7th August 2012
Besides the many who could never claim because they were self-employed or too old, banks offered no choice of policy and charged five to ten times what it cost them. Typical monthly repayments were 30 per cent higher than they would have been – effectively doubling APRs which looked good value in adverts. Some borrowers were told – mistakenly – that they could only have a loan if they took out the PPI on offer.
But after getting away with this for more than a decade, regulators told lenders the game was up two years ago, following media campaigns and consumer organisations hitting banks with massive legal actions.
The big banks now have to give back £10bn or perhaps more in compensation to customers – it is paid out gradually as banks deal with complaints. And the cash, as this Mindful Money story three months ago made clear, is providing a welcome boost to the economy. It said: "The compensation involved has been largely ignored by economists but it will more than make up for lost production due to the extra bank Diamond Jubilee bank holiday in early June. It has received scant, if any, mention in Bank of England commentaries on the economy."
Now the Financial Times has picked up on the story, updating the numbers while retaining the general thrust of the Mindful Money piece.
PPI refunds vs quantitative easing
The PPI refunds work to boost the UK's foundering economy at a time when it needs every bit of help in a far more direct way than the far larger amounts of quantitative easing from the Bank of England – this link proclaims the official QE theory. This Daily Telegraph article sets out the winners and losers but concludes that no one knows or can know whether the policy is really succeeding in its mission to kickstart the nation back onto the growth road.
The PPI refunds work – admittedly for one group – in much the same way as the Debt Jubilee concept from Australian economist Steve Keen. He favours writing off debts, many of which will either never be repaid or only satisfied at crippling costs to borrowers. He compares the effect of a direct injection of money to consumers with its more measurable outcomes with the vague and unproven quantitative easing policy. In the UK case, the easing works out at a little over £5,000 per UK inhabitant.
Keen writes: "A Modern Jubilee would create fiat money in the same way as with Quantitative Easing, but would direct that money to the bank accounts of the public with the requirement that the first use of this money would be to reduce debt. Debtors whose debt exceeded their injection would have their debt reduced but not eliminated, while at the other extreme, recipients with no debt would receive a cash injection into their deposit accounts."
PPI refunds go to spenders, not savers
Those who were persuaded into adding to the banks' trading pool via PPI were always borrowers and often those without many other resources such as saving accounts or investments. They tended to be younger and more susceptible to the hard sell. Bank staff were told how to deal with objections – answers should always be truthful so far as they went. For example, if a prospect asked about commission, the bank employee could honestly reply that she or he did not receive any and that, at most, a sale would get the branch points which might lead to a small bonus such as a hamper at Christmas.
What the bank staff did not say – and probably did not know – was that the banks had "profit-sharing deals" with the insurers which were often captive subsidiaries of the banks. Barclays used a Dublin-based insurer which it owned; Halifax-Bank of Scotland used St Andrew's Insurance, based in the UK but equally owned by the bank.
Nor did they reveal that the PPI premium, which covered the whole period of the loan, was added in one go at the start. So they would pay interest on the insurance as well as the insurance itself.
Sharing out the big profits
How the profit-sharing worked was not important for whether retail bank or captive insurer made the money, it still accrued to the parent. Out of each £1 in premium, the banks got to keep around 80p in profit, an underwriting ratio which most insurers could only dream of.
The beauty of the PPI compensation cash is that it not only goes directly to consumers, it also goes to some of the most hard pressed who have the greatest need to spend the money as it tends to be the less well off who take out bank loans. They take their newly found wealth and go out to the shops. They don't save it. And they probably don't use it to repay other borrowings.
With sums typically around £2,500 to £3,000 but often more, many are using their money to pay for long put-off home repairs and improvements, boosting local economies rather than dragging in imports.
In this spending respect – as well as sheer volume – it is different to the near £290m so far repaid in the Equitable Life pensions scandal. This compensation went largely to better off people and to older people – demographics who are more likely to saver rather than spend.
Effect of compensation on economy
The PPI repayments, which the FT estimates will hit at least £10bn, should add at least 0.1 per cent over a year to the economy. But if the payments are more concentrated, their effect on a quarter in which they are paid will be more dramatic. Some believe that the worst case (for the banks) scenario in which they have to disgorge £15bn, GDP could rise by as much as 0.7 per cent. And while this is a one-off, it could have a multiplier effect, giving additional stimulus.
However the compensation payments work, there is positive proof that, unlike quantitative easing, the money goes directly into the economy, in some ways equivalent to a tax cut.
The great unknowable is what would have happened if the banks had not had the chance to bring in so much cash at so little cost. They might not have had so much cash to trade – profitably in the good years. And without PPI, the dividend and, even more importantly, the bonus position might have been significantly different.
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