to a leading and competitively priced retailer.

During the life of the payment plan for a product from BrightHouse, if a customer consistently fails to meet their obligations, BrightHouse will remove the product from the customer’s home and re-sell it. The customer, regardless of the number of payments made to date, loses the money that they have invested in the item as under the terms of their agreement they do not own the product at any stage until the full set of payment have been met.

If a customer was to seek a loan from a credit union to cover the cost of an item costing £430 they would pay a total of £461.40 (26.8% APR) or £447.20 (12.8% APR) over 30 weeks. For an item costing £119, a credit union loan would cost £128.70 or £124.75 respectively.

The scope of this review needs to be broadened to look at examples, such as BrightHouse, of companies that adopt innovative strategies to manipulate the headline APR on their products.

Alison, Leeds – Case Study Alison is a Surestart client with a toddler son. She has recently moved into a council house in north Seacroft, Leeds, from rented furnished accommodation, and is on benefit. As Alison has very little furniture for her new house she needed to buy some essentials, in particular a new three-piece suite. Without any savings or access to mainstream credit facilities she couldn’t shop around for a bargain or even a second-hand suite, and instead was forced to go to a local store, ‘Brighthouse’, to purchase her suite. The cost was £1,500 plus another almost £1,000 for charges, interest and delivery. The repayment was £45 per week.

ABCUL’s Response – High-Cost Consumer Credit Review

Alison then discovered that the same suite she was buying at BrightHouse for £1,500 was only £600 in the Argos catalogue. With help from a Surestart worker, Leeds City Credit Union lent Alison the £600 she needed to buy her suite from Argos. She is now paying this back at £6 per week for her loan and is also managing to save £3 a week for herself and £1 a week for her toddler.4

Credit brokerage In addition to high-cost credit, credit unions are increasingly being approached by potential members who have been referred to them by unsolicited credit brokerage services. The main purveyor of this service is the Richmond Group which has operated under the names ‘Advantage Loans’, ‘Tenant Loans’ and most recently online at ‘Loanfinder UK’.

These companies operate by targeting low-income communities populated by vulnerable consumers or by targeting the same group online – ‘credit without credit checks’. For a fee, generally in the region of £50, the company will refer consumers to a credit source with which they have had no contact and have arranged no loan. The referral therefore amounts to providing the consumer with the credit source’s contact details.

23 credit unions have reported to ABCUL that these companies are referring consumers to them, and we understand that further credit unions have been targeted in this way. Often the consumers are led to believe that a loan has been arranged for them when this is invariably not the case. Generally, due to the credit union’s lending policies and common bond requirements, the referee is not eligible for a loan and certainly not at the level suggested in the advertising. The information that the company has provided the consumer with is freely available in the local press, telephone directories, online and via ABCUL.

At the maximum credit union rate of interest (26.8% APR), if someone borrowed £200 over 6 months the customer would pay £14.23 total interest. This is the nature of many credit union loans – small amounts over a relatively short term.

The addition of a £50 referral fee increases the cost of the loan by more than 351%. An £85 cost-of-credit on such a loan converts the APR from 26.8% to 168.8%; raising the cost of an affordable credit union loan and bringing it within the scope of this review thus damaging the best efforts of the credit union to make affordable credit available in its community.

This activity is directly opposed to and exploitative of the Government’s Financial Inclusion agenda supported by the DWP Growth Fund.

Any review of high-cost credit should take into account the activities of this burgeoning market. These companies charge vulnerable consumers an extortionate fee for providing consumers with nothing but a telephone number whilst claiming to have arranged a loan for them. The information that they provide is freely available from various public sources. The vast majority of referees are, in any case, ineligible for a loan and those that are eligible find their affordable loan transformed into a high-cost offering.

4 Taken from ’12 Baskets’ a best practice handbook produced for the Poverty and Homelessness Action Week and available at www.actonweek.org.uk.

ABCUL’s Response – High-Cost Consumer Credit Review

In a recent ABCUL survey, 41% of respondents had received referrals from Richmond or similar companies and of those, 92% were receiving up to 15 referrals per month.

ABCUL urges a renewed assessment of such credit brokerage services.

Angus Credit Union – Case Study Angus CU have recently been in touch with us distressed about the behaviour of Loanfinder UK.

Over the past month they have been contacted around 30 times and report referral fees varying between £25 and £75. Referees report the wording ‘your loan is waiting for you’ in their referral letters which is particularly misleading.

Angus CU do not operate instant loans – they do not have a DWP Growth Fund contract.

