Nearly a quarter of households in the lowest income bracket are unable to borrow from the high-street banks and consequently often end up paying crippling amounts for credit. Pamela Lenton and Paul Mosley investigated the role of community development finance institutions in helping households to escape poverty and found that those which enabled clients to build up savings were most effective.
Can financial institutions provide an escape from the poverty trap? Our answer is: yes they can, in those cases where poverty is due to inability to access fair-priced sources of credit (‘financial exclusion’) and as long as they are properly designed. Our findings are based on a study of about 360 low-income households in four UK cities (Glasgow, Sheffield, Derby and Birmingham), interviewed both before the global recession in 2007 and then at its lowest point in 2009. We have thus been able to observe what fair-priced financial institutions can do to enable people to cope with sudden negative shocks to their income, and to understand something of what makes such interventions effective.
Around 12% of households overall – and nearly a quarter of households in the lowest income bracket earning less than £14,000 per annum are unable to borrow from the high-street banks. As a result, if they wish to borrow money they need to have recourse to doorstep lenders, loan sharks, payday lenders and others charging annual percentage rates well into the hundreds or even, in the case of the payday lender Wonga, well over 3000%. For the many that are already overwhelmed by debt and have no idea where to turn, the business of paying these enormous charges for credit may turn a barely manageable situation into a desperate one. The institutions available to help households deal with this predicament are of two kinds: credit unions, which often require members to make savings deposits and thereby exclude the very poorest, and community development finance institutions or CDFIs, which make small loans (averaging about £500) both for small business development and to ease the debts of low-income people typically existing on welfare benefits.
The issue on which we focus is that the manner in which a credit union or CDFI responds to this predicament may be crucial in determining whether a debt-afflicted household is able to escape from the debt trap or is pushed deeper into it. Our own study is solely concerned with CDFIs; but it acknowledges that often the most important contribution which they can make consists not just of money, but of advice and social connections. It is here that the links which CDFIs can make with other finance providers including credit unions come into the picture.
We studied six CDFIs in our four cities: Scotcash and DSL in Glasgow, Moneyline in Sheffield, Derby Loans, and 3Bs (Black Business Birmingham) and Halal Fund in Birmingham – lending to a total of 360 households. To assess the impact of this lending, we constructed a control group of a further 180 households living in similar neighbourhoods. Sixty-nine of the 360 loan-assisted households, against a national trend of declining average income, were able to escape from the poverty trap during our observation period 2007-09, in the sense of rising above the national poverty line of 60% of median income, or about £11500 at 2004 prices (about £14000 at current prices). Our core research question was to try and understand what attributes of CDFIs enabled them to do this.
We discovered, firstly, that the attribute which most clearly distinguished the households who escaped from poverty from those who did not was the ability to save, as this helped them build up an asset base which protected them against shocks. Those who escaped from poverty achieved, between 2007 and 2009, ten times the level of savings of those who did not escape, even though the initial levels of (equivalised) household income of escapees and non-escapees were very similar (i.e. about £10,500 per annum at 2004 prices, or well below the 2007 poverty line of about £11,500 at 2004 prices). This then focuses attention on what enabled these very poor escapees to nonetheless build up their savings. Here the key appears, on our findings, to be two things:
- The availability of money advice to enable people caught in the debt trap to manage their debts. Clients with access to such advice were much more likely to save, not only because it gave them better knowledge of the advantages of saving but because it tended, on our evidence, to help individuals develop a proactive rather than a passive attitude to crises in general and to controlling their debts in particular.
- The social networks in which CDFI clients were involved. Clients who reported that they were members of any social network (both formal networks such as trade unions and churches, and informal organisations such as bands and football teams) reported higher levels of saving than non-members, and we speculate that individuals who are socially isolated are more likely to succumb to a sense that their debts are outside their ability to control them.
We found that money advice was provided to very different degrees by different CDFIs, and in particular that Scotcash, the only CDFI which provided money advice as part of the loan package, was the only CDFI in our sample to exhibit both high rates of impact and rapid growth of loans. We therefore recommend that CDFIs should provide money advice as part of the loan package to starting clients, such that borrowing becomes part of a solution to the problem of debt rather than augmenting it; and that such initial small advice-backed loans should be the first step on a ‘staircase’ in which the loan size, as with many third world microfinance organisations, is gradually scaled up if and only if repayment performance is satisfactory. Social networks are not as easy to organise as money advice, but experimentally we feel that there is merit in organising meetings of borrowers, specifically in areas where doorstep lenders are known to be strong, for purposes of publicity and encouraging solidarity. This would provide the CDFI with valuable feedback and enable it to compete more effectively with doorstep lenders.
This article is a summary of a paper co-authored with Paul Mosley which appeared in the March issue of Urban Studies.
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About the Author
Pamela Lenton is a Lecturer of Economics at the University of Sheffield. Her research interests lie in the economics of education, labour economics and health. Most recently Pamela has focused on the areas of household debt and health and the problems faced by the financially excluded.