Counting on credit

2 3

This Government’s 1999 commitment to eradicate child poverty by 2020 was its boldest and potentially most far-reaching social goal. About half a million children have been

lifted out of poverty. But progress has now stalled and child poverty in the UK actually increased in the last two years for which we have fi gures. Renewed eff ort is now needed.

One of the most salient fi ndings from Barnardo’s recent research Below the Breadline: A year in the life of families in poverty is the burden of crushing debt endured by many low income families. Without doing more to enable poor families to get aff ordable credit, child poverty cannot be eradicated. This short paper proposes aff ordable, practical solutions to the debt problem faced by low income families in the UK.

Now is the time to act. The Chancellor of the Exchequer announced on 8 July reforms to banking regulation designed to prevent another credit crunch by capping lending and placing more demanding requirements on banks regarding their capital reserves and remuneration policies. In this climate of greater support for regulation to protect the economy from banks’ irresponsible behaviour, we should not forget the cost to society of banks’ continued inability or unwillingness to serve low income customers.

Government’s appetite to improve fi nancial regulation should not stop with forcing changes to the macro environment, we believe it must also encompass measures to encourage banks at the micro level to change their practice to promote fi nancial inclusion and help tackle family poverty.

Martin NareyChief Executive, Barnardo’s

Foreword by Martin Narey

On 20 July 2009 Barnardo’s published Below the breadline: A year in the life of families in poverty. This year long study1 followed 16 families living in poverty in the UK. By tracking these families over a period of time we revealed the details of how they deal with money and the challenges they faced in making a low income meet the diverse, and sometimes unpredictable, needs of family life.

Many of the families did not have a basic bank account, even though they had tried approaching high street banks. Without a bank account families are excluded from:■ short-term overdraft facilities■ discounts associated with direct

debit arrangements■ interest free purchase schemes

(e.g. for furniture and white goods)■ bank loans at aff ordable

interest rates.

The families in Barnardo’s Below the breadline study found it relatively easy to obtain credit, often from home credit companies. But, as a consequence, they faced punitively high charges or interest rates2. For example, one of the families in our study had a loan of £100 over 31 weeks from Provident Financial at a rate of 367 per cent APR3.

This paper proposes three ways in which the debt burden could be relieved for poor families, thus helping to tackle child poverty:

■ First, by moving towards truly universal banking so reducing the need for poor families to use the alternative credit market and thus incur sometimes extortionate rates of interest. The Government should renew its eff orts to improve the regulation of the retail banking industry, if necessary using statutory force to replace self-regulation so that banks:– off er a universal service

promise as part of the Banking Code to ensure that banks provide more support to low income customers to access a bank account

– report annually on the extent of their business with low income families and in deprived areas

– establish a Universal Access Fund to which all banks would contribute and from which they would receive payments dependent on their performance in reducing fi nancial exclusion.

■ Second, by establishing incentives for poor families to save, by building on the Savings Gateway4 so helping poor families to cushion themselves against unexpected or seasonal fi nancial pressures.

■ Third, by reforming the Social Fund to enable it to provide small sums of credit quickly and provide better links between Jobcentre Plus and debt and fi nancial capability advice services.

Introduction

1 From January 2008 to January 2009.2 Home credit companies collect the money in person from homes weekly, and do not charge for missed payments.

The high default rate and cost of collecting the loan is factored into the high interest rates clients pay.3 Annual Percentage Rate4 The Savings Gateway is a savings account that provides a matched contribution from Government to incentivise

savings. The accounts will be rolled out nationally from 2010 and will be available to benefi t claimants and people in work on low income. For more details, see: www.hm-treasury.gov.uk/saving_gateway.htm

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Sub-prime fi nancial services have gained an unwanted notoriety since the fi nancial crisis hit the headlines in 2007. But beyond the world of complex fi nancial instruments and derivatives traded by major fi nancial institutions, the market for fi nancial services for those on low incomes in the UK – our sub-prime fi nancial services sector – has increased in importance.

Unemployment is now rising and, combined with tighter restrictions on lending by high street banks, there has been an increase in the demand for high interest rate, sub-prime loans, such as home credit5.

Access to fi nancial services like bank accounts and mainstream credit could give signifi cant savings to some families, because paying by direct debit means lower utility bills, and because it would provide alternatives to high cost sub-prime credit.

‘I pay [gas and electricity] in cash…

I get charged £280 a year more for

having them there (the card/key

meters)... People that pay by direct

debit get a discount. But I pay in

cash... I never get a bill so I should get

a discount... But it’s like speaking to a

brick wall speaking to these people...

They get the poor people all the time.

People that can’t aff ord to pay standing

orders because they haven’t got bank

accounts, they’re the people who

get shafted.’ (Gary, 47, father of two

children aged 13 and nine.)*

Having a bank account is an essential pre-requisite for most jobs, so not having a bank account can provide a practical and psychological barrier to returning to work. Some of those in Barnardo’s Below the breadline report feared changing from managing their fi nances in cash to using a bank account, as they were wary of hidden charges and felt they would have less control over their money6.

