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Building credit with the public sector

Mark Morrin, localism lead and principal research consultant at ResPublica, makes the case for salary-deducted lending to sit alongside a broader set of savings programmes as a solution to indebtedness.

Consumer debt and the cost of financing it is one crucial mainstay of place-based disadvantage. In our report, ‘Credit Emancipation,’ we identified that poor credit ratings are disproportionally concentrated in the most deprived communities. This means that the most financially vulnerable are excluded from mainstream borrowing and exposed to the most penal levels of interest on debt repayments across a range of products, including payday loans, overdrafts, rent-to-own, guarantor loans, store cards, and home collected credit.

This finding is not surprising given that the factors which determine area deprivation are also very important determinants of credit scores. However, this strong relationship, although not directly causal, does suggest that there is potential for improving the social and economic characteristics of an area by building credit.

In making the case for a place-based approach to the problems of unaffordable debt, we have argued that improving credit scores at the neighbourhood or local authority level can help to turn around disadvantaged communities. By connecting residents to comprehensive credit-building resources and financial education services, places can seek to uplift their average credit rating. This would improve access to affordable finance, reducing the amounts of money required to service debt and allowing more to circulate within households and local economies.

An improvement in a local authority’s aggregate credit rating, from the bottom 10% to the middle of the credit score distribution, would equate to improving median weekly earnings by just over 9%. This would represent a welcome boost to living standards at a time when real wage growth has struggled to keep ahead of inflation.

In addressing how local credit-building strategies can help individuals and households take control of their financial lives, we have focused on the role of large public- and private-sector employers. Salary-deducted lending – a scheme where employees can apply for loans to be delivered through their employer’s payroll mechanism – alongside a broader set of savings and financial education programmes, has the potential to make workplaces more productive and local communities more prosperous.

There is mounting evidence that borrowers are displaying signs of financial distress and that money problems are having a negative impact on the nation’s mental health, as well as workforce productivity. The Money and Mental Health Policy Institute has identified that a quarter of the UK workforce are, to some extent, experiencing financial insecurity – which is contributing to the loss of 17.5 million working hours, across both the public and private sectors, as employees take time off due to financial stress. The CIPD has also estimated that 30% of public-sector employees are experiencing financial problems affecting their work performance (compared with 25% in the private sector).

The payback to employers in making financial products and services available as additional employee benefits are clear. Apart from the immediate productivity returns of a healthier and happier workforce, employers can expect a significant reduction in staff turnover and consequent recruitment costs.

The expansion of salary-deducted lending in the UK economy is of particular interest. As a new source of consumer finance, it has the potential to substitute for other forms of lending at substantially lower rates of interest. A shift of £10bn of lending – about 5% of the UK’s total consumer debt – from other forms of credit to salary-deducted loans would reduce debt service costs by around £2bn.

Our analysis is based on the plausible working assumption of a recent Harvard study that customers switching from other forms of credit to a salary-linked loan save about two-thirds of the interest costs which they would otherwise have paid (i.e. 9.9% compared with 29.7% APR, although some payday lenders charge 1500% APR). This figure is significantly greater than the £200m savings per year which the Financial Conduct Authority aims to achieve with its current proposals to further reform the high-cost credit market.

These £2bn savings would increase borrowers’ disposable income, leading to an increase in consumer spending of around £1bn, an increase in GDP of around £1.5bn, an improvement in the public finances (tax receipts net of public spending) of £600m, and the creation of 53,000 full-time equivalent jobs.

An expansion of salary-deducted lending has the potential to reduce regional inequalities as well as reducing wealth inequalities between households by helping users to save money and bridge capital to mortgages and pensions. What’s more, the savings benefits are strongly progressive to those households towards the bottom of the wealth distribution.

There are a growing number of public-sector employers now offering salary-linked lending and wider support for financial wellbeing. But there are few instances in the UK of a whole-system, place-based approach to credit-building and financial capability.

Newham’s MoneyWorks programme is one example of an area-based intervention that aims to tackle the associated problems of indebtedness and poor credit. In the US, the City of Boston is currently undertaking a programme to address the deep structural problems associated with poor credit ratings. Boston Builds Credit is an initiative that aims to move a third of the city’s residents from a poor to prime credit rating.

We have recommended that all local authorities should take a place-based approach to credit-building and that all public-sector employers should adopt salary-deducted lending and savings systems and promote financial education in the workplace. The public sector should seek to lever these benefits by including them as an indicator of social value in their assessment process for public procurement, and use their convening power to encourage private employers to follow suit.

Freedom from high-cost credit and indebtedness for the most vulnerable citizens in our most disadvantaged communities could be achieved with a whole-place approach to credit-building and financial education.

This would require an area-based strategy to include large employers and target priority groups with coordinated and effective measures to both combat the effects and prevent the causes of debt. It would also necessitate the integration of existing services, including public, private and community-based resources, to build a single system with multiple points of access.

Building good credit will not solve all financial difficulties or eradicate the root cause of inequalities which contribute to financial exclusion and indebtedness. But with a focus on the problems of poor credit, it is possible to build the capability to manage finances more effectively and eradicate the predatory high-cost credit market.

And unlike many aspects of inequality, improving credit is relatively straightforward to achieve if certain habits and behaviours are adopted.

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