Financial Exclusion 1. Introduction Financial exclusion refers to the notion that significant numbers of people are excluded from financial services of one sort or another: from particular sources of credit, insurance, bill-payment services and accessible and appropriate deposit accounts. They may be excluded as a result of the policies and behaviour of the financial services industry or they may be 'self-excluded' because of the type of financial products available, or because of their assumptions about the likely behaviour of financial institutions. That is, they might not apply for financial services because they assume they will be rejected. The term refers particularly to poor members of the community, for whom financial exclusion is just one aspect of general deprivation. Thus, financial exclusion is a major element within the idea of 'social exclusion', to enquire into which the current government has set up a task force. The term 'social exclusion' refers to the processes that cause a lack of economic, political or social citizenship1. These are defined, in turn, as follows: • economic citizenship includes access to good-quality employment and financial services; • political citizenship refers to the capacity to influence processes of decision-making that affect one's own life; • social citizenship includes a sense of belonging and the ability to maintain supportive social networks. (see Rogaly et al) page 3. Thus, social exclusion is not identical to poverty, although the two ideas are closely linked. The standard indicator of 'financial exclusion' is the lack of a bank or building society account, either a current or savings account. About three million people fall into this category in Britain. Between 14 and 23 per cent of the population do not have a current account. However, there are other possible indicators. For example, one in three households has no home and contents insurance, one in four has little or no savings, and one in three people does not have pension arrangements. A major study by the Joseph Rowntree Foundation showed that as many as 1.5 million homes - one in 14 - make no use of financial services at all and that 4.4 million households - one in 5 - use just one or two services. People can also be regarded as financially excluded if they are unable to obtain a mortgage or other types of loan from a bank or building society. They are either unable to borrow or are able to borrow only at much higher rates of interest than are available from banks and building societies. People who are financially excluded are also likely to lack 'financial literacy'. This 'includes a knowledge of sources of credit and rights in relation to specific creditors, budgeting skills and an understanding of basic financial terminology, such as annual percentage rates for comparison of borrowing costs'.2 2. The causes of financial exclusion Social exclusion in Britain has grown alongside the growth in poverty in the period since 1979. Between 1979 and 1994/5, the real incomes of the poorest ten per cent of the British population fell by 8 per cent, while average real incomes rose significantly. In terms of both income and wealth, Britain became more unequal through the 1980s and 1 see Rogaly et al, pp 8-9 2 Rogaly et al, p. 23 early 1990s, and more unequal more rapidly than in any country in the world except New Zealand. Thus, one cause of financial exclusion has been the growth of poverty. Clearly, however, a number of people are excluded from financial services by the actions of the financial institutions. People who are refused loans can be said to be credit rationed. We looked, last week, at a possible explanation of a refusal by banks to lend. This was the lack of information possessed by financial institutions about the default risk associated with potential borrowers. We particularly mentioned the problem of asymmetric information in this connection. In theory, a lender should add a risk premium to the interest charged on each loan to reflect the default risk of the particular borrower. However, since default risk is difficult and costly to assess, this cannot be done with any confidence. Thus, we said last week, banks have two options. The first is to treat all borrowers as homogeneous and to lend to all at the same rate of interest, a rate of interest that takes into account the average level of risk faced by the lender. The problem with this is that good risks will be charged too high a rate and 'niche lenders' will compete these good risks away from the banks, with the result that the average riskiness of banks' portfolios of loans will become more risky. The second possible policy is to place people into broad categories intended to reflect the degree of risk generally associated with these categories. Then it would be possible to vary the risk premium for different groups of borrowers or, much more simply, to refuse to lend to high-risk groups. Varying the risk premium for different groups still leaves open the possibility that potential borrowers who are better than average risks within any category will either be put off borrowing or might seek to borrow from a more specialized lender. The path of credit rationing will often be the cheapest and most secure policy for banks to follow. The next question, then, is how to recognize high-risk groups. In recent years, the decision-making of banks has become much more centralized. Banks and building societies have amalgamated leading to many branch closures. Local bank branches were then steadily reduced in importance as banking habits changed with financial innovation. For example, the widespread use of automatic teller machines (ATMs) to obtain cash reduced the need for people to visit bank branches. Initially, smaller bank branches remained open but many services including the granting of loans were