Alternative creditFor those who cannot access mainstream fi nancial services, borrowing money means using the alternative credit market. This market includes home credit providers, pay day loans, pay-as-you-view arrangements and pawnbrokers – all off ering a valued service, but at a high price. Typical interest rates for a £300 home credit loan are 254.5 per cent7, and for a pay day8 loan of the same amount, a charge of £75 for credit means the typical APR of the lender is 1737 per cent9. Pay-as-you-view arrangements can also be an extremely costly way to purchase large household items. Barnardo’s has found an example of a washing machine listed with a cash price of £479.99 that could be bought online elsewhere for £337. When the cost of credit – at

Part one –

Extending fi nancial inclusion

5 New customer applications to the largest home credit provider, Provident Financial, have increased sharply over the last two years. The total number of new customers in 2008 was 558,000, up from 525,000 in 2007 (2008 Annual Report: http://www.providentfi nancial.com/fi les/reports/ar2008/index.asp), but the proportion of new applicants refused loans has increased from a third in 2007 to over 60% in 2008 (New Local Government Network, Circling the loan sharks, 2009) http://www.nlgn.org.uk/public/press-releases/recession-could-cause-increase-in-loan-sharks-says-new-report/

6 Below the breadline www.barnardos.org.uk/belowthebreadlinereport. Pages 19-237 Provident Personal Credit website: https://www.providentpersonalcredit.com. Accessed 6 July 2009.8 Pay day loans off er very short-term loans, normally to people in employment to be paid back on the customer’s

next pay day.9 Payday UK website: http://www.paydayuk.co.uk/pages/our-charges.html. Accessed 6 July 2009.* All the quotes in this report are taken from Below the breadline: A year in the life of families in poverty

Barnardo’s July 2009 at www.barnardos.org.uk/belowthebreadlinereport

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10 www.bayv.co.uk/products.html accessed on 28 May 2009. Illustrated costs for a Hotpoint Aquarius washing machine WMF740K.

11 Save the Children The poverty premium, 2007, ww.savethechildren.org.uk/en/docs/poverty_briefi ng.pdf12 Formerly the third largest home credit lender, London Scottish Bank plc entered administration on 30 November

2008 (www.london-scottish.com). The second largest, Cattles plc, ceased off ering new home credit loans on 23 March 2009 (www.ft.com/cms/s/0/6829795c-01e4-11de-8199-000077b07658.html) and an investigation was launched into accounting irregularities (www.ft.com/cms/s/0/89dc7148-07c6-11de-8a33-0000779fd2ac.html).

13 New Local Government Network, Circling the loan sharks, 2009 www.nlgn.org.uk/public/press-releases/recession-could-cause-increase-in-loan-sharks-says-new-report

14 A better deal for consumers: Delivering real help now and change for the future, CM 7669.15 www.competition-commission.org.uk/inquiries/current/homecredit/

49.9 per cent APR – and maintenance were added, the total amount repayable was £1,137.24 – more than three times the cash price elsewhere10.

These costs contribute signifi cantly to the poverty premium, the extra money paid by poor families for cash, credit, goods and services. This can be over £1,000 a year, of which the costs of credit make up over a quarter11.

Despite the high interest rates, home credit providers have not been immune from fi nancial diffi culties, with the second and third largest home credit providers either entering administration or ceasing to make new loans12. This has led to concerns that there may be an increase in the number of people forced to borrow money from illegal, unlicensed loan sharks13.

The Government’s recent white paper, A Better Deal for Consumers, published

on 2 July 2009, responded to some of these concerns by announcing that the Offi ce of Fair Trading (OFT) would investigate the high cost credit market14. This welcome move has been long awaited since the Competition Commission’s report into the home credit market, published in 200615.

Barnardo’s believes the OFT review must propose ways to increase competition and reduce the amounts of interest low income families are paying for credit. The OFT should examine current arrangements which allow lenders to quote a ‘typical APR’ that they do not off er to all successful applicants. The lender is legally committed to off er this rate to only 66 per cent of its customers. Those who, because of their low income, are considered to be a poor credit risk will frequently be off ered a loan with a much higher APR.

At the same time, we hope the review will look closely at how alternative credit providers are sometimes illegitimately infl uencing customers into taking on more credit, over diff erent repayment periods, than they would have otherwise done. Barnardo’s found evidence of the infl uence that home credit agents and catalogue fi rms can have over the amount that families borrow and over the repayment periods16. What is in the fi nancial interest of the lenders is too often very much against the interests of the low income consumer.

In addition, Barnardo’s is concerned that the review may not investigate some pay-as-you-view companies. In its white paper A better deal for consumers, the Government defi ned high cost credit as being 50 per cent APR or higher. This would exclude the example given above of the washing machine at 49.9 per cent typical APR. But, as we have shown, the quoted APR does not include the infl ated price of the goods. In the example of the washing machine, if the cash price was the same as we found elsewhere, but the repayments were unchanged, this would equate to an APR of 200 per cent. Therefore, the review of the high cost credit industry by the OFT should investigate all of the alternative credit industry, including pay-as-you-view arrangements.

‘[I] borrow, borrow, borrow. It’s so

easy… they tend to give it more to

people on benefi ts… I mean I can get

credit no problem and I’ve got it…

I’ve got a lot of debt and I’m not…

ashamed of it… ’cos everybody has

debt. If somebody says they don’t have

debt they’re telling lies… I am careful

with my money and budget well. I pay

all my bills and even though I have a

lot of debt, I pay it.’ (Jane, 32, mother

of fi ve children aged between one and

eight years.)*

One way of bringing down the costs of credit to low income customers would be to encourage competition in the alternative credit market. But a greater eff ect could be achieved by giving low income families other options, by extending fi nancial inclusion and by reforming the Social Fund.

