Select Committee on Treasury Written Evidence

Memorandum submitted by Provident Financial

EXECUTIVE SUMMARY

—  Provident Financial welcomes the Treasury Select Committee's inquiry into financial inclusion. As a commercial supplier of small sum credit to some 1.6 million customers in the UK, Provident has a thorough understanding of the credit requirements of those on moderate to low incomes.

—  Affordable credit for people on lower incomes has to be designed around the realities of life on a lower income where cash budgets are tight and incomes can fluctuate without warning.

—  The home credit sector provides small, short-term loans collected weekly from the customer's home by a company agent. Repayments are small, and therefore manageable, and there are no extra charges at all for late or missed payments.

—  The cash price of a loan is important to customers, but the qualities of convenience, good service, flexibility and control are key elements in product design. The agent's weekly home visit is central. It is the major factor in the cost of providing home credit, but it helps manage the risk of lending, assists the customer's budgeting and provides regular face-to-face communication.

—  DTI research shows that sub prime credit models such as home credit can work out cheaper than mainstream products. Customers often cannot avoid missing occasional payments, so credit products that accommodate volatility of income or unexpected expenses offer a rational alternative to mainstream products. Customers on lower incomes prefer systems that enable them to stay in control.

—  Many people judge home credit solely on its APR, but APR is a flawed measure. It distorts the apparent cost when loan terms are short and fails to deliver usable comparisons for products with different characteristics. It also fails to include the default charges and service fees often levied on products other than home credit.

—  Home credit customers use other products. Between 70% and 85% have bank accounts and between 30% and 45% have credit cards. They nevertheless have strong preferences for home credit as shown in very high satisfaction levels—Provident's customer surveys show 94% are satisfied.

—  The cost of providing home credit leads to higher APRs and some commentators have called for price controls. However the UK's mainstream advice agencies all agree price controls would not help widen access to more affordable credit.

—  Credit counselling services report they receive few complaints and advise on few problems related to home credit.

—  Provident Financial supports the Government's initiatives to broaden the provision of affordable credit.

INTRODUCTION

  1.  Provident Financial welcomes the Treasury Select Committee's inquiry into financial inclusion and the opportunity to submit its views on this policy area.

  2.  We note that the committee is undertaking a wide-ranging enquiry on financial inclusion. Provident Financial's experience in this area arises from its position as a commercial supplier of small sum credit to around 1.6 million customers in the UK. Our submission will therefore focus on affordable credit.

  3.  Small sum credit in the UK is available from a range of providers—from purely commercial organisations such as Provident Financial or credit card providers to departments of Government such as the DWP, and newer Third Sector providers such as Community Development Finance Institutions. We welcome this growing diversity of provision and the choice it offers to consumers.

  4.  It is widely recognised that credit is now an integral part of daily life. Credit provides individuals with a `financial smoothing system' to enable them to match income with outgoings. It is beneficial to the vast majority of those who use it and to the wider economy.[269] Many of Provident Financial's UK home credit customers are on lower than average incomes. Our experience of providing credit to such customers is that, in common with other groups, those on lower incomes can benefit from access to credit products which match their requirements and enable them to better manage their personal or household finances.

PROVIDENT FINANCIAL—COMPANY STRUCTURE

  5.  Provident Financial is a public company listed on the London Stock Exchange. Provident's principal business is home credit, which is the provision of small, short-term, unsecured loans, which are collected from customers' homes by company agents. The company has been providing home credit products since it was established in 1880.

  6.  In recent years, Provident has extended its product range in the UK. It now has a credit card subsidiary called Vanquis Bank. Until recently, the company also had a motor finance subsidiary, Yes Car Credit. This was closed for business at the end of 2005.

  7.  Provident has two home credit subsidiaries in the UK: Provident Personal Credit (PPC) and Greenwood Personal Credit (GPC). Currently PPC has around 1.3 million customers and GPC around 300,000. Together they have around 12,000 agents who make around 80 million home visits a year. They also employ 2,800 staff.

  8.  Both businesses are licensed and regulated by the Office of Fair Trading (OFT). The OFT reports extremely low levels of complaint about Provident's home credit businesses (indeed any home credit business).

