What does responsible lending look like in today’s economy?

As the cost-of-living crisis deepens and inflationary pressures affect household budgets, lenders are seeing the market change considerably in front of their eyes. The most vulnerable consumers in society are at greater risk from the rising cost of living, and, if refused credit by mainstream lenders, they could turn to high-cost, predatory alternatives.

“The cost-of-living crisis is pushing millions of people whose circumstances mean they can’t borrow from mainstream lenders towards loan sharks and very high-interest lenders,” says Theodora Hadjimichael, CEO of industry body Responsible Finance, which represents community development finance institutions (CDFIs) in the UK.

“Affordable, fair credit has never been more needed, and Responsible Finance providers improve their customers’ financial resilience – not just with credit, but by helping them strengthen their finances even if they cannot offer them a loan. Credit is not the answer to the cost-of-living crisis or to low pay, which are issues for politicians and employers to address, but credit is a fundamental part of how we live our lives.”

“Demand for us has never been as large,” explains Tim Rooney, CEO of responsible lender Salad Money. “The people that we're serving are in the lower four or five deciles of income. They are people who, typically, would have used high-cost credit to deal with the bumps in the road that they have. Many would automatically be rejected by lenders that use credit scoring, but our applicants have adopted the use of open banking."

What does it mean to lend 'responsibly'?

In a world where companies are constantly trying to get one up over their competitors, the question of what it means to be a 'responsible lender' in these times is a very pertinent one. A low-interest loan can save consumers money – an average of more than £300 with CDFIs compared to the alternatives available to them, Hadjimichael asserts.

To be part of the organisation she represents, lenders must meet certain criteria: "Lenders must have a social purpose and asset lock written into their governing documents; must be not-for-profit organisations (in other words, distributing profit is not their primary objective) or social enterprises; must be able to demonstrate a positive contribution to community, economic and social development and the environment within communities or markets that are not adequately served by mainstream financial service providers; be able to demonstrate accountability and transparency to stakeholders, target communities and customers; and comply with the Responsible Finance Code of Practice."
Research about Responsible Finance's membership

It's not just about loans though; responsible lenders can help customers out in other ways – and this can be the point of difference that sets them apart from faceless and unscrupulous mass lenders. Responsible Finance members Salad Money, Scotcash, and Moneyline have all pioneered an automatic benefits calculator that tells applicants if they have unclaimed benefits. This allows those eligible for government support to unlock extra cash, even if their application isn't successful.

“Nearly 7 out of 10 applicants aren't claiming things like Universal Credit [a government welfare programme in the UK] and other benefits they're entitled to,” Hadjimichael says. “CDFIs have helped tens of thousands of people identify an average of more than £410 per month each in benefits they were due.”

Salad Money – which specialises in affordable credit for healthcare workers and public sector employees with impaired, poor, or thin credit files – addresses financial exclusion by tapping into open banking. It also replaces traditional credit scores, the bane of many-a-loan-applicant, with its own proprietary credit decisioning software for affordability assessments.

“Open Banking data enables our social enterprise to categorise and analyse an average of 1,600 individual transactions spanning the previous 12 months for every applicant,” Rooney says. “We use this, and AI, not only to make an approval decision but to generate unique insights into applicants’ financial health, because we want to use the power of this data to drive change."

Despite the best intentions, there is still a harsh reality to confront. Lenders like Salad Money can't accept all applicants, as that would be irresponsible. But they can have a tangible impact on the availability of credit to some underserved populations. This comes at a cost; Salad Money's interest rate is 79.5% APR, which Rooney readily accepts sounds “horrific” to most consumers. That, however, is simply the cost of doing business.
“The reason why we have to lend at that rate is because of the losses that we see, the cost of funds that we have, and then the scaling of the business. Our lifetime loss rates are well below market average due to the application of AI and our ability to analyse thousands of data points from the consumer. But it is the cost of funds that really affects us."

Has buy-now-pay-later (BNPL) impacted vulnerable consumers?

With the most vulnerable consumers struggling to afford week-to-week essentials, buy-now-pay-later (BNPL) has proven incredibly popular. Consumers can offset the cost of purchases over several monthly instalments, often at no extra cost. But Responsible Finance has noticed “an explosion” of consumers with 'stacked-up' BNPL loans, Hadjimichael continues.

“Community lenders only lend if people can afford the repayments and it’s concerning to see some BNPL providers accepting applicants we don’t think can afford to repay loans,” she says.

"Our members' customers are typically those on low or changing incomes or in vulnerable circumstances who cannot access mainstream credit, so we are concerned about the impact, transparency and affordability of BNPL. It can soon add up to unsustainable amounts and over-indebtedness and can cause defaults on these and other payments, impairing people’s credit ratings and pushing them into financial exclusion.”

She says that regulation for BNPL is “long overdue” and would improve both transparency and affordability, stopping people from getting into unsustainable levels of debt.

Todd Latham, CEO of technology platform Divido, believes there are steps that consumers can take to protect themselves against the perils of BNPL: “It's important to remember that checkout finance is designed for large baskets and big-ticket transactions. It may seem tempting to use interest-free credit for small purchases, but these small loans can quickly add up and become unmanageable. If you are committed to a purchase and have the cash to pay for it there and then, it's usually better to choose this option.

“This is especially true in situations where the lifespan of the loan could outlast the lifespan of the product, as in the case of using BNPL to pay for food and grocery shopping. In this way, you can stop yourself from ending up in a situation where you are managing multiple loans with different repayment terms, which can become confusing and increase the likelihood of missed repayments.”