Financial inclusion policyGovernment regulation of the UK retail banking industry has, over recent years, focused on the introduction and development of a voluntary code of conduct, the Banking Code, to which all the major high street banks have signed up. The code is enforced by the Banking Code Standards Board, who conduct research such as mystery shopper exercises to monitor compliance.

16 See, for example, Gary and May, page 33, Below the Breadline, 2009 www.barnardos.org.uk/belowthebreadlinereport ‘Realising they would struggle to aff ord [the loan], they phoned the Provident and negotiated to pay £20 a week instead. However, when they saw the local representative she asked them to keep the payment at £40 as otherwise she would lose commission.’ Another example is Ralph, page 22 ‘[the catalogue company] billed him for the reduced payment… according to the ‘new’ arrangement that he had not agreed to’.

* All the quotes in this report are taken from Below the breadline: A year in the life of families in poverty Barnardo’s July 2009 www.barnardos.org.uk/belowthebreadlinereport

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17 Features of Basic Bank Accounts do diff er slightly between providers. A signifi cant diff erence is whether the accounts are accessible at post offi ces. At the moment, 16 banks off er access to the accounts at Post Offi ce branches (British Banking Association Press Release Banks Pledge to Build on Financial Inclusion Progress, 26 June 2009, www.bba.org.uk/bba/jsp/polopoly.jsp?d=145&a=16152)

18 HM Treasury, Promoting fi nancial inclusion, 2004, www.hm-treasury.gov.uk/d/pbr04_profi ninc_complete_394.pdf 19 An additional 5 per cent of households in the poorest fi fth have a Post Offi ce Card Account, but not a bank

account. Source: Family resources survey, information accessed at www.poverty.org.uk/73/index.shtml on 20 June 2009.

20 Source: Family resources survey, accessed at www.poverty.org.uk/73/index.shtml?2 on 20 June 2009.21 HM Treasury, Reforming fi nancial markets 2009

www.hm-treasury.gov.uk/d/reforming_fi nancial_markets080709.pdf 22 Details of Post Offi ce Card Accounts are available from

www.postoffi ce.co.uk/portal/po/content1?catId=19100189&mediaId=1920017723 Citizen’s Advice Government contract for the Post Offi ce Card Account (POCA), www.citizensadvice.org.uk/index/

campaigns/social_policy/parliamentary_briefi ngs/pb_consumerandebt/government_contract_for_the_post_offi ce_card_account_poca

This approach, based on partnership and voluntary self-regulation, has been successful up to a point. But Barnardo’s believes it is time to strengthen the system, if necessary with the threat of statutory regulation, if further improvement in banks’ performance is not forthcoming.

Basic Bank Accounts and benefi t paymentsThe Government worked with the high street banks to off er simple accounts under a consistent brand name – Basic Bank Accounts – from April 2003. These accounts were designed to meet the needs of those currently without an account: to receive money, make free cash withdrawals and pay bills directly, without an overdraft facility. The aim was to facilitate the complete switch away from the use of Giro cheques and pension books to direct payment of pensions and benefi ts into bank accounts.

The introduction of the Basic Bank Account meant that all high street banks off ered an account that was appropriate for low income or previously unbanked customers17. To ensure that these eff orts actually achieved the goal of increased fi nancial inclusion, the Government created the Financial Inclusion Taskforce in 2005. In partnership with the banking

industry, the Taskforce set a target to halve the number of households without access to a bank account from its 2003 level18.

Between 1996/97 and 2006/07, the proportion of households in the lowest fi fth of the income distribution without a bank account fell from over 25 per cent to 11 per cent19. Progress was particularly fast between 2003/04 and 2005/06, but subsequently appears to have stalled20. There are 1.9 million adults in the UK living in households without a bank account21. The DWP’s move to direct payment of benefi ts has been largely successful, but many recipients still receive their payments through a Post Offi ce Card Account (POCA). These accounts allow benefi t and pension deposits only, and money can only be withdrawn at a post offi ce counter. No bills or standing orders can be paid from a POCA22. For these reasons, a POCA is not considered a true bank account, but despite the limitations, over 4.7 million have been opened23 to receive benefi t or pension payments.

Universal banking?Some of those without a bank account simply prefer to manage their money in cash. Many of these people manage their money on a weekly or fortnightly basis, and keep their money in cash

as a way of staying in control of their fi nances. There are others who have been put off banking because of experience with high unauthorised overdraft charges that caused hardship. These charges can not only be high relative to an individual’s weekly income, but can multiply alarmingly fast because one charge can lead to others being accumulated24.

There are also those who have tried but been unable to open bank accounts. Barnardo’s research includes examples of families who have been unable to open a bank account after many attempts. They were told consistently that the only acceptable forms of identifi cation were a passport or driving licence, neither of which the families had access to, or could aff ord to get hold of 25.

‘You can’t get the money any place else,

you can’t go to a bank.’ (Gary)*

Money laundering regulations do require that banks fi nd ways to confi rm the identity of applicants for bank accounts, but they do not require that the identifi cation be in the form of a passport or driving licence. There are some excellent guides available on what forms of identifi cation can be acceptable26, but it is clear that best practice is not always followed in branches. Other organisations, such as Citizens Advice, have also found examples of potential bank

customers being unable to open Basic Bank Accounts, such as credit scoring applicants before being prepared to off er them an account that does not off er a credit facility27.