centralized. This meant a loss of local information about potential borrowers. Later, bank branches were closed in large numbers. This came about largely because of increased competition faced by banks. This was the result of globalization, deregulation and technological change, which have led to rationalization, mergers and new entrants. “New competitors, ranging from telephone banks and insurance providers to supermarkets, utilities and other service companies like British Airways, often use the extensive growth of customer databases to target the lucrative parts of financial services markets”.3 Faced with this sort of competition, the banks have sought to retain their most profitable customers and to reduce costs by closing branches, at the expense of less profitable customers, notably the poor who are not in the market for the highly profitable financial products. The loss of local knowledge increased the degree of asymmetry of information. Banks moved to the assessment of default risk based on the responses to questions on standard application forms. These forms were processed by computer and loans were offered according to points allocated for the various responses. We shall look at some of the implications of this later. Banks also refuse to allow some customers to open accounts. This might seem a little more difficult to explain. However, one needs only to realize that banks do not make profits from ordinary accounts with low average balances, especially if there are frequent small deposits into and withdrawals from them and frequent requests to know the current balance. Banks offer accounts in the hope of selling other, profitable, 3 Rogaly et al, p.27 financial services to their clients - loans (to people with low default risk), credit cards, insurance and financial investments. Given that people seldom change banks, the banks are happy to offer accounts to people who currently make use of few of their services, but who can be expected to do so in the future - such as university students. However, many poor people are clearly unlikely ever to be in that position and so are unlikely to be welcomed by banks. Things were complicated by the introduction in 1993 of strict rules to combat money laundering. Before allowing a person to open an account, banks and building societies are required to see proof of identity and evidence of the person's address. Some banks require new customers to produce a driving licence and a passport, which the less affluent might not possess. More commonly, a driving licence and a utility bill bearing name and address are sufficient but even this can cause problems. For example, the Guardian reported the case of a disabled, unemployed ex-soldier, a seller of The Big Issue, who had a government cheque for £17,366 in backdated disability pension and a regular pension. Nonetheless, he was unable an account at HSBC, Lloyds, Barclays or NatWest. The ex-soldier lived in a housing collective and had neither a driving licence nor a utility bill bearing his name and address. He presented his army certificate of service and letters bearing his name and address from his landlord and local council, but these were deemed insufficient by all four banks. Another case reported in the press was that of a recently divorced woman with a cheque for £21,000 after the sale of her home, who was turned away by every bank and building society she approached, again because she did not have the correct identification. Banks argue that they are simply conforming to legislation and the British Bankers Association is to produce a leaflet - You and your proof of identity - to make it easier for both branch staff and their customers, to allow accounts to be opened. However, there is a strong suspicion that banks sometimes make use of the law to provide a pretext for denying accounts to people who appear unlikely to provide profits for the bank. We need to note as well that many households fail to make use of financial services because of an ingrained suspicion of financial institutions. Again, some people exclude themselves because they believe that banks will deny them an account, whether this view is justified or not. In addition, as bank branches have closed, older people with no private transport have found it more difficult and expensive to get to banks or even to cash machines. This is particularly true in rural areas. There are stories of four-mile bus journeys to reach the nearest cash point. The movement of banks to telephone banking and now to internet banking seems certain to make the problem of financial exclusion worse. The branch network seems likely to continue to shrink. Those banks that remain in the High Street are likely to continue to evolve away from providers of basic financial services into sales offices. In addition, the government is encouraging plans to automate all social security payments by 2003 to 2005. This will reduce the Post Office role in cashing benefit cheques and put greater emphasis on facilities provided by banks and building societies. The lack of a bank account will require people to make use of the expensive facilities of specialist cheque-cashing firms. 