  9.  The UK home credit sector as a whole comprises about 550 companies and serves about 3 million customers via 28,000 agents.[270]

HOME CREDIT

  10.  The key characteristics of home credit are as follows:

—  Loans offered by the home credit sector are small—typically in the range of £100 to £500;

—  They are short term, usually from 23 weeks to a year in duration;

—  Repayments are collected from the customer's home by a company agent;

—  Most agents are women; for example 80% of Provident's agents are women. Many have been customers themselves and live in the same communities as their customers;

—  Repayments are collected on a weekly basis, which means repayment amounts are small and manageable;

—  There is a fixed, all-in charge for the credit, which is set out clearly for the customer in the contract;

—  There are no penalty fees for late or missed payments; extra interest does not accrue; each repayment brings down the amount owed;

—  The loans are unsecured.

  11.  The key to the business is the home collection system. This provides customers with a convenient, personal service. It imposes a discipline on the agent whose reputation depends on treating her customers well. It also offers a discipline for the customer which they find helpful for control and certainty over their spending and budgeting. This was confirmed by the National Consumer Council (NCC) who found that:

"home collection provides a highly valued discipline over repayment that helps low income customers keep on top of their finances."[271]

  12.  Home collection also builds in flexibility. The agent can easily reschedule payments on the spot if that is what the customer requires.

TRANSPARENCY

  13.  Home credit is almost uniquely transparent. There are no penalty charges for missed or late repayments. For instance, if a £100, 50 week loan carried a £35 charge for credit, the customer would pay nothing more than that £35, even if the loan took 60, 70 or even 80 weeks to repay. This facility holds particular appeal for customers, helping them cope with fluctuating incomes or unpredictable outgoings. It also means that, unlike some other types of credit, the customer's costs remain fixed.

  14.  All these characteristics mean that home credit is highly suited to those on lower than average incomes, who work to tighter budgets and may have more volatile incomes. The product design it tailored to customer needs. The majority of Provident's new customers are introduced by existing customers.[272]

  15.  The Competition Commission recently commissioned research into home credit customers that reached the same conclusion:

"home credit loans were well tailored to customers' needs. The application process was uncomplicated (no long forms) and fairly easy; the payments (weekly, fortnightly or monthly) were usually affordable and manageable, and the regular collection at agreed times helped customers make sure they had the money ready and kept up with payments. There was the knowledge that if payments were missed the amount owed would not go up and that agents were usually quite reasonable about missed payments and were willing to accept less rather than miss a payment altogether. Many respondents found that paying in cash gave them a feeling of control over their budget."[273]

THE ROLE OF THE AGENT

  16.  The typical Provident agent is female and has around 130 customers. She is paid on a commission basis according to the amounts she collects—not what she lends. This encourages responsible lending because it is expressly not in the interest of the agent to lend amounts that a customer cannot repay.

  17.  The home collection system also enables the agent to build good working relations with her customers. The weekly visit means that she has a good overview of the household's circumstances and thus whether the customer is going to be in a position to repay. It also ensures that the terms, conditions and costs of a home credit loan can be clearly explained to would-be customers.

  18.  Research conducted by MORI for the NCC illustrates the value customers attach to the agent system. It found that the majority of home credit customers:

"praised the attitude and behaviour of their collectors."[274]

  19.  The agent-based home collection system is an essential part of the home credit model. It is pivotal in managing the risk of lending to those on lower than average or volatile incomes. Without it, bad debt would rise to unsustainable levels. The Competition Commission also recently found that agents help home credit companies to contain bad debt risk and that the relationship between customers and agents was "…good, but businesslike."[275]

WHY DO CUSTOMERS CHOOSE HOME CREDIT?

  20.  Provident's customers know a lot about alternative credit products and actively choose to use home credit. Over 56% of Provident customers said that they shop around before choosing a credit product; and 75% said they had used at least one other source of credit (alongside home credit) in the previous year.[276]

  21.  Convenience, service levels, flexibility and control are what matters to customers. Price, particularly on the basis of the total cash cost of the credit and the weekly repayment, is also important. Professor Elaine Kempson of the Personal Finance Research Centre commented in her 2005 report, Affordable Credit:

"[users of home credit] generally know the total amount of money that they have to repay on their loans. The same is not necessarily true for all forms of credit."[277]

  22.  Many customers choose home credit in preference to other small sum credit products which may appear cheaper in APR terms but which will, in fact, cost more. Elsewhere in Affordable Credit, Professor Kempson concluded:

"buying goods on rental purchase at 29.9% APR can work out more expensive than taking a loan at 200% APR from a home credit company to buy the goods from a high street retailer. This is analogous to the situation with credit cards where variations in the structure of charges mean that a card with a low APR may be more expensive than one with a higher APR."[278]

  23.  These are rational choices, with customers focusing on certainty and fixed repayments to inform their borrowing decisions. Home credit customers are well aware that if they use certain credit products missing payments can lead to significant charges. (For example, a £35 charge for a dishonoured cheque or a £25 charge for a missed credit card payment.) For those on lower incomes such charges are significant and unwelcome.