These examples show the limitations of the current system of self-regulation. Banks are using identifi cation requirements to exclude those people likely to be on the lowest incomes. At the moment there is very little fi nancial incentive for banks to take on Basic Bank Account customers, and as a result, there remains a temptation for banks not to provide all the support they can to new customers on low incomes.

Following a mystery shopping exercise in 2005, the Banking Code Standards Board found that when it came to forms of identifi cation, ‘greater fl exibility is needed at branch level’. Given this concern, it is disappointing that the 2008 research into Basic Bank Accounts carried out by the Banking Code Standards Board did not show any information about the forms of identifi cation requested by branches and how fl exible they could be28. In fact, being fl exible about the type of identifi cation acceptable is not even a part of the Banking Code. The code states only that signatories will ‘tell you what information we need to prove your identity’29.

24 For examples, see chapter 3 of Banking benefi ts: Citizens Advice Bureaux evidence on payment of benefi ts into bank accounts, by Tony Herbert and Francesca Hopwood-Road, 2006. www.citizensadvice.org.uk/banking_benefi ts-3

25 Barnardo’s (2009), Below the breadline, pp 23 and 34.26 See, for instance, ID Guide, published by Toynbee Hall’s Services Against Financial Inclusion team 2008

(www.toynbeehall.org.uk/page.asp?section=00010001000100100001&pagetitle=Tools+%26+ Resources). 27 Herbert and Hopwood-Road, Banking Benefi ts: Citizens Advice Bureaux Evidence on Payment of Benefi ts into

Bank Accounts, 2006 www.citizensadvice.org.uk/banking_benefi ts-328 Full research report does state ‘We have concluded that… where an individual is fi nancially excluded, that

they should be able to obtain information and open a basic bank account relatively easily.’ However, it does not provide evidence on whether banks were fl exible on the forms of identifi cation that would be acceptable. www.bankingcode.org.uk/wpdocs/BBA%20report%20for%20website%20March%202008.doc

29 The Banking Code, 2008, www.bankingcode.org.uk/pdfdocs/PERSONAL_CODE_2008.PDF * All the quotes in this report are taken from Below the breadline: A year in the life of families in poverty

Barnardo’s July 2009 www.barnardos.org.uk/belowthebreadlinereport

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Banking products for those on low incomeOne reason that banks have not considered low income customers to be attractive is because they are unwilling to off er suitable products at interest rates that would be profi table. Banks have been fearful that to do so would involve lending at interest rates that, even if signifi cantly lower than home credit, would be high enough to be damaging to their reputations. This is a missed opportunity because those on low income have shown, through the take-up of home credit and other alternative credit that they are willing to pay for fi nancial services that are tailored to their needs. Innovative approaches from high street banks, copying some of the popular features of home credit, such as transparent pricing without large penalties for missing one or two payments, could reach out to under-served groups in a profi table way to the benefi t of banks and low income customers.

The Third SectorThe Third Sector has been an important part of the Government’s strategy to reduce fi nancial exclusion. Specifi cally, Government has been providing support

to some credit unions and Community Development Finance Institutions (CDFIs) to expand the amount of aff ordable credit that they off er. To achieve this, since 2004 the Government has invested almost £100 million in the Growth Fund30. There are also individual examples of credit unions and CDFIs that have played a very important role in tackling fi nancial exclusion in some communities31.

However, although credit unions are concentrated in low income areas, coverage is far from universal. In addition, most credit unions do not off er the full range of banking services, unless they have an agreement in place with an existing bank. Where banks do work together with credit unions, it can be a particularly eff ective way of tackling fi nancial exclusion.

Going furtherBarnardo’s recommends that the Government extend its work with the banking sector to increase signifi cantly the rate at which households without a bank account are brought into the mainstream fi nancial system. In addition, Government should provide incentives for banks to innovate to provide new services to low income customers and to develop partnerships with third sector organisations such as credit unions.

Self-regulation and voluntary action has achieved much, but has perhaps reached the limits of its eff ectiveness. For this reason, we consider it is now time for the Government to consider whether greater statutory regulation is necessary to achieve its goals of greater fi nancial inclusion.

30 DWP What is the Growth Fund?, www.dwp.gov.uk/other%2Dspecialists/the%2Dgrowth%2Dfund31 See for example, Paul A Jones (2005), Giving credit where it’s due: Promoting fi nancial inclusion through quality

credit unions.

Barnardo’s recommends:

i) To address the fact that some banks are using identifi cation checks as a way of obstructing some people’s access to basic bank accounts, the Government should seek banks’ agreement to introduce a Universal Service Promise through the Banking Code. This would use the current voluntary framework to place a much more specifi c set of responsibilities on banks to increase access to their services. In particular, it would ensure banks are fl exible about the types of identifi cation they accept, and ensure they provide support to customers having problems proving their identity or any other problem opening an account. It would also ensure that no bank could turn away any customer for a Basic Bank Account on the basis of a credit check. This would amount to a Universal Banking Promise on the part of the banks that individuals would have the right to access and support through the application process. In the event the banks are unwilling to take these steps, the Government should also be prepared to legislate to make them a condition of their banking licence.