3. Who are the financially excluded? The hardcore of the financial underclass is easy to identify. Bristol University Personal Finance Research Centre found that 80 per cent of the financially excluded live in council or housing association accommodation. Half live in the 50 most deprived boroughs in the UK. Typically, they are lone parents, unemployed or elderly with incomes of less than £150 per week. Members of ethnic minorities also do much worse than average in their use of financial services. If lone parents work, they tend to be part of the 'flexible' workforce. They have low incomes. They pay more for food and clothes, as lack of transport rules out large supermarkets and other large stores. They pay more for gas because they often do not have bank accounts and so cannot obtain direct debit reductions. One source suggests that the lack of a direct debit facility costs a family £5 per week on average in lost discount. The financially excluded are only half as likely as other householders to be owner-occupiers. Should they borrow for luxuries, they pay very high annual rates of interest. In an address to the Association of British Credit Unions in March 2000, Howard Davies, the Chairman of the Financial Services Authority, told the following story from his time as Deputy Chairman of a Joseph Rowntree enquiry into the distribution of income and wealth in 1995: “As part of that enquiry I went to visit an institution in a northern city which specialised in the provision of finance to low income consumers. And I took with me a senior Treasury official, who was intrigued by what we were doing. Our hosts explained to us that their main business was short term loans, with an average maturity of twelve months and repayments collected weekly, door to door. The average loan advance was around £300 – the price of a modest washing machine. The Treasury official asked what the typical APR was, speculating that it would be quite high. I enquired what figure she had in mind. Oh, she said, 30, perhaps even 40%? The true figure was, in fact, 150%. So, for the single parent on a down at heel estate, a £300 washing machine costs £450.” Indeed, rates of up to 500 per cent a year have been charged on legal, weekly- collected credit. Interest rates can be much higher still from local loan sharks. The unemployed do particularly badly in credit-rating systems because applicants for loans are frequently required to have three years' employment records and wage slips. This adds to the problems they face because of their poverty in any dealings with the financial services industry. Among members of ethnic minorities, people classifying themselves as Pakistani are four times less likely to have a bank account than their white counterparts. Indians are two times less likely and Bangladeshis three times less likely. Bank accounts are a reference point for mortgage companies. Anyone without one has a very difficult time in obtaining a mortgage. Asian families suffer financial exclusion if they work in the family business since they, too, are unlikely to have three years' employment records and wage slips. References will often be supplied by someone with the same name, causing suspicion that financial information is being supported by other family members. Banks and building societies also take a dim view of houses that have been redesigned to cope with an extended family of several generations. In addition to these groups, there are also growing numbers of financial 'square pegs'. These are people who have the resources to repay loans and mortgages, but whose irregular employment and earnings records create difficulties with High Street banks and building societies using sophisticated risk assessment techniques such as financial profiling and credit scoring as calculated by computers. People excluded from credit thus include highly paid freelances in areas such as information technology, design and journalism, as well as people who change jobs frequently. The Guardian quote the case of a media agency boss, who was refused a mortgage because he had been in his job for less than six months - although he had moved jobs to increase his earnings. One in six of the workforce is self-employed or in contract work and these are stuck in the Government's new Social Class 4: small employers and own-account workers. Unless they can produce three years of audited accounts, they are forced to take out loans with 'niche lenders', which can cost half as much again as those on offer to employees. 4. The Costs of Financial Exclusion The costs of financial exclusion range from the need to pay two to three per cent per annum extra on mortgage loans to the inability to obtain loans at all from regular sources, leading to borrowing from loan sharks at rates above 500 per cent per annum. Stories abound of loan sharks and their minders gathering around social security offices to retain the DSS books they hold as security for their loans - the only means of obtaining credit in some disadvantaged communities. Interest payments of this level trap people in a spiral of debt, which makes it impossible to build up savings. The absence of bank accounts and savings makes any sort of financial planning impossible and adds to the expense of living in a variety of ways. Many things are paid for in instalments or by accumulating stamps, often at very high implicit rates of interest. Uncertainty in every day life is greatly increased, further lowering the quality of life. The lack of insurance and superannuation arrangements add to the problems brought on by ill health and old age. 5. Possible Remedies Action that could be taken includes improving access to bank accounts, encouraging credit unions and working in partnership with debt and finance institutions to develop local businesses. Credit unions are the main alternative to banks and building societies for people who want to borrow for personal reasons. There are more than 800 of them in the UK and their membership is increasing by a fifth each year. In Great Britain the number of credit unions has risen by almost 50% in the last five years, the number of members has grown 2½ times, and the asset base has increased 3½ times from just over £40 million to around £150 million. This is a compound annual growth rate of 25%, which compares with only 10% for the major British banks over the same period4. Nonetheless, the credit union sector remains very small in Britain relative to those in other comparable countries such as the USA, Australia and Canada. In both