  24.  Provident has investigated the financial understanding of, respectively, Provident's customer base, potential home credit customers and wider credit market customers, and sought to understand better the criteria driving customers' choices between different credit products. A survey asked customers which credit product they would choose if they had to borrow £500. Customers were provided with details about the cost and value characteristics of a credit card, a bank personal loan or a Provident home credit product. When the products were compared on a headline APR and key product terms basis (ie summary box style information), the personal loan was the cheapest and 75% of the sample chose this product. However, when the same customers were given additional information about the additional charges they could face on the credit cards and personal loans if payments were missed, and on the flexibility of home credit, the proportion choosing the personal loan dropped to 56% and the proportion choosing home credit rose from 14% to 30%.

  Customers were then asked to imagine that there could be a drop in their income over the next 12 months, perhaps because they could be made redundant, and were then asked which product would best suit their needs. Only 41% of the sample then chose the personal loan, whilst 40% chose home credit.

  These changes support Provident's view that, while customers are aware of the relative prices of different credit products, regardless of whether they have experience of home credit or not, customers also appreciate the convenience, flexibility and control associated with home credit.

REPAYMENT REALITIES

  25.  Research for DTI by Policis looking at credit markets in several countries has shown how important it is to understand the realities that face many consumers. There is a consistent pattern showing that those on lower incomes often cannot avoid missing payments whether it is because of volatile incomes, life events (such as job losses) or unexpected expenses:

"regular late and missed payments are a feature of credit account management for a significant minority of low income customers."[279]

  26.  Policis also concluded that it was useful for consumers to have credit product formats which helped them to manage life's ups and downs. This was because:

"under uneven repayment conditions, sub prime credit models [such as home credit] can be cheaper than mainstream models, confirming the rationality of consumer choices."[280]

  Where these products do not exist, consumers have to use second best choices: typically mainstream products which they struggle to repay.

WHAT OTHER CREDIT PRODUCTS DO HOME CREDIT CUSTOMERS USE?

  27.  Provident's customers use a range of other credit products. Competition Commission research indicates that between 70% and 85% of home credit customers have bank accounts and between 30% and 45% have credit cards.[281]

  28.  Provident's own customer surveys conducted in 2004 provide further detail:

Provident customers' usage of other credit products[282]

Customers with a mortgage	17%
Customers using agency (weekly) mail order	42%
Customers using hire purchase	8%
Customers with a credit card	31%
Customers with an overdraft	29%
Customers with a savings account	44%

  29.  Provident customers are most likely to use a home credit loan for a special occasion like a birthday or Christmas, to purchase household items or for holidays.[283]

CUSTOMER SATISFACTION

  30.  The Competition Commission acknowledged home credit customers' high levels of satisfaction with home credit in its Emerging Thinking document:

"the weight of evidence presented to us points to high overall levels of customer satisfaction with the service provided"[284]

  and:

"home credit is characterised by high reported levels of satisfaction among existing customers."[285]

  31.  Similarly the OFT found that there were:

"high levels of satisfaction with the quality of service provided by home credit lenders generally."[286]

  Provident's own surveys of customers indicate that 94% are satisfied and 66% are very satisfied.[287]

THE COST OF PROVIDING HOME CREDIT

  32.  Several features drive the cost of home credit as explained by Professor Kempson:

"Lending to people on low incomes differs from mainstream (or prime) lending in a number of key respects. First, there is a higher risk of default as their circumstances are much more likely to change. Second, people on low incomes want (and often need) to make weekly repayments in cash. Both these factors increase the costs of lending. Third, the amounts they want to borrow tend to be relatively small and for short periods of time. As the costs of lending are largely fixed, this means that the charges for borrowing are high in relation to the amounts borrowed. This explains why charges among commercial sub-prime lenders are high; why not-for-profit lenders with lower charges require subsidies; and why mainstream lenders are reluctant to enter this particular market."[288]

  33.  Home collection—which is an integral feature of the product—also has a large impact on home credit providers' costs, a point recognised by the Competition Commission in its Emerging Thinking document:

"The principal cost is the labour-intensive network of branches and agents which helps to contain bad debt risk and is one of the features of home credit most valued by customers."[289]

APR—A FLAWED MEASURE

  34.  Very often, it is the APR figure that causes some commentators to think that home credit companies' prices are excessive. APR was introduced by the Consumer Credit Act 1974. It was intended to provide a benchmark for comparing the cost of different credit products. However, there are problems with using APR to compare the price and value for money of home credit and other credit products.

