The UK has one of the lowest rates of household saving in the EU, despite being amongst the most developed countries. This seems inconsistent with a history of high participation in home ownership and a financial sector where regulation and consumer protection are globally admired. However, with an estimated 3m to 7m UK households using high cost credit products and with 1.5m people still unbanked Poor credit ratings and are unlikely to generate meaningful interest deposits or banking fees in the UK there appear to be significant coverage gaps in the traditional banking sector. So, what went wrong?

Why the lowest rates of household saving

The reasons for the current situation are broad and numerous. The economic factors of a continued boom, low inflation, low interest rates and continual house price growth created a ´false economy´ of easy credit and property nest eggs. A conspicuous consumption trend, with the emergence of social media as the channel of choice for sharing images of personal wealth also gave the spending boom further momentum.

Banks play a significant role in how customers access credit. Banks´ credit and lending models remain largely unchanged and are seen as outdated and inflexible against today´s changing customer needs. These rely on historical patterns of spending, fixed ratios of income to outgoings and often do not reflect customers´ specific circumstances. Add to this the past issues surrounding incentivized product sales for bank staff, and the ingredients exist for a heady debt cocktail.

Customers will complain that the alternatives to bank lending are too few, too expensive or too risky. At the risky end of the market, unregulated lenders are the last resort, though some may feel the only source of quick cash. The renaissance of pawnbrokers and the rent-to-buy market in High Streets across the UK, as well as the continued presence of high cost credit organisations offering loans at staggering rates of interest confirms the availability of expensive credit for those who are desperate or thinking only of the short term. The High Cost Credit market shows high levels of default, and a debt cycle where customers end up borrowing more to pay down loans that they are not servicing, eventually paying out more on interest than on repaying the loan. To put this into context, outstanding consumer credit lending was £210.6 billion at the end of April 2018. The household average for consumer credit debt in the UK is now £7,744 up around 7% from a year before. The costly and risky options are also too easily available to vulnerable customers. People ultimately make their own decisions, and no-one is forced to spend indiscriminately, but more could be done by oversight bodies to protect those most at risk, and to remove the worst choices altogether.

Alternatives to the traditional banking routines

Alternatives do exist, however. Since the unbanked are not entrenched in the traditional banking routines of branches, ATMs and credit cards, they are more likely to embrace digital banking on their phones. Banking will not only be provided to banks in these emerging customer segments. Orange, France’s largest telecom operator, has applied to expand its banking operations in Africa following the launch of a digital bank in its home country last year. Crowdfunding platforms will offer credit at bank-like rates with more of a social benefit attached, some with a credit history will be able to access these sources of funds but many in the ´sub-prime´ segment will not. Many of those who use high-cost credit options are doing so only because even these alternatives exclude them. Recent press coverage following the FCA´s review on High Cost Credit has highlighted the plight of people caught in a debt cycle and in need of help. Many called for further reaching action beyond the clarification and capping measures, but few solutions were offered.

The underlying issues are more complex, though the solutions need not be. A lack of financial education is at the root of many customers´ financial distress. A lack of understanding of basic components of loans, such as APR, coupled with a skills gap in budgeting sets a weak foundation. Added to this that some of the most vulnerable customers, many receiving government financial support, were until recently receiving cash payments compounds the issue with a lack of control over spending.

Personal Financial Management (PFM)

Banks will counter that Personal Financial Management (PFM) tools exist, and that they have invested heavily in offering tutorials on internet banking, online security and the like. They are business after all with a profit motive and shareholders hungry for returns, and have had to be much clearer on pricing and associated risks when offering lending products.

Education and tools are helpful for the financially literate, internet-enabled and banked among their customer base but do little to address those in most need of financial education. Recent announcement from a number of new-to-market banks have signalled their intent to focus on the ´financially forgotten´ – among them the unemployed, those with criminal records, immigrants, the financially distressed and otherwise unbanked.

Monzo in particular has targeted this segment as a future focus for their expanding client base. FinExos, a financial inclusion start-up, is aiming to go further and help customers in financial distress in the current system to help themselves back to financial stability through a combination of education, tools and control over spending. FinExos´ Founder Mark Fisher set out the challenge and potential solution succinctly. “Customers have been let down by a combination of available credit and pressure to consume. This has resulted in many living beyond their means with little prospect of recovering to a position of financial stability. Financial education is at the core of reversing this trend. We all have a duty to educate the consumer and provide adequate spending power to use financial services as and when needed. The primary objective should be the retrospective education generations past and present to take better control of their finances. A stronger consumer base equals a stronger economy.”

The habit-forming good behaviours encouraged by platforms such as FinExos, Neybar and others address both the root causes and the symptoms of the debt cycle. They do this in four key ways:

1. By prioritising the servicing of existing debt, the customer avoids getting further into financial distress by missing loan repayments or other regular outgoings required to remain solvent.
2. Debt consolidation can also shift the balance of capital and interest repayment more towards paying down the loan so that over time the debt reduces and the customer becomes more creditworthy. This is an important step, as credit is priced based on risk, and therefore the more creditworthy can access lower-priced loans which are more affordable and can be repaid in less time.
3. By applying spending controls on remaining disposable income, the customer learns how to better manage money and avoids becoming financially stretched.
4. As the financial literacy and education scores increase, supported by tutorials and tests to confirm that the behaviours are becoming embedded, the controls are gradually eased so that the customer has greater financial freedom. Over time, this promotes more sustained financial wellbeing.

In addition to the economic benefits of reducing loan impairments and the uptick in consumption enabled through freeing up of disposable income of customers as they progress through to better stability, there are important social benefits to this approach.

Debt Spiral

Financial and Mental Health show strong signs of correlation, both from the point of view of wellbeing and also the ability of those not feeling anxious or confused to make good financial decisions. This in turn over time will reduce the number of unbanked, and reduce the demand for the unregulated services that they are offered. With more customers in the regulated system, they can benefit from better protection and avoid regressing into the debt spiral.

Money Management Platform

An intuitive money management platform with financial education built in will not cure all customers and will not prevent the determined from making poor spending decisions. However, if the UK is serious about helping the millions of households who feel trapped in the debt cycle, and is focused on improving on its lowly position in the European savings league table, then it is a good place to start.

Source: Statistics Archive – The Money Charity. April 2018 latest figures

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