The challenge

Consumers have a set of core financial needs that need to be met if they are to be financially secure and to participate fully and fairly in society. Financial products and services are just a means to an end.

Not everyone will have the same needs and expectations of course but we believe the following core areas are priorities:

·         a transactional bank account is a mechanism for participating fairly and fully in a modern market based society;

·         consumers need income and assets to participate in society;

·         pensions and annuities are vehicles for allowing consumers to accumulate assets to provide a decent income in retirement;

·         access to decent health and social care – particularly important given the massive changes in demographics putting pressure on state funded health care systems;

·         housing – fair and affordable mortgages are critical for meeting the government’s home ownership targets;

·         access to fair and affordable credit allows consumers to smooth peaks and troughs of income and/ or enhance lifestyles. Conversely, overindebtedness is causing real misery for households and communities; 

·         insurance protects consumers against the risks and shocks life throws at them and provides peace of mind;

·         financially capable and confident consumers are better placed to function in a society where financial services play an increasingly important role in people’s lives;

·         in an increasingly complex, unpredictable, and uncertain world access to objective financial advice and information is becoming as important as access to advice on health care.

The Centre's work therefore focuses on making sure that consumers’ core financial needs are met fairly and effectively.

Consumers are not homogenous and are affected in different ways. It is important not to simplify but the Centre focuses its activities on two distinct groups:

Financially underprovided/ insecure: these are consumers who could afford to provide for their core financial needs but aren’t doing so because of demand and supply side factors such as low levels of confidence and trust in financial services, psychological barriers, financial awareness, and supply side factors preventing the market meeting their needs.

Financially excluded: this refers to the ‘traditional’ excluded consumers who because of a combination of low disposable incomes and the economics of access in retail financial services are not commercially viable for mainstream retail financial providers. Alternative business models are needed to change the economics of access and develop affordable products, to complement existing provision.

Key challenges  

We estimate that over 5 million vulnerable households are seriously affected in some way by financial exclusion. There is a real cost to this exclusion – it is estimated that vulnerable consumers could be paying between £800-£1,000 a year in higher costs because they are excluded from mainstream financial services (Source: Family Welfare Association).

There is a direct correlation between income inequalities and financial exclusion in developed economies. However, the problem is not restricted to traditionally excluded groups. There is evidence of serious underprovision amongst the general consumer population. The key areas of concern we have identified are:

·         even though we are on average living longer, millions face the prospect of insecurity or indignity in old age because they have not been able or willing to make sufficient provision for retirement – living on seriously reduced incomes in retirement or unable to pay for decent long term care;

·         as the state withdraws, state provided safety nets do not offer the same level of protection and consumers are increasingly expected to provide for themselves. Yet millions face uncertain or unpredictable financial futures, unable to protect themselves against the risks and shocks life throws at them. because they are underinsured or don’t have enough savings to see themselves and their families through difficult times;

·         increasingly, consumers need to build up substantial assets to participate fairly in society or give their children a good start in life – for example, to pay for university fees or provide a deposit to get on the housing ladder. Yet savings rates are at historic lows and only a minority of consumers have built up investments;

·         the most vulnerable in society face restricted access to basic banking services pushing up costs and resulting in additional detriment such as higher utility bills;

·         as well as low levels of savings, the UK faces record levels of personal debt leaving millions vulnerable to the credit crunch, and the growth in the sub-prime markets. The sub-prime sector serves a purpose but detrimental practices such as high interest rates and penalty fees are widespread;

·         access to objective financial advice is increasingly becoming the preserve of better off consumers, while not-for-profit advice sector agencies are finding it increasingly hard to cope with demand for advice;

·         more generally, exclusion and underprovision will be a growing problem as a result of the credit crunch and as financial institutions become even more sophisticated in the way they segment consumers according to risk or profitability. More and more consumers priced out of the market or denied access to products and services altogether.

The following provides a synopsis of the scale of underprovision and exclusion in key financial services.

