Must credit unions charge more?

A controversial report this week tells Britain's struggling credit union movement it needs to "revolutionise" itself. But the chief recommendation - doubling the interest rates they may charge - makes unpalatable reading.

Despite public support from the government, including Tony Blair joining a credit union a few weeks ago, the movement has struggled to make the big breakthrough in providing a credit service to the "financially excluded".

Membership has trebled in the past decade, to about 500,000. But there are still almost four times that number of households without any kind of bank account.

The report for the Association of British Credit Unions (Abcul), from Paul Jones of John Moores University, set out a radical plan to fast-forward the expansion of credit unions.

"If credit unions are to realise their potential to serve low-income communities effectively they must adopt a more businesslike and professional approach," says Mr Jones.

The report also says that credit unions need to provide the type of basic services that people expect from banks, such as being able to take out cash from ATMs and pay bills by direct debit. The introduction of such facilities looks set to be announced by Abcul later this year.

The report follows a two-year pilot study in the west midlands, where a number of "beacon" credit unions have been helped to grow at a much faster rate than the regional average. They are more professionally run, with paid staff, shop fronts in visible locations and a more efficient image. They have also experimented with separating saving and borrowing, so that members can have loans without having put in savings.

Mr Jones has another proposal that is likely to be highly controversial. He proposes that the limit on interest charges should be raised to 25.4% APR, double the current maximum.

He says credit unions need to have more flexibility about interest rates if they're going to be able to provide small loans to high-risk borrowers.

Mark Lyonette, chief executive of Abcul, is confident that the introduction of current account-style services will see a rapid expansion of credit union members. The international experience, he says, has been that "credit unions have gone through the roof" when they offered such services.

He also says that there is a cultural change taking place in the successful credit unions, which has seen them becoming more responsive to customers. "Historically, people thought you must make people save before they borrow, that's the way to build a habit of thrift and saving. Actually, that's a very niche product, and only a small number of people will be able to save before they borrow."

More than five years ago, a credit union taskforce set up by the Treasury, reported that to serve 1 million "unbanked" people, credit union membership would need to reach around 2 million. It also noted that credit union membership in the United States is about 30% of the population, 20% in Australia, 45% in the Irish Republic but only about 1% in the UK.

Ken Purchase, MP for Wolverhampton North East, in the area where the beacon credit unions are being developed, says: "If we really want them to take off, we have to have full-time workers. And the government has to be prepared to cough up to help, so that this can be established as a normal way of borrowing."

Mr Purchase also advocates biting the bullet on a higher rate of interest. "At 12%, credit unions simply cannot afford to make advances to very high risk poor people - and so many who would be ideal credit union borrowers are forced into very high interest arrangements instead."

Research this week from the Joseph Rowntree Foundation, carried out by the Personal Finance Research Centre at the University of Bristol, shows that no one has so far found a completely successful way to meet the credit needs of low-income communities.

Sharon Collard, one of the report's authors, said that lending a few hundred pounds to people with low and unstable incomes is expensive and credit unions need to be able to charge a higher rate of interest.

"If you want to serve a financially excluded community, you either accept that there will have to be a subsidy, or charge more interest."