Making loans work for students, not the other way around

Juan Guerra is a One Young World Ambassador originally from Mexico and CEO of StudentFunder. He was a delegate speaker during the Education Plenary Session at the 2014 Summit in Dublin.

This blog originally appeared on The Huffington Post.

Should everyone go to university? Of course not! It’s not for everyone; but everyone should have the opportunity to attend, if they so desire. When I was 19, I simply could not afford to attend university in Mexico. I worked hard and funded my own education (while juggling ten  jobs); and eventually graduated. Needless to say, I am someone who values education.

A few years later, I was offered three scholarships to study an MBA in the UK. I sold everything I had but I was still missing the last £10,000 out of £40,000. The university offered me a grant for £5,000; only half of what I needed. It was so complicated for the university to offer me a loan that, in the end, they just gave me a grant for the full £10,000.

That was a great outcome for me, but the whole situation was a bit silly: I would have gladly paid back the £10,000 and someone else could have used those funds in the future. If we kept recycling money, at some point there would be enough funds for everyone. This seemed pretty obvious to me, so why weren’t UK universities lending?

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Realistically, that is not what Universities are required to do. They don’t have the legal or technical infrastructure to lend loans, after all, they expect banks to take care of the issue. However, as it stands, very few postgraduate students in the UK receive bank loans. Most students rely on family support and many talented people miss out for lack of finance. This is a barrier to social mobility and hugely wasteful for the economy, especially the “knowledge economy”.

So why aren’t banking institutions lending more? Surprisingly, the reason for this has little to do with credit risk. In fact, graduate students display excellent repayment behaviour: much better than undergraduate students. Default rates for graduate students are in the single digits in the UK and the US, so it’s not a question of risk. For banks, the operational costs involved in lending to students are too high and the market, in comparison, is too small.

This is where StudentFunder comes in. StudentFunder works with universities to provide loans for students studying masters and professional courses by sharing the risk with the banking institutions involved. In return, the banks provide the capital, and StudentFunder manages the administration.

Why would universities agree to share the risk? Let’s create a scenario: Imagine a university with a capacity for 100 students. It admits 100 students, of which only 50 find enough funds to enrol. The remaining 50 candidates are equally talented but cannot fund their intuition. If loans were offered, however, 100 people would enrol. Suppose out of the additional 50 who enrolled, 10 students did not pay their loans back. However the university had agreed to guarantee 100% of the loans, and reimbursed the bank for those 10 loans. The university would have still received payments from the 40 students who would not have enrolled in the first place. Universities have largely fixed costs: beyond a certain point, each additional student enrolling is contributing to the university’s bottom line.

Universities tend to have excellent credit rating. If they share the risk of their students’ loans, the cost of capital decreases and ultimately makes the loans for their students more affordable. Another way of reducing the cost of capital is to eliminate the need for capital altogether – StudentFunder, for instance, can manage instalment plans on behalf of a university. The university simply agrees to wait for tuition payments to come in overtime and relies on StudentFunder to manage that process.

It is vital that universities share in the risk of loans going to their students – it is a matter of keeping incentives aligned. This is where things have gone horribly wrong in the US. With the best intentions, the US government began subsidising student loans. Universities began charging more and more for their courses which lead to students borrowing more amounts; and so a vicious cycle was created. Today, there are 1.2 trillion dollars in student debt in the USA; an issue that everyone feels is out of control.

If we want to open access to higher education to everyone who deserves it, we can’t just rely on philanthropy and grants. We need to recycle money and we need loans. But any loan scheme which does not penalise universities, if students fail to find jobs, is bound to fail students and society as a whole. It is merely an industry subsidy creating the wrong incentives. We are living in an age where employability attached to the course should be higher, and the overall cost of these universities should be declining.

Above: Juan's delegate speech at the One Young World Summit 2014 in Ireland.