Why no one can bank on this loans plan

November 24, 1995

Haste born of financial desperation is not a good recipe for fundamental reform, warns Christopher Johnson. The student loan scheme announced in the Queen's Speech makes me despair. In 1989, as chief economic adviser to Lloyds Bank, I advised the banks to have nothing to do with the scheme then put forward by the Government. They turned it down. So the Government went ahead with its own scheme the following year. It was a bad scheme, worse administered.

In 1993, the National Commission on Education put forward a better scheme. So what does the Government do? Ignores the NCE scheme, and serves up a rehash of its old scheme alongside the Student Loans Company.

This is timid incremental thinking. The one positive element is the recognition that interest subsidies will be needed to get the private sector on side. In all other respects, the failings of both the SLC and the Government's previous scheme for the banks have not been addressed. Neither the SLC nor the Committee of Vice Chancellors and Principals has been consulted, and the banks have predictably turned the scheme down again. There is every sign that a half-baked idea has been launched prematurely to get it into the Queen's Speech in time. Haste born of financial desperation is not a good recipe for fundamental reform.

The Government is trying to cut public expenditure - not to increase education spending, but to make tax cuts. Higher education spending on tuition fees and student maintenance is pushing against the ceiling, so the Government has at last decided that the only way out is to privatise it. The Private Finance Initiative for infrastructure projects, which are also under threat because of the need for tax cuts, has been botched. The new student loan scheme will suffer the same fate if it is not completely recast before it is too late.

The present government scheme fails on several counts. The take-up rate, although now just over half, is not enough to replace the amount of means-tested grant that has been phased out. Delays in disbursement are also inflicting financial hardship on students. The five-year repayment period is far too short, and must be discouraging potential borrowers. Repayment waivers for those earning less than 85 per cent of the national average are being claimed by 43 per cent of graduate borrowers. The number in arrears, about 10 per cent, is high but not surprising. Only 47 per cent are repaying normally. If that goes on, it will mean that less than a quarter of all graduates will be using the scheme in the standard manner.

The banks are apparently being asked to set up similar schemes, with the same zero real interest rates (the interest rate equals the inflation rate). As well as subsidies to top up the interest rates to market rates, they are apparently being guaranteed against defaults of 5 per cent - half the current rate, so hardly very tempting. They are expected to administer increasing millions of student loan accounts, which will have to be distinguished from their existing student account, sometimes with different banks. The banks already give interest-free overdrafts to students to get them as customers, so the last thing they need is yet another loss-leader product, which in this case is more likely to repel than to attract.

The proposed bank or building society schemes would have all the defects of the Student Loan Company scheme, and then some students would have the invidious task of choosing between two similar schemes. Unit costs would be higher in each, and duopoly would be no substitute for competition. This is the kind of operation which makes sense only if it is centralised to give economies of scale, and regulated to ensure fairness and efficiency. There should be one good scheme, not two bad ones. A reformed Student Loan Company might as well be part of the new scheme, but it would have to operate within a completely different context.

The NCE scheme is better than the Government's in a number of ways. It increases the existing levels of grant plus loan to meet the rise in student living costs. It sweeps away the remainder of the means-tested grant immediately, and covers 20 years for loan repayments, not five. Like other such schemes, it uses the income tax and national insurance system to collect repayments as a proportion of income not excluding those on less than 85 per cent of average earnings. It reduces the interest rate by making it tax-deductible, rather than overtly subsidising it. Apart from this, it commits public money only to the extent of guaranteeing against a default rate of 20 per cent. Loans made by the SLC would be "securitised", as in the United States, and sold to financial institutions - probably more to pension funds than to banks as a long-term investment almost on a par with gilt-edged.

The standard Treasury objection to all such schemes is that the private sector needs to take on some of the risk, or the Government might as well issue gilts itself to finance them. The default guarantee of only 20 per cent rather than 100 per cent on gilt-edged would give the private sector a small risk, justifying a yield a fraction higher than that on gilt-edged. Private sector lenders would more readily accept such a risk if the tax system was used to collect repayments. The Government should count only 20 per cent of such loans as public expenditure, not the 100 per cent laid down by Treasury convention.

If the Government is offering only a 5 per cent default guarantee to the banks, it would save something compared with offering a 20 per cent guarantee. (In each case there would be an interest subsidy of a different kind.) But such a low figure would be acceptable to the banks only if they were able to cream off the most bankable students. The Government would be left paying 100 per cent of the cost of most of the loans still going through the SLC. It will be better to have one scheme where the Government meets, say, a third of the bill, than two where the Government meets a fifth of the bill on 10 per cent of the loans and the whole of it on 90 per cent.

If we do not move quickly to get this right, either public expenditure on higher education will go through the roof, or students will suffer a deterioration in their education prospects, or both. If the Government wants to privatise student loans, it must be consulting openly with the private sector.

Christopher Johnson was a member of the National Commission on Education and former Chief Economic Adviser, Lloyds Bank.

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