The advantages of this approach are that it would change the way banks deal with those people without easy access to standard forms of identifi cation and encourage people who have been put off from opening an account in the past to try again.

ii) Next, banks should be required to provide more information about the extent of their business with low income individuals and in deprived

areas. As a fi rst step, the British Banking Association should publish each bank’s account activity rates for those in the most deprived areas. The Government should, in consultation with the banks and others, consult on what other measures would most accurately show the extent of banks’ work with people on low income and in deprived areas. The fi gures should be comparable, between banks and over time. The agreed measures should be published in banks’ annual reports. For example, the number of benefi ts and tax credits paid into the accounts of each bank would be a useful measure of the extent to which each bank is reaching out to low income customers.

Once banks publish reliable measures of the extent to which they do business with low income customers, the Government can provide incentives for banks to improve. To do this, the Government should introduce a Universal Access Fund32. The banks would pay a levy into the fund on the basis of their turnover or market share. The fund would then pay the money back to the banks, but the amount received would depend on one or more measures of the bank’s work to reduce fi nancial exclusion, for example, the number of Basic Bank Accounts in active use, or the proportion of benefi t and tax credit payments that are made into accounts run by each bank.

Given the right incentives from the Universal Access Fund, banks would be motivated to reach out to more households currently without bank accounts, and to innovate to attract

32 For a longer discussion of the case for a Universal Service Obligation see Basic Bank Accounts, the case for a universal service obligation from the New Economics Foundation (2005).www.neweconomics.org/gen/uploads/ilifsj554nyi4i45pk2vpk4521112005154109.pdf

iii)

12 13

low income customers away from other banks. This could involve fl exible credit options to compete with the alternative credit market. This may mean high street banks charging fees or higher interest rates than are currently common, but these would be welcome competition to the high rates currently charged in the alternative credit market. In addition, it should mean that banks have incentives to develop stronger partnerships with successful credit unions, to provide a full range of banking services.

Debt crisis supportHousehold borrowing from banks has increased by 159 per cent since 199733. A result of this increase in the use of credit is that, for some, their levels of debt will become too much. On a low income, debts do not need to be very high in order to present serious diffi culties in repayments. Often however, families can struggle on, managing their debts only by taking on more credit. In these cases, debt can be

a tremendous source of worry, anguish, hardship and mental ill-health34.

The Government has taken a number of welcome steps towards tackling serious debt problems, particularly for those on low incomes. For example, there were concerns that neither of the two formal legal options for families with debt problems – bankruptcy or Individual Voluntary Agreements – met the needs of low income families. In response to these concerns, in April 2009, the Government introduced Debt Relief Orders (DROs) specifi cally for people in fi nancial diffi culty with few assets, and whose total debts did not exceed £15,00035.

The Government has also invested in the provision of debt advice. It is clearly in the interests of all parties that people with problem debts are identifi ed early, to avoid hardship and minimise losses on the part of the creditors. The 2007 Comprehensive Spending Review allocated £130 million to the Financial

33 Based on bank lending to individuals, 1997 Q3 compared to 2009 Q1, Table 5.07, Economic and labour market review, July 2009, Offi ce for National Statistics.

34 For example, one quarter of people attending a civil court for money/debt issues in 2006 suff ered a stress related illness as a result, Pleasence, Balmer and Tam, Civil justice in England and Wales, 2008. www.lsrc.org.uk/publications/2007CSJS.pdf

35 For more information on Debt Relief Orders see the website of the Insolvency Service: www.insolvency.gov.uk/bankruptcy/alternativestobankruptcy.htm. Diff erent arrangements apply in Scotland.

Inclusion Fund to provide face-to-face debt advice between 2008 and 201136. On 2 July 2009, as part of the A better deal for consumers white paper, the Government announced an increase in this investment of £300,000. At the same time, it announced an agreement to give breathing space for 30 days after creditors have been approached by a not-for-profi t debt advice agency on behalf of a debtor. During this time, creditors would not chase the debt.

These measures are welcome, and Barnardo’s hopes that the tools are now in place to eff ectively tackle over-indebtedness among low income households. The true success of the measures, however, will be in eff ective implementation. The right information needs to reach the right people at the right time. For this to happen, the debt advice services will have to form eff ective partnerships with other services that can identify the fi rst signs of fi nancial distress. Examples include Jobcentre Plus, local authority housing departments and housing associations and health services and, in particular, the Social Fund.

36 HM Treasury Financial inclusion: An action plan for 2008-2011, 2007 www.hm-treasury.gov.uk/d/fi nancialinclusion_actionplan061207.pdf

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For families in poverty, saving often seems like an impossibility. There are so many other pressures on the very limited family budget, that putting money away can seem unachievable. But savings are very important to provide insulation against unexpected or seasonal costs and savings behaviour is related to feelings of fi nancial control and confi dence37. When they are able to build up savings, low income families often do so in cash, or by letting money build up in a non-interest-bearing account. But even with this limitation, saving can still generate an excellent return if it helps to prevent a family taking out an expensive home credit loan.

‘I don’t want to go that way again. I

want to get that cleared. I would rather

not borrow at all but just have to, to

stay alive.’ (Gary)*

Incentivising savingsThere are two major barriers to families building up savings, other than low income. First is debt – for families with existing debt, repayment is given priority over saving. The second is that saving is hard to do. People’s savings behaviour has been shown to be subject to inertia – it requires more eff ort to start saving than to continue once in the habit38.