  35.  First, it is widely accepted that APR exaggerates the `apparent cost' for short-term loans—particularly for loans of less than a year. The DTI recognised this in its 1999 paper on Extortionate Credit:

"The mathematical formula for APRs can considerably distort the apparent costs of credit involving short repayment periods, particularly agreements of less than 12 months, and small amounts of money."[290]

  36.  Second, the rules for calculating APR allow certain charges to be excluded from the APR calculation for some products. Examples of this are the monthly fee on a current account overdraft or any fees incurred as a result of late or missed payments.

  37.  Also, APR is of absolutely no use when, as with mail order, the credit charge is built into the price of goods. Apparently cheap `0%' credit, may hide a substantial implicit credit charge. Home credit, in contrast to many other products, does not contain any hidden or extra charges.

  38.  A number of different organisations have recognised the shortcomings of APR. For example in its 2000 policy paper, Daylight Robbery, Citizens Advice concluded:

"The interest rate as expressed by the APR figure is not a particularly helpful guide to the overall cost of a credit facility on a small loan. In such cases, the relatively high administrative costs proportional to the amount borrowed results in a high APR figure but one that still represents a non-extortionate agreement. For example, we suspect that most readers would initially be concerned if we were to report evidence of a credit agreement with an APR of 153%. However, the same readers may not be so concerned to hear of a loan of £50 repayable over 20 weeks at a weekly cost of £3 where the lender had the costs of door-to-door collection. The fact is that we would be reporting on exactly the same loan in both cases."[291]

PRICE CONTROLS

  39.  Some have argued that interest rates or APRs should be capped. However, all the authoritative, large-scale research on this issue finds that this would in fact be detrimental to those customers that a price control would be intended to protect.

  40.  In 2004, the DTI commissioned Policis to conduct an extensive study on `The effect of interest rate controls in other countries'. The research concluded that:

"the consumers most likely to be impacted by rate ceilings are thus those operating outside the financial mainstream, either un-banked or, having run into problems with debt, the credit impaired;"[292]

  and

"rate ceilings affect the availability of dedicated sub prime models and create credit exclusion for those who cannot access mainstream credit."[293]

  41.  Professor Kempson also addressed rate caps in Affordable Credit:

"a ceiling on interest rates has been heavily promoted in the UK as a means of tackling extortionate credit. On the surface, this is a simple and attractive idea that ought to benefit people on the lowest incomes. This research has shown, however, that there are high costs associated with lending to people on low incomes who have a high risk of default. An interest rate ceiling could do nothing to reduce these costs. Instead, the APR would be reduced by displacing these costs elsewhere, for example in the form of charges for default—the last thing that low-income borrowers would want. It is also likely that more credit would become tied to the purchase of goods and consumers would be faced with high price mark-ups as retailers seek to recover the costs of supplying credit. Both of these would result in the total costs of borrowing being less transparent. Finally, there is a danger that lenders would move out of this market altogether, leaving poor people even more prey to unlicensed lenders."[294]

  42.  In October 2005, during the passage of the Consumer Credit Bill, a group of the UK's leading consumer groups, money advice agencies and think tanks (including Advice UK, Citizens Advice, the Institute for Public Policy Research, the National Consumer Council, Which? and the Association of British Credit Unions) wrote to members of the House of Lords to set out their views on the impact an interest rate ceiling would have for lower income/higher risk groups. The briefing said that:

"An interest rate cap would not deal with any of these underlying causes of high charges and we believe that it would not help widen access to more affordable credit."

THE MONEY ADVICE SECTOR'S EXPERIENCE OF HOME CREDIT

  43.  Compared with other lenders, home credit companies lend small amounts. Typical loans are in the region of £100 to £500. Therefore, home credit is likely to constitute only a very small proportion of an individual's total borrowing. In total, all home credit lending accounts for only around 1% of total UK unsecured lending.[295]

  44.  Nor does home credit feature significantly in the total borrowings of those who approach the money advice sector with multiple debt problems.