Canada and Australia, around 30% of the economically active population are members of credit unions. In Britain, membership of just over ¼ million is still considerably less than 1% of the working population. Other 'micro credit' organizations have been launched in the past few years to offer small loans to self-employed starting their own businesses. One such organization is the Norwich-based Full Circle (see the article by Rachel Baird, 1999). The government produced a report, Access to Financial Services, on financial exclusion in 1999 as part of its plan to tackle social exclusion in society. This followed the release of a large report on enterprise and social exclusion. This report is available on the web (see below). It also intends to issue a leaflet explaining the flexibility banks and building societies can employ when deciding whether to open an account for an individual. Banks and building societies will be encouraged to set up simple, low-cost accounts targeted at the people without banking facilities. The Treasury later required banks to introduce basic accounts by the end of October 2000 as well as taking part in a government initiative known as the Universal Bank. Although one or two of the banks were a little slow, all have now announced the establishment of such accounts. The accounts can usually be opened regardless of credit-rating. Some form of identification is needed, although several of the banks have relaxed their rules on this. For example, Lloyds TSB now accept, in addition to a passport or driving licence, pension books, recognized ID cards with photo and signature and the new-style orange disabled drivers passes with photos. The Bank of Scotland accepts a birth certificate plus a recent utility bill with their name and address. The main features of the accounts are: 1. fee-free: no charges for everyday transactions; 2. no credit facility, helping to prevent customers from getting into debt; no overdrafts; at most, some of the accounts offer a £10 buffer zone, so that you can draw all of your money (down to the last £) from a cash machine. 3. wages or other regular income can be paid directly into the account; 4 These figures are taken from the speech by Howard Davies – see references 4. a cashpoint card is usually included, giving access to cash at convenient access points; 5. cheques and cash can be paid into the accounts by the account-holder; 6. direct debits can be set up on the accounts so people can pay bills in this way and save money; 7. some of the accounts provide a debit card, allowing people to pay for goods and services in shops; 8. some accounts pay interest on credit balances and offer free telephone and internet banking. The banks will make little money from these accounts and critics argue that there is thus no incentive for them to promote the accounts. However, the government says that it will be watching to make sure the banks tell people about the existence of the accounts. Some banks are clearly promoting the accounts. For example, the Bank of Scotland has introduced a pioneering face-to-face financial advice and information service for the residents of Glasgow’s Easterhouse estate. The Bank of Scotland’s basic account was launched in March 1998 and was held by around 130,000 people by October 2000. Also, Barclays has teamed up with Salford City Council, the University of Salford and several housing associations to make opening an account as easy as possible by providing assistance with filling in application forms and organizing proof of identity.5 Another way of tackling both social and financial exclusion is the development of time banks. Time banks use a broker at the end of a telephone and allow people to earn time credits for each hour they help out in their local community. Credits can be spent on help for yourself when you need it, or donated back to the system (most is). Because time banks match an hour for an hour, everyone has something to offer and there is no distinction between givers and receivers. Time banks make it possible for people – especially older people – to ask for help. By measuring people’s effort and feeding it back to them, time banks have been successful in attracting people who don’t volunteer. Time credits are tax-free and can be accumulated to pay for health care and other services. The idea originated in the USA and has also grown in the USA. It is new to the UK, the first time bank being less than two years old, although there are now a dozen in operation. 5 Jones, p. 8-9 Sources Rachel Baird, 'Clean money, clear conscience', New Statesman, September 13, 1999 Patrick Collinson and Tony Levene, 'Can pay, will pay, can't get', The Guardian, Saturday, December 5, 1998 Rupert Jones, “Back to basics grows on the high street” Guardian, 28/10/2000 Jobs and Money supplement, p. 8-9 Neasa MacErlean, 'How you'll learn to love your warm, cuddly bank,' The Observer, October 3, 1999 Ben Rogaly, Thomas Fisher and Ed Mayo, Poverty, Social Exclusion and Microfinance in Britain, Oxford: Oxfam and New Economics Foundation, 1999 Speech by Howard Davies, Chairman, Financial Services Authority, to the Association Of British Credit Unions Limited Annual Conference and AGM, Caird Hall, Dundee, Scotland Friday 3 March 2000. Text available on the FSA website: www.fsa.gov.uk The government report, Enterprise and Social Exclusion (1999) can be downloaded from: http://www.hm-treasury.gov.uk/docs/1999/pat3.html Other websites you might try include: http://barataria.org.uk/exclusion.htm http://www.lhu.org.uk/LHN80articles/Financialexclusion.htm For information on time banks (including the possibility of donating time to a national time bank charity), consult the following: www.funny-money.co.uk www.fairshares.org.uk www.timedollar.org www.timebank.co.uk www.timemoney.co.uk The funny money site also has useful links.