How interest-free banking works: The case of JAK
In 2001, Feasta's money group investigated the feasibility of establishing an interest-free bank in Ireland. The most promising way seemed to be to persuade the Swedish JAK Bank to establish an Irish branch. However, since JAK had no experience of running branches in Sweden, its directors turned the idea down. This is a report from a money group member who went to Sweden to study the bank.
Can a bank operate successfully if it does not charge interest on its loans? The Swedish JAK Medlemsbank (Members' Bank) certainly does - it has been called the safest bank in Sweden. This account of how it does so is based on two visits to its headquarters in Skövde and numerous conversations with JAK's enthusiastic staff and members, both in Sweden and in Ireland. I am indebted to the staff of JAK for their hospitality and assistance, and to Feasta for its financial support.
JAK's primary objective is to provide its members with interest-free loans. In order to accomplish this, it must attract interest-free savings. JAK uses a system of "Savings Points" in order to balance saving and borrowing.
Given the choice of borrowing without interest or saving without interest, most of us would gladly choose borrowing. While people are generally willing to save temporary surpluses of money in current accounts that don't pay interest, few are willing or able to save more significant amounts over a long period of time with no compensation. JAK cannot, of course, lend money without having savings on deposit and so, using an imaginative system of Savings Points, each member who wishes to take out a loan must save money first and, over a lifetime with JAK, every member will have saved roughly as much money and for the same period of time as they will have borrowed. You could almost imagine JAK as allowing its members to borrow (interest-free) from their future selves.
For a new JAK member, the first step towards an interest-free loan is to save and thereby earn Savings Points. These are calculated as the amount saved, multiplied by the number of months for which it is saved, multiplied by a Savings Factor. This factor varies according to the type of savings account the member has selected and is lower (about 0.7) for a demand account from which savings can be withdrawn at any time. For example, assuming a Savings Factor of 0.9, we have1 :
€100 1 Month 0.9 = 90 Savings Points
The Savings Factor varies with the type of deposit account and is lowest for demand accounts where savings can be withdrawn at any time (about 0.7).
After saving for a minimum of six months, a member may apply for a loan. In order to borrow €1 for one month, one Savings Point must be redeemed. The amount borrowed and the time taken to repay are entirely up to the member, provided that the appropriate Savings Points are available. For example, borrowing €90 (or €9,000) over 1 year uses as many savings points as borrowing €45 (or €4,500) with repayments spread over 2 years.
In addition to a Basic Loan that uses Savings Points already earned, members may apply for an Additional Loan using Savings Points that will be earned in the future. An "Allocation Factor" (currently 14) is multiplied by the member's current Savings Points to determine the number of points available for an Additional Loan.
Each loan repayment includes a savings instalment, and the payments are structured so that when the loan is fully repaid, all necessary Savings Points have been earned. A consequence of this is that upon full repayment of an Additional Loan, the member has built up significant savings. Savings made during the course of repaying a loan are known as Post-Savings, while those that precede the loan are Pre-Savings. Once the loan has been repaid, the balance of the post-savings is available to the member to be withdrawn or, as frequently happens, to be used as the start of saving for a new loan.
There is no interest charged on a loan, of course, but members must place 6% of the value of the loan on deposit for the duration of the loan, and additionally pay a loan fee to cover administration costs. Members also pay 200 SEK (about €22) when they first join JAK and 200 SEK per year as a membership fee.
JAK is a virtual bank in the sense that it has no branches and business cannot be transacted in person. A necessary and prudent decision since the membership of JAK is quite spread out over a large country, and also resulting in no bias against rural members who would have to travel much farther to their nearest branch. A result of this "virtual" status is that JAK members must have an account with another bank with which to conduct their day-to-day financial affairs. Members transfer money into or out of their JAK basic account via post giro, bank giro or Internet into their other accounts. With improvements in technology and the changing financial infrastructure, JAK hopes in the near future to offer direct deposit of paycheques and credit/debit card facilities to its members. For some members, this might negate the need to bank elsewhere.
Like any bank, JAK must ensure that loans can and will be repaid. Unlike most banks, however, JAK's system of saving and borrowing has several unique features that combine to give it an enviably low default rate.
A member applying for a loan is given a range of options for the loan size and duration based upon their desired loan amount, desired repayments and available savings points. When they have made their selection, the loan department within JAK must assess the member's ability to repay the desired loan. The member's income and expenses are evaluated with the assistance of computer software that calculates average living expenses for individuals and families based upon age and gender.
