The increasing relience of UK households to consumer credit forces the Bank of England to intervene

The Prudential Regulation Authority, the Bank of England and the Financial Stability Commitee all concern with the increase consumer credit has from April 2016 to April 2017 and proceed in measures in order to verify the suitability of lenders and borrowers in the consumer credit market.

The Governor of Bank of England (BoE) expresses his view on consumer credit by stating “Consumer credit has increased rapidly.Lending conditions in the mortgage market are becoming easier and lenders may be placing undue weight on the recent performance of loans in benign conditions.“ Mr Carney agrees with the worries of the Prudential Regulation Authority (PRA), recently communicate in its review,and the BoE Financial Stability Report.Both authorities concerns over the increasing amount of available credit to UK households and their tendency to opt in order to sustain consumption.The BoE instructs the Banks to prove that the boom in lending of credit cards and other households loans are not excessively risky. The directive was given since Officials of BoE are worried that debt is at an extraordinary pace which it can only be achieved if lenders are taking more risk and giving loans to households that are less able to afford. The statistics from the Bank of International Settlements reveals that UK household debt is at 87.6% of GDP the last quarter of 2016 and has show a tendency to rise in 2017.

The Financial Stability Report analyzes the issue of the rising of consumer credit, whose annual rates increases faster than the household income . During this period (2013-2017) dealership finance (car finance) has the fastest expansion although other forms of consumer credit (mainly credit cards and personal loans) accounted more than half of consumer growth in the past year. Lenders are expected to continue to grow their portfolios through 2017 at the same time as the real household’s income growth is weak.The Financial Stability report also refer that the total amount of UK consumer credit was at 198 billion pounds, and account less than 10% of banks stock lending. In comparison the consumer credit is account for higher proportion of losses, since 2007 UK banks’ total write-offs on UK consumer credit have been ten times higher than on mortgages. The consumer credit market is highly diverse with a wide range of products and lenders. But there are some common features across product types:

1) Short terms, most consumer credit lending is at maturities of five years or less

2) Higher interest rates, while interest rates vary considerably across product types, they are typically materially higher than for mortgages

3)Fixed rates, most consumer credit products have interest rates that are fixed for the entire term of the loan

Banks provide around 80% of lending in the credit card and ‘other’ categories, but less than half of dealership car finance as the statistics from the Financial Stability reports shows: the amount of credit cards loans is at 67 billion pounds and from those 52 billions are provided by banks and 14 billion provided by non-bank institutions. Personal loans are at 72billion pounds of whom 62 billion are bank loans and only 10 billion are from non-bank institutions. In the case of dealership loans the amount is at 58billion pounds with 24 billion to be bank loans and 34 billion to be non-bank loans.

We could argue that the causes for the increase of consumer credit are the following: The first is the intense competition between lenders. The Credit Condition Servey from BoE reports that interest rates have fallen since 2013 squeezing interest margins and lead the lenders to try to increase the amount of credit which provide in order to increase their profitability.The second reasoning is that households increase their consumer credit for the purpose to sustain their living standards due to the wage stagnation the UK economy has the last two years. Mr. Haldane chief economist of BoE comment on BBC newshight that the business haven’t invest enough in productivity improvements to push up pay. According to Mr. Haldane productivity –how efficient firms and workers are-is one of the biggest contributing causes of lack of pay growth. Firms choose the low productivity road and this cause the failing growth on wages although the UK unemployment is very low (4.5%).The third factor that makes the households to increase their dependence in consumer credit is the continuous shirking of their savings. The Office of National Statistics (ONS) calculates the saving ratio at 1.7% from January to March 2017 which is considerable lower than the 3.3% in the previous quarter and the lowest rate since the record began in 1963. Saving ratio fall according to the ONS the tax payments on September which was considerable high, led to the shrinking of disposable income and saving ratio of British households. More specific Mr. Darren Morgan Head of GDP of ONS said ‘’ The saving ratio has fallen again this quarter to a new record low partly as result of higher tax payments reducing the disposable income’’.  ONS has calculated that the real disposable income fell by 1.4% the first three months of 2017.  The combination of intense competition, wage stagnation ,falling saving ratio and decline disposable income led to the increasing reliance of household to credit in order to sustain their consumptions norms.

This situation poses a danger for the UK economy from two sides, the lenders (Banks and non-Banks institutions) and the borrowes (households). According to the Financial Stability Report for the lenders if all things equal the falling of interest margin mean less interest income is available to them in order to absorb the losses from consumer credit risk. The average risk weight for consumer credit also fallen in recent years reducing the loss-absorbing capital required to fund these exposures. The fall of margin do not appear to  have been accompanied by a corresponding improvement in the underlying credit quality of new lending.The Bank of England Credit Condition Survey indicates that lenders have been loosening their credit scoring criteria for non-credit card unsecured lending since 2013. All else equal, this makes it easier for households with lower credit scores to access consumer credit. The data also show that losses on consumer credit are higher than mortgages because, in the face of adverse shocks, borrowers are much more likely to default on their consumer credit loans than their mortgages. And as the majority of consumer credit lending is unsecured, lenders cannot rely on the value of collateral to cushion their losses.A situation as the one describe by the Credit Condition Survey could lead the financial system to increase instability.

From the borrowers side the increase of consumer credit basically happen in order the households to sustain their consumption but it also led to the decline of their savings ratio and disposable income, in a period of wage stagnation. The continuously fall of household income eventually will lead to a decline in consumption, at a time when the increase of household consumption support the UK economy after the Brexit referendum. The impact of a sudden decline in consumption will lead to a decrease in business productivity, low exports and further pressure to middle and low income workers.The inability of households to serve their debts will cause a series of defaults which will destabilize the already fragile financial system.

This precautious situation probes the BoE to act in accordance with the instructions of the PRA and FCC. The measures the Bank of England implement was:

1)     To increase the capital availability of the Banks by 11.4 billion pounds the next 18 months.

2)     To issue a directive in the lenders to take in account the borrowing condition of the borrower

3)     To conduct the stress test earlier (adding an increase in unemployment by 4.6%) in order to decide if the lenders have the ability to withstand loses in their assets from the write offs of loans by household who would be unable to continue their payments.

The objective of the BoE is with these measures to succeed the banks to have additional capital in case of a serious number of credit defaults from households.The rising of the standards for the banks and non-banks institutions to provide credit with more strictly criteria for their costumers help them to avoid the availability of credit to households which will be unable to repay their debt.The Bank’s annual stress-test exercise assesses banks’ resilience to risks in consumer credit and the BoE will commerce them earlier this year. The reason is that the stress tests will inform the BoE’s assessment at its next meeting of any additional resilience required in aggregate against this lending. The Bank of England through the Financial Stability Report express it beliefs that effective governance at firms should ensure that risks are priced and managed appropriately and benign conditions do not lead to complacency by lenders.