Helping to cut debt misery

1 September 2009

Where there’s debt there’s opportunity for lenders, the debt advice industry, asset managers, lawyers and even bailiffs.

But equally, where there’s excessive debt there’s misery and debt advice - especially if offered late in the day - seems rather like locking the stable door after the horse has bolted.

But what if banks and building societies were to design and deliver their products in a different way?

Instead of focussing on short-term profit they could build their customer relationships on a partnership basis and steer consumers through the big events in life such as setting up home, having children and retirement.

This novel proposition is put forward in a report entitled Fair Banking: The Road To Redemption For UK Banks, funded and published by the Centre for the Study of Financial Innovation.

“Report author Anthony Elliott is an odd bird,” states Andrew Hilton, director of the CSFI, in his preface to the report. “He is a senior banker with many years of experience in retail banking and the hedge fund sector who is committed to changing the industry that has served him well.

“What he and Fair Banking, the charity he runs, want to do is nudge banks in the direction of showing greater responsibility towards their customers.”

The word nudge is perhaps more appropriate to the technique Elliott wants lenders to adopt by developing products that encourage consumers to manage their finances more effectively. But that presupposes that banks know where their customers want to be in the snakes and ladders game of life.

To their credit, Elliott and his team of researchers take this as their starting point and through their research explore the concept of financial well-being and what it means to various age groups across an income range of £15,000 to £60,000 a year - being broke isn’t just the prerogative of the poor.

One striking conclusion of the report is that the most important component of financial well-being is not the level of income but rather the perception of being in control of one’s finances.

What Elliott proposes is a suite of relatively simple products that would enable customers to get a better handle on their finances.

His research focusses on two groups - young workers and families with young children where at least one adult is in full-time employment.

For the purposes of the report young workers are defined as being aged between 18 and 29 with no children while families have two adults aged between 25 and 39 and at least one child under the age of 16 living at home.

Some 300 representatives of each group were interviewed with a view to develop- ing what is termed an index of financial well-being - or put another way, a money worry index.

The resulting index shows that while gross income is more important to young workers than families it is still not an overriding factor.

“The level of financial well-being is determined by the extent to which households exercise sufficient control to have enough money to pay for essentials, have some left over to buy luxuries, service their debts and have regular savings,” states the report.

For both groups, control of finances is cited as the most important factor in financial well-being, being twice as significant as the next most important factor which for young workers is gross income and for families the ratio of unsecured debt to gross income.

The research indicates that young earners cope better with higher levels of debt than older families, and that for families financial satisfaction falls as exposure to unsecured debt as a percentage of income increases.

Families are obviously more concerned about the financial impact of significant life events such as having chil- dren, buying property and redundancy although a surprising number agree with the assertion that it’s better to enjoy life than worry about money.

As the report concedes, at its most extreme this attitude could lead to reckless financial behaviour and one suspects that in some cases it does.

But Elliott and his team go on to argue that a level of control that ensures money worries do not interfere with the ability of families to enjoy life is necessary if a high level of financial well-being is to be attained.

The report focusses on how financial services providers could help both groups improve the control of their finances and encourage them to reduce or avoid debt that is not related to mortgages.

Research reveals that young workers are interested in how banks could encourage them to plan their expenditure, perhaps using money pots as a planning tool, while families are interested in financial firms helping them adjust early to significant life events.

Responding to this, the researchers devised and tested an income and expenditure management tool, a savings tool and a debt reduction tool.

But to do this they first had to discover how often the two groups used their bank accounts, why they did so and how they accessed them. They also had to identify which expenditures could be controlled and which were regarded as essential, along with how respondents might prioritise cutbacks.

The bad news for the restaurant trade is that both groups say eating out would be the first thing to go but shareholders in Sky can relax - only 9% of respondents say their satellite television subscriptions would be top of the list of luxuries to be junked.

The design of the proposed tools also had to take into account lessons from the school of behavioural economics, in particular the ideas of Richard Thaler and Cass Sunstein as expressed in their recent book Nudge. “When people are asked what they intend to do, they become more likely to act in accordance with their answers,” Nudge decrees.

Thus, with the report’s mooted income and expenditure tool customers were asked to identify the areas in which they intended to reduce expenditure. Similarly, with the savings tool they were asked to specify when they would start saving and how much they would save.

In the same vein the tools had to take into account our innate optimism and propensity to underestimate expenditure as well as the need to set realistic targets.

Tests of various types of income and expenditure management tools showed that individuals like features that tell them if they are spending more or less than the previous month on items being tracked while allowing them to set spending targets. They accept these in either a tabular or picture-based format. The savings tool was also offered in both guises, allowing individuals to see how their savings build towards their target.

Elliott’s recommendation for improving money management turns out to be a debt reduction tool accompanied by a briefing to individuals on how to reduce their overdrafts and credit card debts.

“The bank provides your overdraft details and you add your other debts to it, setting a target reduction,” the briefing reads. “As an incentive you will receive a bonus for achieving your goal.”

The tool’s features allow individuals to view their non-mortgage debt and set realistic targets for debt reduction, with an additional facility for identifying specific reductions in expenditure that could be used to reduce debt or stop it rising.

This concept was well received by those participating in the research project, with 57% considering it to be extremely or very useful and only 11% con- demning it as not useful.

So is it possible to create an online tool that will help consumers reduce their debt, even with the assistance of behavioural economics? Obviously, Elliott likes to think so and believes it would be possible if only lenders would get on board with the idea.

There’s no doubt that the problem of debt needs addressing. According to the Bank of England, consumers in this country now have £231bn of unsecured debt, of which £54.5bn is on credit cards.

Meanwhile, research conducted by Moneysupermarket.com in May shows that 54% of us now hold debt that is not related to mortgages and average personal debt is nearly £7,000. These figures suggest that our collective sense of financial well-being might be a tad on the low side, according to Elliott’s index.

The good news from Moneysupermarket.com is that 40% of debtors have reduced their non-mortgage debt in the past year but the bad news is that 27% of all adults have taken out more debt over the same period.

And of those who are carrying debt a worrying 14% believe it will always be a part of their life. For them, a healthy sense of financial well-being seems an elusive prospect.

The extraordinary career of report author Anthony Elliott

Anthony Elliott has worked for banks in the UK and overseas, including spending 10 years as group risk director at Abbey.

In 2003 he became involved in research into why consumers take on too much debt. Taking its inspiration from a Stevie Smith poem, the 2005 report that resulted was called Not Waving But Drowning: Overindebtedness By Misjudgement. This led to a banking product called the capacity card, on which a patent is pending. It contains many money management features.

Elliott is also founder of charity Fair Banking and currently divides his time between working for a large hedge fund and developing a vision of a banking system that helps individuals to manage their money.