Credit unions tend to deal with those people who are at the edge of society in terms of their credit worthiness and financial literacy. Credit unions do a great deal of good because they help some of the more disadvantaged members of our society avoid falling into the hands of some of the more unscrupulous lenders around. Sounds great?
Well not exactly, nothing in life is. .. you see I believe the current model for credit unions is fundamentally broken and the proposals for mending that model and growing the sector are flawed, such that it’s a disaster waiting to happen.
Why do I say that?
Let’s go back to some of the basics…
Credit unions lend generally small amounts on an unsecured basis to people who tend to have poor financial skills and little or no assets of real value. Typically these people are employed – they are neither self employed nor of the ‘professional classes’ – or they rely on benefits. (sorry if you think I’ve been a little too generalist here, but bear with me, please). They are often unable to get credit elsewhere (often for good reason).
This means they have little or nothing a lender can seize and sell should they default on repaying their loan. It also means they have little of worth to lose should they decide to go bankrupt or into a DRO. They also tend to be easily persuaded to take ‘solutions’ such as debt management plans as and when their debt problems become unsustainable. They have poor skills in terms of being able to manage their money, they’ve often got into some really bad habits in managing their money, some even have a ‘YOLO’ approach to life and expect others to pay for it!
The point is it’s not such a big decision for them, as it may be for others such as a ‘professional’ accountant, lawyer, banker, or businessman, to jettison their debts by going bankrupt, into a DRO or DMP . Add to this borrowers’ focus on paying down higher interest bearing debts when they get into trouble, leaving lenders charging lower interest rates, particularly credit unions which are generally seen as a softer touch, bottom of the pile – and we have a situation whereby many credit unions have a major bad debt problem, one that is hidden from the board. It’s similar to the banks’ over-extension of lending which led to the current depression starting in 2008.
The result of this is that credit unions are already experiencing a higher level of debt write off and debt deferral than the normal High Street banks. But this will get worse as the rift between the most well and worst off in our society continues to get wider.
If I am right then every credit union in the UK is carrying a large, yet at the moment unquantifiable, level of bad debt, which like the banks’ follies pre- 2008 must come home to roost some time.
The next point is that right now the maximum interest that a credit union can charge by law is limited to 2% per month, about 27% a year. To put that into perspective, that’s about 1/150th of what Wonga charges, and 1/75th of what most payday lenders charge.
(pregnant pause – why is that?)
There are discussions going on over raising the cap on what credit unions can charge by 50% to a massive 3% per month – that’s the figure the Department of Work and Pensions think will make unions sustainable. It seems to me like a figure plucked out of the air by someone who hasn’t the faintest idea of how to run a business that’s commercially viable in the long term. It’s more like a figure plucked out of the air that the government would like to see charged so that the UK’s personal debt burden can be managed down over time – many MPs are now expressing their concern that it is the huge level of personal debt that is the major risk to the recovery. That’s to say the figure seems to be one of political expedience rather than commercial calculation.
If the limit is increased to 3% pm, in my view, it will make no difference at all to the outcome for many unions – unless the interest unions can charge is at least trebled from the current cap of 2%, they do not have a sustainable business model, they are mere Ponzi schemes, taking money from new investors, lend it to new borrowers many of whom won’t pay it back, never returning a profit nor paying interest to their lender members.
So why do I say that?
Let’s look again at some of the basic maths this time.
In HM Treasury’s June 2013 report ‘Raising the maximum interest cap’ , one union said it cost them an average of £108 to administer a typical small loan. About 350, one third, of the loans that union made were under for £500 (my feeling is that proportion isn’t unrepresentative of many, in fact it may be higher in a good many more); the income from them (assuming they all pay on time and there are no bad debts) over a year would be £13,000, the cost of administering them £38,000 – that’s to say, assuming no bad debts, that union lost £25,000 on one third, by volume, of its loan book. To survive, their bigger borrowers had to subsidise the smaller ones.
The biggest problem as I see it is that unions can now expect upwards of one in eight of their borrowers to take shelter from their debts in a bankruptcy, DRO or DMP – and if they receive interest of anything less that 6% per month on their loans out, once we take into account bad debts and the unions’ running costs, no union’s model is sustainable, there’s simply not enough money to cover the losses and overheads and pay a dividend or interest to investing members.
The bottom line is that unions cannot make enough money to survive in the long term on their bread and butter lending unless they can charge several times more than they’re currently able to under the law.
And when any organisation cannot survive on its bread and butter, there’s a major problem, where something very big has to change. Tinkering around, increasing the cap from 2% to 3%, merely gives false hope to those better managed credit unions. But at the end of the day, the mathematics of the situation will determine the future, all the goodwill in the world will not help them.