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Target impairments – a correction (of sorts)

August 10, 2017

What is the Treasury target impairment on student loans?

Back in 2013/14, the government changed its accounting and budgeting procedures for student loans to handle exceptional volatility that threatened to undermine the higher education budget. Part of this change involved introducing a target impairment each year. This was initially set at 36% and, in the event of its being exceeded, a new budgeting facility could be accessed to smooth the budgetary pressure resulting from changes in projected loan repayments (either owing to new modelling data or variance in key macroeconomic conditions).

At the 2013 Spending Review, Business Innovation & Skills (BIS) – then responsible for loans – was allocated £2.9bn to cover loan impairments in 2014/15 and £4.4bn for 2015/16. With loan outlay expected to reach £11.7bn in the latter, the first financial year to have three full cohorts on the new fee-loan regime, it appeared that the relevant budgetary allocations were in line with the target impairment.

Then, at the 2015 Autumn Statement, George Osborne announced a series of changes to student support along with a decision to reduce the discount rate used to value future loan repayments.

Until 2015, the discount rate for student loans was RPI plus 2.2%. This was reduced to RPI plus 0.7%. Lowering the discount rate increases the value of future cash repayments (a future £1 is now worth more than it was before). As such, the cost of issuing loans was reduced.

Since discount rate changes are treated as “classification changes”, they cannot create new spending “headroom” for the relevant department. That is, the activity being undertaken by BIS had not changed, but how those same loans were scored had. BIS’s budgets were recalculated accordingly. Although this was a slow process: I chased BIS for 8 months to get an answer as to what the new allocations would be. Eventually, the publication of the 2015/16 annual accounts revealed the expenditure allocations for depreciation (under which student loan impairments were included).

These were reduced even though estimated loan outlay was (and is) increasing from around £12billion in 2015/16 to over £16bn by 2019/20.

Depreciation Allocations: £3.4bn (2016/17), £3.8bn (2017/18), £4.2bn (2018/19) and £4.5bn (2019/20).

At the time I was told by the department that the estimated long-run figures for loan impairment would be “about 30%” and the BIS accounts published in July 2016 contained the following passage on page 88:

“The current Resource Accounting and Budgeting charge (23%) is well below the HMT target rate of 28 per cent, largely as a result of the reduction in the HMT discount rate during the year, which was the first reduction in ten years.” (p. 88)

That would indicate that the target impairment was 28 per cent in 2015/16 down from 36 per cent in the previous year. And that was entirely consistent with the budgetary allocations and what you would expect to happen following a classification change: the target impairment was lowered and the relevant allocations were too.

However, the Department for Education, responsible for student loans since last summer, have confirmed that the target impairment is 36% and have just alerted me to a correction slip that was issued some months after the 2015/16 BIS accounts were published.

It corrects the passage just quoted, which has been revised to read: ‘The current Resource Accounting and Budgeting charge (23%) is well below the HMT target rate of 36 per cent.’

So the target impairment is 36% (I have gone back through my blog and corrected various posts accordingly). But the budgetary allocations to cover loan impairments are a long way below that: in fact, the DfE allocations are even lower than BIS’s despite estimated loan outlay now looking close to £19bn by 2019/20.

I am unable to come up with a convincing reason for the discrepancy (particularly since officials refer to the target internally as the ‘management charge’ on loans) and the DfE have been unwilling to respond to my questions on this matter, despite confirming that those depreciation allocations mostly comprise loan impairments.

There may be advantages in separating the ‘target’ (which can trigger the alternative budgeting procedures) from the planned allocations, with DfE using supplementary estimate procedures to cover the gap between allocations and the target as needed.

There may also be a political advantage in maintaining the 36% target.

In 2015/16, as we saw above, the impairment on new loans issued was 23%, last year it rose to 29%. It is likely to keep rising in the next couple of years as the new student support arrangements bed in  – that is, as we move to having three cohorts on higher maintenance loans and loans issued to nursing students – and we see the expected inflationary rises in undergraduate tuition fees.  (The changes to student support announced in 2015 were projected to add over £4bn to annual student loan issuance – these changes dwarf the introduction of part-time maintenance loans and postgraduate loans, which are estimated to have little to no impairment).

Why does this matter? The sustainability of the loan scheme in its current iteration is about how resource is allocated and utilised today. Control is imposed at the departmental level. The decision not to reset the target impairment in line with the discount rate change would seem to show that conditions on loans have been relaxed, but the low planned budgetary allocations suggest a pull in the other direction. When the new budgeting procedures were introduced in 2013/14, I was told that they were designed to ‘incentivise’ BIS – it’s not clear now how the incentives work.

Earlier, when I thought the target impairment was 28%, I suggested that this meant it would be difficult for ministers to address concerns about student loan interest rates and that planned inflationary increases to tuition fees may be reviewed. An announcement on the maximum fee level for academic year 2018/19 is due in the next month.

A DfE spokesperson provided the standard line on loans:

“Our student finance system ensures that graduates only start paying back their loans when they are earning over £21,000 and that loans are written off altogether after 30 years. Unlike commercial alternatives, student loans are available to everyone, regardless of background or financial history.

“This approach ensures that costs are split fairly between graduates and the taxpayer, and does this while helping more young people from disadvantaged backgrounds go to university than ever before —up 43% since 2009.”

“The student finance system introduced in 2012 has been recognised as sustainable by the OECD. We have made further changes to the student loan system since then to make it even more so.”

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