  45.  In a 2003 report, Citizens Advice (England and Wales) found that home credit did not feature as a major source of debt among those seeking debt advice. Even among those on low incomes (less than £800 a month) home credit featured as a debt for only 3 to 4% of clients. Of the 12 categories of debt recorded by Citizens Advice, clients were more likely to have 9 to 10 other categories of debt before home credit.[296]

  46.  The Competition Commission also noted that:

"credit counselling services and Citizens Advice Bureaux, which handle many cases of overindebtedness or other debt problems, have told us that they receive few complaints and advise on few problems related to home credit."[297]

CONCLUSION

  47.  Provident Financial welcomes the committee's interest in financial inclusion. We have been pleased to co-operate with the Government's earlier work on developing policy in this important area—from contributing to the work of Policy Action Team 14 in 1999, to more recent assistance to HMT's Financial Inclusion Taskforce.

  48.  Our contribution to these processes has been to share our knowledge and experience of how credit can be provided effectively on a commercial basis to those on lower than average incomes.

  49.  Our experience, and the findings of academic researchers, consumer groups and regulators, highlight that convenience, service levels, flexibility and control are what matters to would-be borrowers on lower than average income. Product design is key.

  50.  `Affordability' is one of the essential design features of a small sum credit product. However lower income customers judge credit to be affordable on several measures and not just in terms of APR. For such customers, affordability also means:

—  manageable individual repayments which can be made on a regular basis that matches their budgeting schedule;

—  a fixed, all-in cost which will not increase if payments are missed; and

—  reassurance that each repayment made will reduce the total amount owed by the amount of that repayment.

  51.  We welcome the Government's ongoing initiatives to broaden the provision of affordable credit. We believe that lower income borrowers will welcome an increased range of small sum credit products. We have offered our experience of the home credit lending model to leading practitioners in the Community Development Finance sector and the credit union movement.

January 2006

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269   See for example DTI White Paper, Fair, Clear and Competitive-The Consumer Credit Market in the 21st Century, DTI 2003. Back

270   Figures from Consumer Credit Association website. Back

271   Claire Whyley and Steve Brooker, Home Credit, an investigation into the UK home credit market, National Consumer Council 2004, p 26. Back

272   Provident internal research, Customer Survey year to December 2004. Back

273   Andrew Irvine Associates for Competition Commission Home Credit Market Inquiry, Research Report, 2005, p 30. Back

274   op cit NCC, 2004, page 11. Back

275   Competition Commission, Home Credit Market Inquiry, Emerging Thinking, 2005, para 21. Back

276   op cit Provident internal research, 2004. Back

277   Elaine Kempson and Sharron Collard, Affordable Credit, The way forward, Joseph Rowntree Foundation/Policy Press, 2005, p 15. Back

278   ibid p 28. Back

279   Policis for DTI, The effect of interest rate controls in other countries, DTI, 2004, p 22. Back

280   ibid, p 25. Back

281   Competition Commission, Emerging Thinking, 2005, para 12. Back

282   Provident research year to December 2004. Back

283   ibid. Back

284   Competition Commission, Emerging Thinking, 2005, para 11. Back

285   ibid, para 34. Back

286   Office of Fair Trading, Home Credit, The OFT's reasons for making a reference to the Competition Commission, 2004, para 45. Back

287   Provident research year to December 2004. Back

288   Kempson and Collard, 2005, p 19. Back

289   Competition Commission, Emerging Thinking, 2005, para 21. Back

290   Elaine Kempson and Claire Shyley for DTI, Extortionate Credit in the UK-A report to the Department of Trade and Industry by Elaine Kempson and Claire Whyley, DTI, 1999, page 29. Back

291   Citizens Advice, Daylight Robbery-The CAB case for the effective regulation of extortionate credit, 2000, pp 33-34. Back

292   op cit Policis for DTI, p 21. Back

293   ibid, p 34. Back

294   op cit Kempson and Collard, 2005, p 30. Back

295   Datamonitor, UK Non Standard and Sub Prime Lending 2004, 2004, p 135. Back

296   Citizens Advice, In Too Deep, CAB clients' experience of debt, 2003, page 120. Back

297   Competition Commission Emerging Thinking , 2005, para 36. Back

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Prepared 16 November 2006