25 Jul 2013

Can credit unions really wallop Wonga?

The Archbishop of Canterbury says he wants a more ethical lending model to “out-compete” payday loan companies. But are credit unions up to the challenge?

The Most Reverend Justin Welby said he told Wonga’s chief executive Errol Damelin he planned to put the lender out of business. The businessman apparently “took it well”.

It comes as the Church of England launches a new credit union for Church of England clergy and staff.

The archbishop, a former banker who served on the parliamentary Banking Standards Commission, says he wants to see credit unions expand, and there are plans to encourage church members to volunteer at local unions.

Credit unions for beginners

Credit unions are non-for profit organisations run by and for the benefit of members.
Membership is usually limited to people who share a common link like living in the same area, working for the same employer, or belonging to the same church.
They offer a range of financial products from current accounts to life insurance - but it is their ability to provide low-interest loans to members that is attracting all the attention at the moment.
Credit unions are only allowed to charge 2 per cent interest per month - the equivalent of 26.8 per cent APR. That's a fraction of the kind of rates offered by Wonga and its competitors.
The companies offer short-term loans on small amounts at interest rates that can run into thousands of per cent APR.
Wonga's reprensentative APR is currently a massive 5,853 per cent, but the company only offers loans for up to a month and says measuring interest annually inflates the actual amount it expects customers to pay back.
Nonetheless, a loan from a credit union will almost certainly be cheaper, although many charge small amounts for membership.

‘Not financially sustainable’

The Department of Work and Pensions (DWP) warned in a report last year that many credit unions are not financially sustainable and the business model has to change.

Essentially, many are running at a loss, as costs are too high and interest on loans, as set by law, is too low.

Traditionally, the government has helped prop up credit unions by giving them money. Between 2006 and 2010 the DWP provided £137m of loan capital to third sector lenders, mostly credit unions, through its growth fund.

The department also gave money to lenders to help cover administrative and staff costs, and to help increase capacity.

It remains to be seen whether credit unions can become generally profitable without government subsidy.

The government report recommended increasing the interest rate limit on loans to 3 per cent a month, but says that will not be enough to balance the books.

DWP wants credit unions to modernise, expand and drastically cut their costs, and recently announced a £38m investment to help selected unions become more competitive.

The government said last year that 25 credit unions had closed or been forced to merge after civil servants cut off funding due to poor performance. Others have gone bust since then – four credit unions collapsed in as many months in the first half of this year.

How big can they get?

DWP’s best-case scenario suggests that if its 95 favoured credit unions improve their performance, their membership could increase six-fold by 2021, by which time they would be trading at a small surplus rather than a loss.

International figures suggest there are only around 1 million credit union members in Britain now, about 2.5 per cent of the economically active population.

In Ireland there are three times as many members, representing the equivalent of 7 out of 10 working people.

On the other hand, Experian estimated that there is a potential market of 7 million working-age adults in the UK who might use credit unions.

The sector’s fortunes could be affected by the outcome of Competition Commission investigation into the entire payday lending industry.