The Financial Inclusion Centre (The Centre) believes that the UK financial markets need to be reformed so they are fair, efficient and inclusive and work for society not just the few. We would argue that these objectives can be best achieved through the ‘holy trinity’ of reforms: better regulation; enhanced corporate governance and ethics; and market forces – we need to get competition working better for consumers and innovation that meets the needs of consumers not just the business models of firms.
On the theme of innovation, there is certainly plenty of resources and activity focused on product development. Much financial activity is socially useful but much innovation in our view has been of doubtful value for consumers.
But one of the issues that concern us most is the lack of what we call ‘social purpose financial innovation’ – that is, innovation designed to meet public policy needs such as financial exclusion or the housing crisis rather than just market needs.
The need for social purpose innovation will take on even more importance due to the new economic and financial reality I’ve written about before –a confluence of socio-economic, demographic and financial trends including poor economic growth, low financial returns, austerity measures, expensive legacy business models, the legacy of household debt, squeezed household incomes, changing labour markets with the rise in zero hour contracts and workers facing more uncertain, unpredictable earnings, and so on. The result of this will be a growing number of consumers who are not commercially viable for ‘mainstream’ financial services underprovided for important financial needs, facing financial exclusion and/ or being targeted by more unscrupulous financial providers. Added to this, we face one of the most challenging housing problems for decades with a chronic lack of supply of affordable homes – whether for buying or renting.
To be blunt, the future does look bleak for many households and this might read like a counsel of despair. But we can make a difference if we confront these huge challenges head on and develop radical and innovative solutions to meet the needs of these groups. There are a number of specific initiatives which could address the problems outlined above.
Social investment bonds
One of the main reasons behind the growth in payday lending is the gap between the need for borrowing and the current capacity of community lenders such as credit unions and CDFIs to meet that need. The comparatively huge resources available to payday lenders mean they are filling that gap to the serious detriment of many households. The Centre wants to promote the development of social investment bonds (SIBs) in the UK to help community lenders compete properly and meet the needs of more households.The SIB model is well established in the USA and combines financial innovation with a clear, social purpose. SIBs are aimed at private investors (such as philanthropists, ethical investors and pension funds) and can be structured to provide investors with a reasonable financial return and channel investment to community lenders to lend to households.
We are confident that the community lending sector can innovate and provide a real, viable alternative to payday lending but the sector desperately needs additional funding to close the needs gap.
New forms of financial intermediation and housing bonds
It goes without saying that the housing shortage is one of the biggest public policy problems facing us now. There is no getting away from it but dealing with the housing shortage will require funding on a massive scale. Funding social housing is a particular challenge.
Again, this is an area where we think financial expertise and innovative thinking could provide immense benefit to society. We need to grow alternative forms of financial intermediation to complement traditional forms of bank lending.
One logical way is to develop social housing bonds. There have been some interesting developments in this field – for example the M&G housing bonds – but this is only a small fraction of what is needed. To face the social housing challenge, we need to map the needs properly so we know where to direct social housing finance and create social housing bonds to channel the funding to meet those needs. An effective way of doing this is to create partnerships between local authorities, social housing providers and financial institution to help manufacture, issue and manage the bonds.
The simplest and most economically efficient way would be for government to issue special housing gilts to finance massive house building programme. But, this is unlikely to be popular given fears about the possible impact on public finances. This is of course is illogical given that house building has to be funded in some way and just because it is not funded through the state’s books doesn’t make the cost disappear – the cost just has to be funded through private sector funding which is more expensive than funding through the state. But this is unlikely to be politically palatable. Alternatively, another cost efficient way of raising social housing funds would be to enable National Savings & Investments (NS&I) to issue dedicated social housing bonds paying a decent rate derived from the revenues provided by fair social rents. Some NS&I products do count against the national debt but it would be perceived as one remove from the state.
Designing more relevant products
One of the more difficult challenges for the financial industry will be designing products which meet the changing needs of consumers. The business models of many mainstream financial providers, product features and charging structures are built around the idea of workers having progressive careers and predictable, rising earnings. This is no longer the case for growing numbers of workers who face more uncertain, unpredictable futures. The question now is whether the financial sector can develop and distribute products that are more flexible but at the same time provide good value.
Innovation in distribution and new partnerships
The fourth area where we think much good work can be done is in creating new forms of distribution to extend reach to underserved or excluded groups of consumers. Distribution and ‘persuasion’ costs make up a huge chunk of the total costs of manufacturing and selling financial products. As outlined above, we fear that growing numbers of households are becoming commercially unviable for mainstream financial services using traditional forms of distribution. The households we are interested in actually have fairly basic financial needs which need to be met by simple, transparent, low cost, flexible products. There is unlikely to be much margin in these products. Therefore, reducing distribution and persuasion costs is key to making this model work. This requires creating economies of scale and overcoming the ‘trust barrier’. The most feasible way to do this we think is for the financial sector to harness the networks of established trusted intermediaries in the third sector (housing associations, charities, and local authorities and so on) to create efficient partnerships. We recognise that this has been tried before but developments in technology and communications could change the economics of distribution.
Those are just a few ideas which could allow us to tackle these great public policy challenges. But there are more. But for these to work, we need financial and technical support from the UK financial sector. The sector’s involvement would demonstrate how London the leading global financial centre can play a major role in developing socially useful financial innovations as well as the more traditional financial innovation for which it is better known. If anyone is interested in supporting us, we would be delighted to hear from you.
Financial Inclusion Centre