More specifi cally, Barnardo’s Below the breadline research revealed how hard

it is for low income families to manage their fi nances on anything other than a day-by-day or week-by-week basis. The constant stress of robbing Peter to pay Paul left them exhausted, discouraged and feeling unable to plan or exercise control over their fi nances in the long term. Families in this situation need more help.

The simplest way to encourage the build up of savings is to provide monetary incentives. In 2002, the Government began pilots of the Savings Gateway to provide this type of monetary incentive to low income households. A second round of pilots followed in 2005 and the Savings Gateway will be rolled out across the UK from 2010. It will provide a Government match of up to 50 per cent of the amount paid in39.

Evidence from the pilots was encouraging, showing that signifi cant numbers of families benefi ted from the Government match, but there was less evidence that the Savings Gateway increased savings behaviour signifi cantly, rather than simply diverting savings from other sources40. While this may be disappointing, it does not mean that the Savings Gateway is the wrong savings vehicle to kick-start a savings habit, but rather that more eff ort needs to be put into making it easier for families on low income to begin and to continue to save.

Part two – Savings

37 Sodha and Lister, The Saving Gateway: From principles to practice, 2006 www.ippr.org/publicationsandreports/publication.asp?id=502

38 See, for example, Madrian and Shea, The power of suggestion: Inertia in 401(k) participation and savings behaviour www.nber.org/papers/w7682

39 Up to £200 per month can be paid in and the match will be paid in after two years based on 50 per cent of the maximum balance achieved. There is limited eligibility based on benefi t receipt or low income. HM Treasury, Saving Gateway: Operating a national scheme, 2008. www.hm-treasury.gov.uk/d/bud08_saving_340.pdf

40 ‘The results from the quantitative analysis show that those off ered [a Savings Gateway account] were more likely to have increased savings held in cash deposit accounts. However, when we look at a broader measure of net worth (including investments as well as all cash deposit accounts), there is no statistically signifi cant evidence that funds held in these forms have increased.’ Final Evaluation of the Saving Gateway 2 Pilot: Main Report, 2007 Harvey, Pettigrew and Madden (IPSOS Mori) and Emmerson, Tetlow and Wakefi eld (IFS). www.hm-treasury.gov.uk/d/savings_gateway_evaluation_report.pdf

* All the quotes in this report are taken from Below the breadline: A year in the life of families in poverty Barnardo’s July 2009 www.barnardos.org.uk/belowthebreadlinereport

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Developing the savings habitOne of the messages from Barnardo’s research is that low income families fi nd repaying a Social Fund loan less stressful than paying off other credit, because the money is taken from the benefi ts at source.

‘It’s a loan but not the same pressure…

the good thing about the Social

Fund, the money – they take it all

out [at source] so you don’t have to

worry about going down and paying

the bill…’ (Ralph, 36, father to fi ve

children, aged between seven and 17.)*

In exactly the same way, it is much easier to make one decision about how much you want to save on a regular basis than be faced with the decision each week or month. If families receive their money with the amount they have agreed to save already taken out, the loss of that amount feels less painful.

The Government could make this easier for families to achieve by giving the option of receiving a proportion of their benefi t or tax credit payment direct into a Savings Gateway account. In this way, families would only need to take one decision about how much to save. The money would be available to them to withdraw at any time. But, when combined with the match available from the Savings Gateway, this could signifi cantly increase the amount of money saved.

In addition to providing the facility to pay money into Savings Gateway accounts directly, there would clearly be a role for Jobcentre Plus to promote

and facilitate this method of saving. In particular, there are times at which it makes sense for Jobcentre Plus to be proactive about promoting the Savings Gateway, for example around the times of benefi t increases, or in the new year, at times when Christmas savings clubs begin promotion.

Another signifi cant point at which families may fi nd it easier to begin saving is at the time a Social Fund loan is repaid. At this point, families will see their disposable income increase and could be in a good situation to begin regular saving. Claimants could be given the option of payments continuing to be taken from their benefi t after they have paid off their Social Fund loan, with the payments going directly into their Savings Gateway accounts. If they were given this choice when they take out the Social Fund loan, it could be even more eff ective, in a similar way to a technique for increasing pension savings known as ‘Save More Tomorrow’41. ‘Save More Tomorrow’ encouraged employees to increase their contributions to their pension scheme by asking them to agree to their contribution rate being increased at a future date, such as the date of a pay rise or a promotion, rather than immediately. In this way, individuals do not see their net earnings fall, but increase their pension contributions.

At present, Savings Gateway accounts are designed to run for two years42 to kick-start a savings habit. The costs will depend greatly on the take-up and the Government has estimated that

the amount that will be paid out in matched contributions will be around £130 million43. If the Government is successful at achieving a higher take-up of the Savings Gateway than it currently expects, then the costs will be higher. However, each pound spent will have helped to kick-start a savings habit and build up savings among the lowest income households.

The Government should ensure that the Savings Gateway has a long term future and that low income households will be able to benefi t from matched savings beyond the fi rst two year period. With its future secure, the links between benefi ts and tax credits, the Social Fund and the Savings Gateway have the potential to increase the savings of low income families. This in turn would decrease the amount of expensive credit taken and increase families’ control over their fi nances and help to tackle the eff ects of child poverty.

