Select Committee on Treasury Written Evidence


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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