Between 20 and 25 applications are processed per week, and 95% are approved. Most loans are secured, either against property or with a personal guarantor. Loans for up to 37,000 SEK (about €4,000) with 2-5 years' duration can be unsecured, but these are limited to 5% of JAK's turnover and so surplus applications must be held in a queue until funds are available. The most common reason for borrowing is to refinance a conventional bank loan obtained to buy a house followed by purchasing a car and making home improvements.
In general, people who can save regularly are good performers when it comes to loan repayments. The JAK system where saving must precede borrowing is therefore ideally suited to attracting these regular savers. In addition, around half-way through repayment of a loan there is a break-even point where the Post Savings on deposit are equal to the balance outstanding on the loan, and from this point forward the loan is fully secured by the member's savings.
Very few JAK loans end in default. Borrowers are decidedly involved "members" as opposed to disinterested "customers". Many feel quite strongly about the idea of interest-free banking and this common bond goes a long way towards encouraging good behaviour. Personal guarantors rarely need to be asked to make good on their guarantee.
At the simplest level, a bank takes one person's savings and lends them to someone else. Ideological arguments aside, this presents some practical difficulties. Firstly, what if a saver wants their money back before the borrower has finished with it? Secondly, what if there are not enough or too many borrowers relative to savers?
The first point is generally dealt with in the banking system by having a reasonably large number of savers and making sure that enough money is set aside to cope with those who, on any given day, want some of their money back. While individuals might withdraw their savings in a random manner, a large group of savers will tend to be stable and predictable.
It is JAK's policy to keep a minimum of 20% of pre-savings available in either a bank account or in government bonds, either of which can be made available almost immediately. Too much liquidity means that money is lying idle rather than being lent out to members, so it is not seen as desirable to have much more than 20% on reserve. Post-savings do not need to have a component on reserve since these can only be withdrawn at specified times.
JAK also encourages stability from its savers by offering a higher Savings Factor in long-term deposit accounts. JAK members can choose from 6, 12 and 24-month deposit accounts which represent the advance notice required to make a withdrawal.
With regard to the second point, JAK has a more difficult balancing act between saving and borrowing than other banks, due to the fact that the two are intimately linked by Savings Points. Most people save with the intention of borrowing in the future. An excess of saving today could indicate too much demand for borrowing next year.
The Allocation Factor has a central role in the relationship between supply of savings and demand for loans. In general, the JAK board sets the Allocation Factor to reflect the current level of liquidity within the bank. The greater the pool of excess savings, the higher the Allocation Factor to encourage members to take out loans and reduce the excess. Unfortunately for JAK, the relationship between the Allocation Factor and the demand for loans is not as simple as this. In the short term, increasing the Allocation Factor can actually make things worse, as members decide to increase their Savings Points with a view to taking out a larger loan in the future. Excess demand for loans would be particularly problematic for JAK. Reducing the Allocation Factor would likely lead to an outcry from members who had made financial plans based on a higher factor. The alternatives, however, would be to refuse more loans or to introduce a waiting list. The dynamics of this saving/borrowing relationship are likely to be a constant challenge to JAK's management as the membership grows and the range of banking services offered by JAK expands.
A significant amount of JAK's energy is devoted to communicating with its 21,000-strong membership. JAK is a co-operative, fully owned by its members. In addition to a quarterly newsletter, 24 regional offices staffed by trained volunteers keep in touch with members through study groups and exhibitions. While JAK's primary function is to provide interest-free banking, it is also viewed by the membership as a vehicle for economic reform.
A recent innovation in support of economic reform is the Local Enterprise Bank. Community members save in a special JAK account and, rather than earning points themselves, their savings are used to provide an interest-free loan for a local enterprise. Savings are fully guaranteed, so members are not exposed to any financial risk. The first two projects to be funded in this way are an ecological slaughterhouse and a replica Viking village. It is an interesting experiment in local finance for local projects, and so far has been very warmly received by local media and participants. While savers don't, of course, receive any interest on their savings, they benefit both economically and otherwise from the improvements in their local economy and infrastructure as a result of the projects.
The JAK Members' Bank is unique in the commitment it inspires from its volunteers and staff. It provides affordable and responsible finance, and enables its members to have a say in where their money is invested. I have no doubt it will continue to be true to its purpose and values while exploring new frontiers in ethical finance.
|This paper is from
Growth:The Celtic Cancer,
the second Feasta Review. Copies of the Review can be ordered online from Green Books, priced at £9.95 plus postage and packaging.