Memorandum submitted by Derbyloans
BACKGROUND
Derbyloans is a CDFI that operates in Derby
and has been trading since May 2003. At the time of writing (early
December 2005) we have made about 680 personal loans with a total
value of about £440,000 and about 50 business loans worth
about £180,000. In other words, Derbyloans is one of the
very few CDFIs with a strong bias towards personal lending. Initial
personal loans are charged at 25% APR and have an absolute maximum
of £1,000. Subsequent loans are charged at 22% and are not
allowed to exceed £2,500. Repayments are almost always by
direct debit, either weekly or monthly. (The exceptions pay by
PayPoint card—only introduced in the last few weeks).
The need for the business was identified by
a report commissioned by Derby City Council in 2000, which identified
high levels of financial exclusion in certain parts of the city.
Personally, I spent the year from May 2002 to April 2003 setting
up Derbyloans while on secondment from Rolls-Royce. In May 2003
I left Rolls-Royce and became Chief Executive of Derbyloans. The
business is an Industrial and Provident Society and currently
employs one full-time and three part-time staff. We are members
of the CDFA.
As a relatively experienced practitioner in
a very new industry I have made a few observations under three
of the six headings published on the website.
1. Access to banking services
The biggest single change since Derbyloans started
trading is that back in 2003 about 25% of customers did not have
a bank account. In 2005 customers without a bank account are extremely
rare and usually have some real or imagined reason for "not
trusting banks".
However, the almost universal ownership of a
basic bank account (or more) is not a cause for celebration. As
part of our personal loan appraisal process we view the last three
months of personal bank statements. Possibly as many as 30% to
40% of our applicants will withdraw all but a few pence of their
wage or benefit on the day it is credited and carry on using cash
as before. All the ownership of a bank account has done is to
add an additional step to getting access to their money and has
produced no change in their financial behaviour or aspirations.
Until very recently it was a condition of our
personal loans that payments would be by direct debit, either
weekly or monthly. While accepting that these accounts are not
profitable for the banks, the imposition of typically a £35
charge for a failed direct debit is a huge burden for someone
on an income of, say, £600 per month. It is no wonder that
some customers, having been charged 5% or more of a months income,
feel wronged and either move from bank to bank (until they run
out of banks) or revert to cash. They often cancel the direct
debit instruction and it is not uncommon for a customer to be
on the fourth or fifth instruction (and possibly the same number
of banks) after, say, nine months. Consequently we now offer a
repayment card in certain circumstances—such loans are charged
at 29% APR due to the significant extra costs.
2. Access to affordable credit
Obviously I feel that access to affordable credit
is very important. We regularly see loan agreements with doorstep
collection companies such as "Loan of £250, repayable
by 32 weekly payments of £12.50, total repayable £400".
I make this 401% APR. However, if there is no CDFI locally and
the customer has not saved with a credit union, there may be no
alternative. Banks (justifiably) are not interested in loans of
£250 and such customers may already have CCJs.
Clearly this is a high risk market and a commercial
company has to price to risk, but I do not believe that 400% is
ever justifiable. A community finance company can provide a much
cheaper service, which has the additional benefit of retaining
money in the local community. The nearest equivalent to the above
loan would be £250 repayable over 26 weeks by DD. Twenty-six
payments of £10.18—total of £264.68. Not only
does the customer have an additional £135 to spend locally
over the life of the loan, but also the £265 that he/she
does have to pay is retained in the local economy for relending.
In my view, access to professionally managed
affordable credit is necessary to reduce financial exclusion.
However, it is not a solution in itself. (See next item)
3. Financial education and advice
Having seen probably 800 personal customers
over the last three years, I believe that financial education
is as necessary as affordable credit. A few anecdotes ...
— Many customers have no understanding
that 6.9% is better than 25% is better than 400%. If it solves
today's problem, then lets do it! This attitude provides an environment
in which doorstep collection companies thrive. We even have customers
at Derbyloans who we think understand the benefits who go back
to a doorstep collection company for a quick fix if they have
a crisis.
— Customers will happily sign deals
with white goods retailers who target those on low incomes. Recently
we saw an example where a customer committed to pay over £1,000
over three years for a base spec washing machine (£200-£220
retail).
— Virtually no customers use the direct
debit facility to pay utility bills, but continue to use payment
cards.
— I saw a customer this morning with
no fixed phone who regularly pays £100+ per month on pay-as-you-go
charges. Her monthly income was about £700.
— Customers will buy a car without
considering the cost of insurance (often more than the value of
the car).
— We do a simple income/expenditure
balance on our application form. Many customers have never considered
working out where their money goes and often seek to borrow less
than the alleged difference between their monthly income and expenditure.
In other words they have no idea of their expenditure.
— Many customers believe they can borrow
their way out of trouble. (To a degree they can if they can replace
debt at 400% with debt at 25%, but the belief does not only apply
to doorstep collection customers).
— Customers will often seek to borrow
to clear rent or utility arrears in the belief that a new loan
will "wipe the slate clean". In general we do not lend
for such purposes, but the ensuing conversation can reveal a frightening
lack of understanding about priorities (what is more important
than paying your rent?) or that interest free debt (utility arrears)
is always cheaper than even Derbyloans.
I agree that lack of financial awareness is
a huge problem, with a new batch of financially illiterate people
leaving education every year. There is no instant solution. Getting
people together for classes is never likely to work (requires
self confidence to admit inadequacy!) so the only real solution
is to counsel people one at a time when they contact appropriate
organisations like CDFIs, credit unions and CAB. Clearly such
counselling makes the already fragile economics of such organisations
unsustainable.
In reality, the supply of financially illiterate
people will exceed the capacity of society to educate them. This
suggests that the best solution is to do the financial literacy
training in schools. In general it is hard to convince people
to solve a problem that they don't know they have got, so mid-teens
who have never thought about a domestic budget are likely to be
pretty hard to motivate.
CONCLUSION
As Chief Executive of one of the relatively
few personal lending CDFIs in the country I genuinely believe
that that a professionally managed CDFI can make a significant
impact on financial exclusion. A CDFI, as I continually tell the
board, is a "business with a social purpose". It can
do some of the "not-for-profit-but-for-the-good-of-mankind"
things but it has to operate in the commercial environment and
ultimately pay its way, even if that includes grant funding for
some of its overheads or loanfunds. In is hard enough running
a non-viable business in a commercial environment, without adding
to the overheads by doing the things like financial literacy training.
The existing proposals to support personal lending CDFIs are to
be applauded and will undoubtedly make a difference in time. It
should be recognised that non-commercial activities cannot be
delivered by commercial organisations.
There are three current developments that can
enhance the contribution that a CDFI can make.
— The Financial Inclusion Fund. Obviously
additional funding will enable existing personal lending CDFIs
to develop and to share their expertise with new CDFIs.
— The extension of CITR to personal
lending CDFIs. A properly constructed scheme should enable personal
lending CDFIs to attract investment from private funders, but
only if there can be some guarantee that their capital is not
all at risk. A personal lending CDFI is, after all, a massively
risky business that economically should not exist.
— The proposal that payments to accredited
organisations (like CDFIs but not doorstep collectors!) could
be stopped from benefits after an agreed level of default (say
three months arrears). This would significantly reduce the capital
risk (see previous item) and would increase the capacity of these
tiny organisations. I estimate that around 40% of our staff time
is spent managing loans that are in some way non performing. Obviously
this time would be better spent in dealing with new customers.
December 2005
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