41 Thaler and Benartzi, Save More Tomorrow: Using behavioural economics to increase employee saving, 2001 www.anderson.ucla.edu/faculty/shlomo.benartzi/savemore.htm

42 HM Treasury, Saving Gateway: Operating a National Scheme, 2008. www.hm-treasury.gov.uk/d/bud08_saving_340.pdf

* All the quotes in this report are taken from Below the breadline: A year in the life of families in poverty Barnardo’s July 2009 www.barnardos.org.uk/belowthebreadlinereport

43 Commons Hansard 13th January 2009 Column 135 www.publications.parliament.uk/pa/cm200809/cmhansrd/cm090113/debtext/90113-0004.htm

18 19

The Social Fund plays an important role in the lives of many families on benefi ts. Barnardo’s Below the breadline research into the experience of families in poverty has shown some families rely on the fund so much that they take a new loan out as soon as they have paid off the last one. The majority of the families who took part in the research had taken a Social Fund loan in the past. This is in some ways a sensible approach, because the Social Fund provides interest free credit to a population who are likely to be fi nancially excluded, and who fi nd it hard to access credit at even a moderate rate of interest elsewhere.

The Social Fund provides interest free loans and grants to households in three ways: through Budgeting Loans, Crisis Loans and Community Grants. Budgeting Loans are available to claimants of Income Support or Income-Based Jobseekers Allowance who have been claiming for more than 26 weeks. Crisis Loans are available to any household in a position of extreme need. Community Grants are available to particularly vulnerable individuals meeting some restrictive conditions44. Government spending on these three programmes was £178.20 million net of repayments in 2007/0845. The recent

increases in unemployment have stretched the resources of the fund, and in the 2009 Budget the Chancellor announced that the Social Fund budget would increase by £145 million a year by 201046.

Appetite for reformThe Government has recently expressed a strong interest in reform of the Social Fund, publishing a consultation document in December 2008. The proposals include using Third Sector providers to off er loans through the Social Fund, simplifying the Budgeting Loan and Crisis Loan into a single scheme, allowing advance payment of benefi ts which have been applied for but not yet granted, and for those successful in applying for a grant, moving away from cash towards direct provision of goods and services47.

The Government’s interest in reform of the Social Fund is very welcome. Barnardo’s and other groups have been calling for reform of the Social Fund for a number of years48. Calls for reform have focused on an extension on the grants for necessary larger items of household expenditure, more funding to allow more loans to be made and an improvement in administration to speed-up decision making49.

Part three –

Reforming the Social Fund

44 An overview of the eligibility for the Discretionary Social Fund is available in Pettigrew, Webb and Ganesh, The Discretionary Social Fund and money management, 2005 research.dwp.gov.uk/asd/asd5/rports2005-2006/rrep241.pdf

45 Department for Work and Pensions Annual report on the Social Fund 2007/08, CM 7483.46 HM Treasury, Budget 2009: Building Britain’s future

www.hm-treasury.gov.uk/d/Budget2009/bud09_completereport_2520.pdf47 Department for Work and Pensions, The Social Fund, A new approach, 2008 and

The Social Fund: A new approach response document, 2009. Both documents available at www.research.dwp.gov.uk/consultations/2008/social-fund-new-approach.asp

48 See, for example, Barnardo’s calls for child poverty to be at the heart of Budget, Press Release April 2002. www.barnardos.org.uk/news_and_events/media_centre/press_releases/press_releases_archive.htm?ref=13888&year=2002&month=4

49 Child Poverty Action Group, One Parent Families Gingerbread, Family Action and Save the Children, Response to the Department for Work and Pensions consultation on the Social Fund, 2008.www.cpag.org.uk/info/briefi ngs_policy/social_fund_response_1208.pdf

20 21

Based on the experiences of the families that use Barnardo’s services, there are two important requirements that could be met by the Social Fund. One is for quick access to small amounts of credit – this is often the sort of need that home credit or hire purchase arrangements are used to fi ll, and it is these smaller amounts that attract the highest interest rates in the alternative credit market. Second, the Social Fund could do more to meet the needs of low income families by linking various sources of information and advice to families when they apply for a larger loan. For example, those applying for a larger Social Fund loan may be more likely to benefi t from debt advice, fi nancial capability training or support accessing fi nancial services.

Replacing high cost creditOne advantage that home credit has over the Social Fund is that it is faster and easier to get a small loan. Also, the Social Fund requires applicants to have a reason for the loan that fi ts into prescribed categories. While these categories are fairly wide, they do not cover every reason that families may have for requiring a loan50. In addition, there is no monitoring of use of the loan, so experienced applicants are able to claim for eligible items, even if they use the loan for other purposes, while less experienced and potentially more vulnerable claimants may not qualify. This leads to unnecessary administration in processing and checking the eligibility of the application, which also adds to

the time it can take to approve a loan. Therefore, the administrative burden can lead to applications being declined or taking too long to come through, which can drive families to turn to high cost alternatives.

Barnardo’s proposes that a new category of Social Fund loan is created designed to provide small sums of credit quickly, simply and without complex eligibility criteria, which could be administered easily and cheaply. Eligibility would not be based on an analysis of the reason the loan is required, but rather would be available to any eligible claimant who was not already paying back a similar loan.

