The muddied waters of 'financial inclusion'

'Basic' accounts and credit unions have a long way to go when it comes to bringing banking to people on low incomes, finds Esther Shaw

Can you imagine managing your money without any sort of bank account - no debit card payments, ATM access, cheques or overdraft?

Nearly three million adults in the UK do; they include the unemployed, the retired, those in low-income jobs and part-time workers paid in cash. The National Consumer Council (NCC) says half of these people have been on benefits for over five years.

Since state financial support is channelled through the Post Office, many may not want or need a bank account. After all, handling cash is often better because you can't spend what you don't have.

But "financial inclusion" - the Government's buzz-phrase for bringing low earners into the mainstream - is high on the political agenda. During the Treasury's Spending Review last year, it was announced that ministers intended to tackle areas such as banking and affordable credit. So the rise and rise of "basic" bank accounts, first launched in 2000, should form a key part of their plans.

These accounts offer a stripped-down version of an ordinary current account. You can make cash deposits and withdrawals, and pay bills by direct debit or standing order.

But there is no chequebook or overdraft facility, so you can only take out or spend money if there is enough in your account.

You do get a basic Solo or Electron debit card, but these are not accepted at all shops or restaurants and won't work unless your balance is in credit.

On the surface, the initiative has been a success: between launch and December 2004, some 5.7 million basic accounts were opened. However, critics say the banks could do a lot better.

"Mystery shopper" surveys by the consumer arm of the Financial Services Authority (FSA), the City regulator, have exposed either a lack of staff knowledge or unsuitable attempts to open current accounts, and credit facilities, instead.

The NCC is now calling for a new basic-banking model that includes a small penalty-free overdraft (to act as a buffer zone) and weekly direct debits to aid budgeting.

Alongside basic accounts, there is growing demand for credit for those on low incomes.

The £150 average loan sought by these people is not catered for by mainstream lenders, and many also have a poor credit score, which rules them out of contention. That can leave the worst off (and often those most desperate for cash) with little choice but to turn to doorstep lenders and, worse, loan sharks.

A report in January by Paul Jones of Liverpool John Moores University showed that low-income consumers can pay an annual percentage rate (APR) of more than 1,000 to gain access to credit.

In less extreme but still expensive cases, a credit card with an APR of 60 is available through Vanquis, a subsidiary of Provident Financial, one of the biggest doorstep lenders.

The Joseph Rowntree Foundation, the social policy charity, wants to see a big expansion of the government-sponsored Social Fund. Administered by the Benefits Agency, this provides interest-free loans repaid through deductions from social security payments. But the current system isn't flexible enough, the foundation warns: monthly repayments for loans are still too high.

An alternative banking service for those in deprived areas is provided by credit unions. These are financial co-operatives, regulated by the FSA, which can take deposits, grant loans, receive benefits and provide bill-payment budgeting schemes.

By law, they can charge customers no more than 1 per cent a month for any product - equivalent to an APR of 12.7.

New figures from the Association of British Credit Unions Ltd (Abcul) suggest that as many as half a million people are benefiting from their services.

But despite government support, there are concerns that the unions still have some way to go in providing a credit service to the financially excluded.

A separate report from Liverpool John Moores University in February recommended they adopt a more "businesslike approach", with links to ATMs and direct debit facilities. Controversially, it suggested that APRs had to rise to bring in greater flexibility.

However, Mark Lyonette, Abcul's chief executive, stresses that its version of the basic bank account - which should be available next year - will prove a major boost.

Concern remains, though, as to whether credit unions can achieve the scale required to offer a solution to credit exclusion. The need for commercial involvement, says an NCC spokeswoman, must not be overlooked.