Credit unions ‘must raise interest rates’

The sector, which offers an important alternative for lower-income borrowers, is struggling to achieve viability because of a statutory cap on interest rates, says a DWP study

The low-income customers of Britain’s credit unions could face paying more for their loans after a government-commissioned report concluded the sector is “not financially sustainable”.

A rise in the maximum annual interest rate that people can be charged for a credit union loan from 26% to 42% is a key recommendation in the report, which also calls for more government cash to be invested in the sector.

There are 400 credit unions in Britain, with more than 950,000 members, and they are seen as offering a vital alternative to banks, expensive payday lenders and loan sharks. But the report, commissioned by the Department for Work and Pensions, warned that without additional government money, many could close.

Credit unions are huge in countries such as Ireland, the US and Australia, but have not taken off in a big way in the UK, where just 2% of people belong to one. Their progress has been hindered by restrictions that have limited take-up, but new rules were introduced this year designed to enable them to compete more effectively. For the first time, credit unions are able to pay people interest on their savings, and they no longer have to demonstrate that all those joining the union have something in common.

The report was commissioned to look at possible ways of increasing the numbers of people who use credit unions. It found there was a potential market of at least 7 million people for the services that credit unions could deliver. Many of them currently fall into the trap of high-cost credit, with some being charged more than 6,000% in interest on short-term loans by “predatory” lenders, according to the government.

The study’s authors said credit unions have been helping to provide affordable credit to those on low incomes, but added: “Their operating costs are relatively high, and they are not financially sustainable at present.” Many rely on grant income from the DWP and other bodies, such as local authorities and social landlords, but these sources of funding are likely to come under even greater pressure in the future.

The report proposes that the DWP should provide £51m of funding for a modernisation and expansion programme. One option would be for the government to do nothing, but the authors say of this scenario: “Given the current funding landscape, it is likely many individual credit unions will face severe financial difficulty, and pressure from the Financial Services Authority to reduce their loss-making business or close.”

Credit unions frequently offer best-buy rates for people looking to borrow smaller sums as, by law, they cannot charge more than 2% interest a month on the amount owed – an APR of 26.8%. They are the only financial institutions in the UK to have such a cap on interest rates. The 2% limit “does not allow even the most cost-effective to break even on smaller loans at present,” said the report, which called for an increase to 3% a month – equating to an APR of 42%.

Someone who borrows £400 over one year at a rate of 2% a month would currently be charged a total of £54 interest. If the rate rose to 3%, that individual would pay £82 in interest. However, the report stated: “This still compares very favourably to the interest of more than £300 that would be charged on a similar £400 loan from a leading home credit lender. In hard cash terms, the cost to the consumer of increasing the rate to 3% per calendar month on a £400 loan would be just over 50 pence per week.”

Lord Freud, the welfare minister, said: “For too long, predatory lenders have been plaguing the homes of vulnerable people, who often have no other way to get cash when they need it most. I welcome this study – it offers expert advice on helping credit unions grow and modernise to meet the needs of vulnerable people in the 21st century.” © 2012 Guardian News and Media Limited or its affiliated companies. All rights reserved. | Use of this content is subject to our Terms & Conditions | More Feeds

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