Personal Finance: Beefing up the people's moneylenders

The Government is on a mission to strengthen the role of low-interest, mutually-owned credit unions

PATRICIA HEWITT, the Economic Secretary to the Treasury, is on a mission to tackle one of the ugliest blots on Britain's financial landscape, a problem she calls "financial exclusion".

The Treasury estimates that between 2.5 million and 3.5 million adults have no bank or building society account - and probably no other means to save. Money is kept under the mattress or in a drawer. And credit, where it is available, costs an extortionate amount in interest.

"We have one of the most competitive and sophisticated financial services sectors in the world - but some people still miss out," says Ms Hewitt. "And for those people financial services mean cheque-cashing shops and illegal loan sharks."

Last week, Mrs Hewitt unveiled the biggest step so far to combat financial exclusion when she launched a package of reforms designed to encouraged the growth of credit unions.

Credit unions are small, mutually-owned co-operatives which offer loans as low as pounds 50, and no larger than pounds 10,000. Interest is typically charged at1 per cent a month - a better rate than most credit cards. A lower, but still competitive rate, is paid to savers. If the credit union makes a surplus, it is either ploughed into reserves or distributed in a dividend to members.

For people with a low income or a poor credit record, credit unions are often the only alternative to semi-legitimate loan shops which can charge upwards of 30 per cent in interest.

They key to the success of credit unions is what is known as a "common bond". With no more than 5,000 members, they usually restrict membership to people living in the same local area or working for the same employer. Greater Manchester Police has a credit union, so do London cab drivers, so do many local communities in towns in the north of England and Scotland, and so do trade unions.

Because of that common bond, members of credit unions see them as totally distinct from the distant, impersonal banks. The money is coming from people you probably know. And once you become a member, it is also your money.

The "common bond" is no abstraction: it has a dramatic effect on repayments. Bad loans at High Street banks often run at around 5 per cent: many credit unions suffer defaults of less than 0.5 per cent. Chris Smith, spokesman for the Association of British Credit Unions (ABCU), explains: "People in this country who get into a credit union feel they have much more control over their affairs. The bad debts are low because people are much less likely to welsh on a loan when they know they are welshing on people they know."

The trouble is that regulations are stifling this good idea. In 1979 Parliament passed the Credit Union Act, which placed tight legal restrictions on credit unions. Ostensibly they safeguard savers and borrowers. In fact, they restrict credit unions to a tiny niche.

Whereas more than a half of all workers in Ireland belong to a credit union (and more than a quarter in the US), barely 1 per cent - or 216,000 people - belong to a credit union in the UK.

Ms Hewitt is proposing to lift some of the restrictions. The maximum membership limit of 5,000 will go. Credit unions will be able to offer basic services such as bill payment. A strict legal definition of the common bond will be relaxed so that people can carry on as members when they move job or move house. And a rule restricting the maximum repayment term of a loan will be relaxed.

"The Government is determined to encourage the sector and these proposals aim to build on the vital work that credit unions do, particularly in poorer communities," says Ms Hewitt.

For the credit unions, though, the reforms - which are under consultation for three months - come with a nasty sting in the tail. While the Treasury is relaxing some restrictions, it appears to be imposing others. These include a requirement for unions to hold 10 per cent of their loan book in reserves in order to get full approval. Other desirable reforms, such as relaxing rules on the maximum loan available, seem to have been rejected.

"We feel that there's a definite will in the Government to do something about this but there doesn't seem to be the same will in the Treasury," says Mr Smith. "The regime in this country is the most restrictive in the world - we just want it freed up a bit."

People wanting to join or form a credit union can contact the Association of British Credit Unions on 0161-832 3694