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A new UK Government report questions whether the restrictions that credit unions are currently subject to leaves them in a financially unsustainable position. The interest rates that they can charge are currently capped at 2% per month (an APR of 26.4%). It’s believed that this restriction makes the provision of smaller loans uneconomical. It’s proposed that the cap be increased to 3% per month (an APR of 42%) to solve this problem. The interest cost of a one year £400 loan at 2% per month is £54, which would rise to £82 at 3% per month according to The Guardian.
This report comes at a time when the Accountant in Bankruptcy is consulting on whether credit union debts should continue to be included in protected trust deeds and bankruptcies in Scotland. There is a concern that credit unions are especially financially vulnerable to the losses they may suffer when this occurs. A 2009 review of a sample of protected trust deeds determined that only 0.2% of the debts included were in fact owed to credit unions. However, AIB analysis suggests that because their interest rates are capped a credit union may need to “lend and recover over £350,000 in a year to cover the cost of a £7,000 debt that is written-off”.
The UK Government and AIB interest in the subject of credit unions is timely. Scottish trust deed firms are increasingly working with clients that have accumulated significant totals of high-cost credit from payday and doorstep lenders. Without the support of high street banks providing affordable smaller loans, people are increasingly turning to high-cost credit when inevitable short-term financial needs arise. The high interest costs and ease of rolling over such credit has become a recipe for indebtedness.
Credit unions have much potential to deal with the cause and symptoms of this growing problem. By encouraging regular saving, members of credit unions are more likely to have an emergency fund available to them when short-term financial needs arise (and therefore possibly avoid borrowing at all). If borrowing is necessary, it can be sourced at a reasonable and affordable rate rather than at the enormous APR’s charged by payday and doorstep lenders.
Credit unions might therefore have a huge role to play in helping people avoid the need to ever enter into Scottish trust deeds or bankruptcy. They are also well positioned to help people manage financially throughout the term of a trust deed (assuming that they’ll allow insolvent persons to become members of course). Following protected trust deeds or bankruptcy, credit unions can do much to help restore access to the responsible use of affordable credit, a resource that most people will require from time to time.
There is a clear case to allow credit unions greater flexibility on their interest rates to ensure their viability and therefore to encourage increasing membership amongst the public. But should credit unions also be protected from trust deeds or bankruptcy? Is there a risk that such an exclusion could weaken the need for credit unions to check that members can afford to repay loans before advancing the money? If credit unions are allowed to charge a more commercial interest rate, should they be protected in a way that other creditors are not? Is it fair to other creditors that the continued repayment of a credit union debt might significantly reduce any dividend subsequently due to them?
It will be interesting to see whether credit unions are treated differently in insolvency in the future. Perhaps the most important area for attention now however is to promote credit union membership to the public. Currently only between 2% and 3% of the UK adult population are members. It seems very likely that greatly widening credit union membership in the future would be a significant step towards reducing the use of Scottish trust deeds and bankruptcy in the long-run.