Why does the UK shun credit unions when other markets love them?

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.