April 9, 2014
How to wave Wonga goodbye
Pay day lenders pepper the high streets of the country’s poorest neighbourhoods. They justify their business model on the premise that they serve a segment of the market that would otherwise have no access to credit. This was the precisely same situation that faced deprived neighbourhoods in the US during the 1960’s – the banks had ‘redlined’ these neighbourhoods and refused to do business with anyone living there. Civic rights groups embarked on a course of action that could still apply here and which would see the end of these legalised loan sharks.
In 1960s America, if you lived in the wrong neighbourhood, you wouldn’t get credit. The practice of redlining blocked lending in particular areas – a red line on a map circled ‘unsafe’ zones where lenders wouldn’t go. And evidence grew of low income neighbourhoods, and in particular African American communities, only getting access to loans and mortgages on less favourable terms.
After campaigning from civil rights groups, the US government took action, and in 1977 passed the Community Reinvestment Act. It requires financial institutions to help meet the needs of borrowers in all segments of the communities they operate in, including low-income neighbourhoods. They are required to do so in line with safe and sound practices, and their compliance with the Act is taken into account when banks apply for mergers and acquisitions, or to open new branches.
The legislation was strengthened in the early 90s, with the creation of the US Treasury Community Development Finance Institution (CDFI) fund, to help fill finance gaps. The Act is widely credited with having extended financial services to communities that previously struggled to access them. Since its introduction the CRA has facilitated more than $6tn in lending and in 2012 facilitated 5.9 million small business loans.
Key players in the UK community development sector have long been calling for similar legislation here. Are we any closer to achieving this, and do we still need an Act for the UK?
Access to credit has remained a headline grabbing story in the UK over the past five years. The inability of small businesses to get finance and the huge numbers of consumers turning to payday lenders is problematic for national, local and indeed household economies. It means businesses are not growing and jobs are not being created, and money is draining away from our poorest neighbourhoods. We may not be experiencing redlining, but we are experiencing market failure. We have a small number of large finance providers dominating the market; given the still high barriers to entry for new ‘challenger’ banks and the market disadvantages for alternative finance providers, there is a strong case to be made for using legislation to re-balance the market.
The Community Development Finance Association (CDFA) is working with partners in the Community Investment Coalition (CIC) to raise awareness of how new legislation could work for the UK. At the end of 2013 the CDFA and CIC hosted a visit from three instrumental actors in the US (Joy Hoffman, Jeff Nugent, and Mark Pinsky) to share their lessons from the CRA.
What the UK can learn from the US
Dissatisfaction with banks has led to the rise of payday lending
Discussions highlighted four key elements of the CRA that have helped its success in the US, and that need to be replicated in the UK:
1. The importance of transparency
2. The crucial role for an independent regulator to oversee and scrutinise disclosure
3. The need for formal partnerships between key actors
4. The pivotal role of a government-backed CDFI fund
The CDFA hosted fruitful meetings between the US delegation and the main political parties, which elicited cross party interest and support. Perhaps the time has finally come for the UK to legislate for change. Indeed Labour policy is already committed to new banking solutions; meanwhile, the coalition government’s introduction of the voluntary agreement with the British Bankers’ Association (BBA) to disclose bank lending data is a positive first step.
So while progress is being made, action is needed in four key areas:
1. Transparency: In the US the disclosure of lending data, including geography, ethnicity, and gender has enabled the identification and targeting of markets that were receiving little investment. Following the recent UK voluntary agreement, the BBA and Council of Mortgage Lenders released the first lending data in December 2013. Data has been provided at an aggregate level and individually by seven of the largest banks, detailing loans and overdrafts to SMEs, mortgages, and unsecured personal loans (by first half of the post code plus one digit). It is an important first step in transparency that will enable other finance providers, such as CDFIs, to understand where investment should be targeted. Work is currently underway to analyse the data, and assess if it is of sufficient quality and comprehensive enough to be useful and relevant.
2. Independent regulator to oversee and scrutinise disclosure: Since the legislation was introduced in the US, the Federal Reserve Bank has overseen the data disclosure, testing it for discriminatory behaviour and managing on-going compliance. This role of an impartial regulator has been crucial in holding banks accountable and ensuring that fair lending standards are maintained. An equivalent role is needed in the UK. The CDFA is calling for the Financial Conduct Authority and Bank of England to play this role and ensure the continuity and quality of disclosed lending data.
3. Formal partnerships between key actors: An important policy decision that proved powerful in advancing community finance in the US was the establishment of partnerships between stakeholders such as banks, private companies and CDFIs. The US experience suggests that a neutral, respected convener is needed to bring stakeholders to the table and mediate the conversation on addressing the market gaps. In the absence of a requirement for these parties to work together (which the CRA ensures in the US), voluntary engagement will require strong, impartial and legitimate leadership. There is a clear role here for the treasury.
4. The pivotal role of a government-backed CDFI fund: The US CDFI Fund has been an important force in allowing CDFIs to operate sustainably by providing them with equity, managing guarantee programmes, providing capacity building training and tax relief programmes. Bodies such as the Federation of Small Businesses and British Chambers of Commerce have requested a similar fund for the UK. The CDFA is now calling for a dedicated community finance facility of £150m as a base for leveraging significant private sector investment.
A role for local groups? US regulations give community groups the right to comment on or protest about banks’ non-compliance with the CRA. Such comments can help or hinder banks’ planned expansions.
In the UK local groups can take advantage of the data that has already been disclosed, and encourage councils and local enterprise partnerships (Leps) to do the same. Understanding the geography of local lending can provide powerful information for planning and funding decisions – for example, for financial inclusion programmes.
Long-running debates over a CRA for the UK have moved on in recent months. We now need to seize the opportunity offered by voluntary disclosure and renewed political interest, to ensure that this translates into improved access to financial services in every neighbourhood.