Private Banking for the Poor
The jailing of John Kiely in August 2009 brought into public view the seedy, shady world of the loan shark.
It starts with a small loan, maybe only a hundred pounds, for someone unable or unwilling to borrow from family, friends, or a bank. Interest payments are due weekly or monthly and missed payments are rolled-up into the outstanding debt.
The rate of interest might be as much as a half of the original loan size, payable within a month: with compounding, this gives an annualised percentage rate of many hundreds and perhaps more than a thousand percent. Those who cannot pay back what they owe are subjected to threats, intimidation and acts of violence.
Welcome to the harsh, unforgiving world of sub-prime personal finance. There are almost 2 million adults in the UK who do not have a bank account. They live outside of the mainstream financial system. Of these, around 1 in 10 makes use of loan sharks when they need credit; that is close to 200,000 people in Britain paying vast sums of interest to illegal lenders.
Quantifying the scale of the problem is relatively easy; working out what to do about it is much harder. Barnado's has recently issued a report (Counting on Credit, July 2009) that calls for government action to force banks to do more to provide services to the financially excluded. More drastically, London Citizens - a network of trade unionists, community groups and religious groups in London - is calling for new laws to restrict usury: they want a cap on the amount of interest that can be legally charged for a loan to be set at 8%.
The problem with a legal restriction on interest rate levels for personal credit is that the likely result will be an immediate reduction in the amount of such credit available. It will force poor people into more expensive, illegal borrowing. I assume that London Citizens did not set out to boost the loan sharks' business, but they need to be reminded that the road to hell is paved with good intentions.
While the Barnado's report contains much good sense, all of its recommendations rely on government action to force banks to do this or to stop banks doing that. The presumption of the report is that market failure must be met wholly by state action. But the problem is complex and cannot be solved by legislation alone: this market failure needs a market solution.
Many people in the UK suffer from financial exclusion and need access to credit at a reasonable rate of interest. However, many others suffer from a surfeit of finance: they have over-borrowed and need good advice to help them pay back their debts. We do them no favours if we encourage mainstream banks to offer easy credit in order to meet government targets for lending to the poor.
What the UK lacks are financial institutions to provide credit to those who need it most and debt advice to those who have already had too much credit thrust upon them. To deliver these services in a responsible manner is difficult to do well. A personal approach that takes account of the specific needs of each customer, that offers financial advice and education when necessary, and loan and investment products only as appropriate, is costly to provide.
Of course financial institutions of this type already exist: they are called private banks. They offer bespoke services, based upon face-to-face meetings between the bank and the customers, to ensure that products are tailored to suit the customer's particular needs. Unfortunately most UK private banks do not compete with the loan sharks.
Fair Finance is a private bank for the poor. In the four years since our launch we have lent over £1.5mn to financially excluded people in London at annualised interest rates below 45%. Previously, more than half of our customers were paying interest rates of over 250% to other sub-prime lenders or to loan sharks.
We have also given financial advice to over 950 people who, between them, had debts of over £7.5mn. In all we have provided loans or advice to over 5000 people, but we have only started to scratch the surface. However we have a robust business model and we are planning for growth.
In the short term the best remedy against the predatory lending of the loan shark is forceful action by the police. In the medium term the best way to put loan sharks out of business for good is through the creation of financial institutions that deliver quality services at a reasonable price to those who live outside of the financial mainstream.