This service would provide sums of up to £500, paid back from benefi t income over a few months, to claimants of the same benefi ts as are eligible for Budgeting Loans, but from the very start of the claim, rather than eligibilty beginning six months into the claim. It would provide a service that many families on benefi ts are currently unable to get from mainstream fi nancial services and prevent families that could be eligible for a Social Fund loan taking up home credit – either because they are not experienced at applying to the Social Fund or cannot wait for the application to go through. Under reasonable assumptions of take-up, this scheme, once established, would cost less than £120 million a year51 – but this investment would take the place of some of the existing Social Fund expenditure, reducing the overall cost.

Linking to supportIn addition to the need for quick access to small loans, there is clearly a role for the Social Fund to continue to assist with larger amounts over a longer period. The smaller, short-term loan provision would require minimal administration, and this will allow administrative eff ort to be concentrated on improving the service off ered to those applying for the longer term loans. These applicants will often be those most in need, not only of fi nancial assistance, but also of fi nancial capability skills or debt advice.

The point at which individuals apply for a longer term Social Fund loan should be an opportunity for Jobcentre Plus to assess their needs and refer the applicants to assistance. In many cases this can be provided by existing government funded provision, if better links can continue to be made between the Jobcentre and the debt and fi nancial capability advice services, in particular the MoneyAdvice service funded by the Financial Inclusion Fund. The support provided should seek to ensure that applicants have access to mainstream fi nancial services like a Basic Bank Account, that they have the confi dence to manage their fi nances to meet their needs and identify issues with problem debts.

These changes to the Social Fund would ensure that the fund can better direct its resources. Firstly, to provide small amounts of money quickly to those claimants who need an advance of their benefi t income and to avoid expensive home credit. Secondly, to focus administrative eff ort on assessing the needs of those applying for larger loan amounts, and providing appropriate support.

50 For example, 24,800 applications for Crisis Loans were refused in 2007/08 because they were to pay for excluded items. Department for Work and Pensions Annual report on the Social Fund 2007/08, CM 7483 www.dwp.gov.uk/docs/2008-annual-report-social-fund.pdf

51 This estimate is based on the eligible population of 2.8 million claimants of Income Based Job Seekers’ Allowance and Income Support, in November 2008. Average loan assumed to be £400 over fi ve months. There were three applications for a Budgeting Loan for every four eligible people in 2007/08. We assume that take up will be higher and that during each year there is one successful application for each eligible person each year. In 2007/08 the ratio between amount of money paid out and the amount received was 0.91. Based on this, we assume that 10 per cent of the money loaned out is not recovered.

22 23

Further signifi cant progress on tackling child poverty will, we believe, be impossible without addressing the burden of fi nancial exclusion and high interest debt carried by poor families. Barnardo’s recent research Below the breadline indicated that the disposable income of many families is far lower than the nominal value of their earnings or benefi t payments due to repayments on high interest loans. Families were forced to take out such loans even though they saw how expensive they would be because they lacked savings, were excluded from mainstream banking services and were caught by the infl exibility of the Social Fund:

‘I think it actually does cost you more

money... I think they might even tell

you it costs more money... if you read

the small print.’ (Ralph)*

We have made proposals in this report as to how the Government can tackle the burdens of fi nancial exclusion and debt for families in poverty. Barnardo’s recommends that:

On fi nancial inclusion:■ The Government should ensure that

banks introduce a Universal Service Promise through the Banking Code. This would use the current voluntary framework to ensure banks are fl exible about the types of identifi cation they accept, and that they support customers having diffi culties opening an account.

■ Banks should be required to provide more information about the extent of their business with low income individuals and in deprived areas.

■ The Government should introduce a Universal Access Fund to provide incentives for banks to reach out to the fi nancially excluded.

The OFT review into high cost credit should investigate all parts of the alternative credit market, including pay-as-you-view arrangements, current arrangements which allow lenders to advertise a ‘typical APR’ to poor families but off er them a much higher rate for the product and look closely at how alternative credit providers infl uence customers into taking on more credit.

On savings:■ The Government should give benefi t

claimants the option of receiving a proportion of their benefi t or tax credit payment direct into a Savings Gateway account.

■ Claimants should also be given the option of payments continuing to be taken from their benefi t after they have paid off their Social Fund loan, with the payments going direct into their Savings Gateway accounts.

On the Social Fund:■ Barnardo’s proposes that a new

category of Social Fund loan is created, designed to provide small sums of credit quickly, simply and without complex eligibility criteria.

■ More support should be provided to those applying for a larger Social Fund loan. At this point, Jobcentre Plus should assess their needs and refer the applicants to assistance, such as debt or fi nancial capability advice, where necessary.

Conclusion

* All the quotes in this report are taken from Below the breadline: A year in the life of families in poverty Barnardo’s July 2009 www.barnardos.org.uk/belowthebreadlinereport

These steps would help families living in poverty, like the ones across the UK that Barnardo’s works with every day, to manage their money more effi ciently and cost-eff ectively, reduce the amount they pay in interest and help them to build savings. The Government will not meet its targets on child poverty without investing in tax credits to provide higher incomes to poor families. But an important part of the Government’s approach should be responding to the diffi culties that families face in living on a low income.

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Counting on credit

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This report was written by Tom StewartPolicy and Research UnitJuly 2009

Download the research report Below the breadline: A year in the life of families in poverty from www.barnardos.org.uk/belowthebreadlinereport

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