They have been in contact with Richmond directly asking to be removed from their referral database and were told that this is not possible because their service guarantees a full search of the UK credit market.

Angus CU are considering legal action against RG with a view to stopping them from misleadingly referring people in future. They have written to James Benamor, MD of the Richmond Group, and have received no reply.

Although in a visit to Nottingham CU in February Benamor informed his hosts that they now only charge within 2-6 weeks and after a loan has been confirmed, this is not what has been reported by Angus CU – all referrals to them have been charged without any loan being confirmed

Quantification of consumer detriment and development of remedies

An APR cap? Given the restriction in available credit, especially to low-income consumers, solely introducing an APR cap without a guarantee of growth in affordable credit supply could have potentially damaging consequences.

There is a strong case to answer as far as APR capping is concerned for the protection of consumers against unreasonable charges. However, there is an equally compelling case that operating in the low-income market and serving low-income, credit-impaired consumers who often miss payments or default on loans and who require extra attention – e.g. the home credit model – requires a much higher APR to account for the additional administration costs and to compensate for the higher rates of bad debt.

A recent study funded by the Joseph Rowntree Foundation found that to operate a not-for-profit home credit business, for example, would still require an APR above 100% and would cost many millions in initial investment before becoming self-sustaining. 5

5 See http://www.jrf.org.uk/publications/not-for-profit-home-credit for the full report.

ABCUL’s Response – High-Cost Consumer Credit Review

Given the restrictions already observable in the high-cost credit market, we have concerns that to impose an APR cap would further impede competition and entrance to the market – indeed, set low enough, it might force the withdrawal of the home credit industry altogether.

Until alternative forms of credit, such as credit unions, have achieved sufficient capacity this would leave very few options open to low-income consumers. This could potentially be extremely detrimental to consumers. Credit unions and sources of affordable credit must be supported in their continued growth alongside consideration of any APR cap.

That said we believe the Government should look with greater interest at the work that Post Office Limited and ABCUL are doing to consider whether they can jointly deliver a major disruptive influence in the low income credit market. This initiative may represent the significant increase in scale of affordable credit that would give any Government the confidence to introduce an interest rate cap.

Conclusion

Credit unions work to provide ethical and affordable financial services to a wide range of people not just those who are users of high cost credit. Within that credit unions serve many that are excluded by the mainstream and are left, otherwise, with no option but high-cost alternatives. They have vast experience of engaging vulnerable consumers, working with them to escape the cycle of debt and facilitating a transition to affordable credit and sound finances.

The experience of our members has shown that APR, alone, is insufficient to properly inform consumers of the amount they are paying to borrow. Alternatives need to be considered, in particular, the adoption of a system of Total Cost of Credit comparisons. The advantages of TCC as a comparator of loan costs have been recognised by the www.lenderscompared.org.uk website, set up as part of the remedy from the Competition Commission investigation into high cost credit; this is the default search option on the website.

Companies such as BrightHouse, although on face value outside the scope of this review, are adopting ‘innovative’ methods of maintaining low typical rates of APR whilst increasing vastly the total cost to the consumer of their offerings. These organisations need to be addressed.

Across the country the work of credit unions is being undermined by unscrupulous companies, like Richmond Group, whose only objective is to profit from ill-informed consumers and the growth of the credit union movement which they have had no hand whatsoever in bringing about. Although their practices conform to the letter of the consumer law governing this area, they do not conform to its spirit. A reassessment needs to be undertaken to see how this industry can be better regulated to serve the interests of consumers rather than working against them.

Users of high-cost credit are generally the poorest in society whilst they consistently pay more for financial services. Credit unions seek to address this imbalance and to provide an affordable alternative. Regulation must be strengthened in order that the consumer is better informed and not knowingly misled by organisations that prey upon their vulnerability. Introducing a comparative regime of Total Cost of Credit and reassessing

ABCUL’s Response – High-Cost Consumer Credit Review

the activities of the Richmond Group and BrightHouse are two important ways that this market can be better regulated.

ABCUL is concerned, however, that rash or disproportionate regulation introduced before a sound, affordable alternative is available to all could restrict credit options even further for the most vulnerable in society – the only alternative might be illegal moneylenders. This possibility should be central to any recommendations considered by the review.

The Government should also look at any levers that it has to stimulate competition in this area. We believe the Post Office Limited and ABCUL partnership has the potential to introduce massive consumer benefit in terms of a competitive, attractive and widely available offering that would counterbalance any detriment arising from a move towards capping interest rates.

August 2009