A new report published by Consumer Focus warns that with UK household debt predicted to rise to £2.1 trillion, affordable credit options must be made available to those on low incomes.
The watchdog is urging mainstream banks in Britain to follow the lead of their overseas counterparts in France, Germany and Australia and do more to promote social lending to help fill affordable credit gaps in the UK.
While the Government announced recently that it will research whether a cap on high-cost credit could help prevent people building unmanageable debts, Consumer Focus says the cap alone would not provide a solution to the whole problem and could potentially fund illegal lending.
Whether or not caps are introduced the watchdog urges an improvement in social lending. Financial services expert at Consumer Focus, Marie Burton, said: 'High cost credit can be crippling and can lead some people into a debt trap it is difficult to escape from. A cocktail of falling incomes and increasing living costs could lead to more people using high cost credit to fill the gaps and falling into trouble.
'At the moment we have the worst of both worlds - high cost credit and very little in the way of affordable alternatives. Capping interest rates is one option, but unless other affordable options are put in place this risks driving people to illegal loan sharks.
'Social lending through credit unions and community initiatives is a key part of making affordable credit available, but the big banks should also follow the example of banks overseas and work with charities and public bodies to provide low cost borrowing to people on low incomes.'
The UK has the second highest level of consumer borrowing in Europe - almost twice the level of France and Germany. It also has one of the most developed sub-prime credit markets in the EU - which means that lower income groups take out billions of pounds each year in high cost credit from non-mainstream lenders, such as home credit, pawn-broking or payday lending.
The lessons we could learn
Both France and Germany have rules which provide a cap on interest rates (like those the British government is investigating) but each has a small sub-prime sector, which the Consumer Focus says suggests lenders may struggle to design viable financial products because of these restrictions. This seems to result in some people on low incomes having difficulty accessing credit if they need it.
However, social lending is available to low income consumers in both countries - for example, the French Government guarantees loans through co-operative and postal banks and Germany has socially orientated co-operative banks competing with mainstream banks to provide simple accounts and products to low income groups.
Like the UK, Australia has a fairly liberal approach to credit regulation and one of the largest credit markets in the world. The difference though, is that in Australia banks are an important part of social lending. Aided by Federal Government, charities work in partnership with government and major banks which fund their own micro-finance and loan programmes.