General banking services

• around 2 million adults (1.3 million households) are without access to bank account –while a further 4 million use accounts infrequently;
• In certain deprived areas, there are free ATM/ bank branch deserts. Low income groups are more likely than higher income groups to withdraw small amounts of cash frequently – which means they can incur effective charges of 10-15% if they only have access to fee paying ATMs;
• basic bank accounts provide an alternative for excluded consumers but there is huge variation in performance of individual banks in terms of opening and operation of accounts;
• branch closures – the closure of bank branches in local areas can have a negative multiplier effect in vulnerable communities.

Credit and debt

• total UK personal debt now equal to £1.4 trillion (@130% of disposable incomes);
• the debt burden, and restricted access to fair and affordable credit, disproportionately affects vulnerable consumers ;
• 2.3 million use home credit, paying  APRs of between 180-500%;
• 165,000 use illegal loan sharks;
• sub-prime market is characterised by higher APRs, unfair contracts such as huge penalty charges for arrears (FIC research found that penalty fees for in arrears can be £50 per month plus £30 per missed item), while there is evidence of major misselling;
•  sub-prime arrears up to 20 times mainstream level, sub-prime lenders quicker to repossess;
• on some measures, total debt servicing costs are higher than in 1990s, first time buyers spend 34% of post tax income servicing mortgage debt, house price earnings ratio now record 5.4 times;
• over 1/3^rd of mortgagors spending more than 20% of pre-tax income servicing mortgage debt;
• consumers are being hit by a perfect storm of events – record levels of personal debt, the credit crunch, the ending of 3 million plus fixed and discounted rate deals over two years, and increases in utility/ household bills – expected to lead to substantial increase in arrears and repossessions (we estimate repossessions could rise to 50,000 for 2008)
•  credit crunch and risk averse behaviour by mainstream lenders will lead to increase in non-standard/sub-prime markets -  on some measures, 1 in 3 households will be classified as non-standard risks, more consumers will be priced out of/ denied access to affordable credit;
• other developments such as growth in equity release, sale and rent back schemes and debt consolidation companies in response to growth in problem debt expected to cause major consumer detriment.

Savings and assets

Underprovision and exclusion applies to short and long term assets.

• The personal savings ratio is the lowest for 50 years.
• 48% of households have negligible savings – defined as less than £1,500. 28% have no savings at all. In other words nearly half the population have savings worth less than 3 weeks salary (as defined by average earnings in UK). In some parts of the UK, the situation is even worse. For example, in Northern Ireland, over 40% have no savings;
• Over 60% have no investments to speak of.

Provision for retirement – pensions and long term care

• Nearly half of individuals are not making enough provision for retirement.
• 70% of consumers with incomes <£20k have no pension in place
• Around 60% of the total £6.5 trillion wealth in the UK is in property; the over 65s have £1.1 trillion of unmortgaged equity, yet the home equity market has so far fallen well short of its potential;
• Decumulation options are limited for consumers with small defined contribution pension pots.

Insurance and protection

The UK population appears to be seriously underinsured and as a result they are unprotected against the risks and shocks life throws at them.

• According to Swiss Re: the total ‘protection gap’ is estimated to be in the region of £2.3 trillion. As measured on an annual basis, the income protection gap amounts to £130 billion per annum.
• Only 1 in 3 households with incomes under £20k have life insurance, only 12% have income protection insurance.
• One-third of households have no home contents insurance. Close to half the households in some of the most deprived areas do not have home contents insurance.

Financial capability

• Excluded consumers face many barriers to access - restricted options are compounded by low levels of financial capability, awareness and confidence;
• 5 million adults in the UK have literacy standards expected of 11 yr olds;
• excluded consumers are trapped in a vicious cycle. They have less exposure to/ experience of financial services, which means they have less confidence when dealing with financial services and so on. For example, research shows that:
  • many basic bank account customers have low levels of awareness of direct debit facilities
  • 65% of pre-payment customers unaware they pay higher fees
  • there is a general lack of awareness of which bills can be paid without fee.

Overall, we believe that a concerted effort by policymakers and other stakeholders combined with development of innovative solutions are needed to combat financial exclusion and underprovision in each of these key areas.

Data sources: Swiss Re:, Association of British Insurers, HM Treasury, Financial Services Authority, Bank of England, Council of Mortgage Lenders, Which?, The Financial Inclusion Centre.