By Corey Allan, Research Analyst, Motu Economic and Public Policy Research
New Zealand has seen an increase in the number of so-called 'third-tier lenders', such as payday lenders, over the past few years. Based on where these firms locate, they appear to target low income households. These lenders offer low value, short term loans to households at often exorbitant interest rates (in the range of 500+% per annum!). Families can get locked into a vicious cycle of high cost debt, as happened to this Porirua family.
In an attempt to break this vicious cycle, a micro-credit scheme is likely to be introduced in New Zealand. Micro-credit is the provision of small loans to low income households, who would otherwise not have access to mainstream financial services or reasonably priced credit (known as financial exclusion). This could be because low income households have little to no collateral or a poor credit history. Therefore, lower income households may to resort to third-tier lenders. This makes saving difficult for these households as they must come up with relatively large sums of money in a short time to repay these loans.
An Australian micro-credit scheme, Good Shepherd Microfinance, has achieved remarkable success with its no interest and low interest loan schemes*. These loans have fairly strict criteria, including what the loans can be used for. Repayments are made fortnightly with a repayment period between 12 and 18 months. In addition, Good Shepherd, in collaboration with National Bank of Australia, offer a matched savings scheme. Savings of $500 are matched dollar for dollar, with no restrictions on access or use. Clients can access these savings accounts after they have paid off a no-interest or low interest loan, providing a financial incentive to repay and getting people into a regular savings habit.
Two questions immediately come to mind - why don't mainstream financial service providers offer these products to lower income households? And does this mean there is a role for some government intervention? Either as a direct provider or as a backer through some public-private partnership, as in Australia? We would expect mainstream providers to offer these services if they proved profitable. A report into Good Shepherd's StepUp low interest loans shows that each loan costs the provider over A$1000*. Therefore, it may not be profitable for a firm to provide these loans, despite the high repayment rates that many micro-credit schemes enjoy. This may force low income households to use third-tier lenders to purchase essential household items or pay unexpected expenses. From a societal viewpoint, it may be beneficial for government or a non-profit organisation to step in and provide these micro-loans.
Does New Zealand need such a scheme? There are options available to low income households to assist with essential household items and unexpected expenses. Work and Income offer grants and loans for essential expenses, subject to their eligibility criteria. For savings, ASB offer the Save the Change scheme, where customers choose an amount to round up each electronic transaction, with the balance being deposited into a savings account. I think this is a great commitment mechanism to get people into the habit of regularly putting money aside.
The availability of loans for essential expenses suggests that New Zealand may not need a micro-credit scheme like that in Australia. The government may be better placed providing information on the schemes already running. However, unlike Australia, New Zealand does not have good data on the extent of financial exclusion. People may be resorting to third-tier lenders because they are not eligible for the Work and Income schemes. If this is true, a case could be made for the introduction of a complimentary scheme, with the aim of providing finance to improve peoples' quality of life.
* Good Shepherd claims a write-off rate of only 1%!
* This report also details the social and economic impacts of the scheme, including a reduction in the use of payday lenders.