The Bank of England finds consumer credit growth is unsustainable
Central bank is gearing up to crack down on lending in July, writes Chris Giles
Central bankers are always “vigilant” in scanning the horizon for risks to financial stability. “Now is not the time for complacency,” they chorus. As a result, most financial stability statements have traditionally been empty of meaning.
The good news is that the Bank of England’s newish toolbox helps it address financial stability risks in a more honest way. This is what it attempted on Tuesday in its twice-yearly financial stability report.
Instead of simply saying the world is better and financial risks are lower than they appeared after the EU referendum, the BoE has a tool it can use in exactly these circumstances. To guard against complacency in a more stable environment, it has set the “countercyclical capital buffer” at 0.5 per cent now and 1 per cent in November, both up from the current rate of zero. This will force banks to hold another £11.4bn of capital over the next 18 months to deal with the likelihood they will extend too much credit if the world remains benign.
If there was a downturn or a fear of a downturn, the BoE could relax the countercyclical buffer, discouraging banks from squeezing credit supply at the same time as demand is weakening and exacerbating any downturn. The use of this tool is potentially powerful in attempting to damp the amplitude of the economic cycle and the BoE deserves credit for using it actively.
The bad news for UK financial stability is that consumer credit growth appears increasingly unsustainable. Total consumer credit rose 10.3 per cent in the year to April, with car finance growing at rates above 20 per cent until recently. Incomes are not keeping pace with prices, so household finances will become increasingly fragile — banks might just need to use that additional capital.
British households have borrowed £200bn in car loans, personal loans and credit card debt — which may sound a lot, but amounts to only one-seventh of the outstanding debt on mortgages. The sting in the tail is that default rates are much higher on consumer credit, so losses have been 10 times higher in such lending than on mortgages over the past decade.
Recently, credit underwriting standards have dropped and default rates would be expected to soar if there was a general economic downturn. No one is talking about vulnerabilities in the lending market similar to those in 2007, but the warning signs are evident. While doing nothing today, the BoE was clear it would tighten rules on unsecured lending in July. The aim will be to curtail lending growth to people who might struggle to repay.
For consumers and investors, there are two conclusions to draw. If you have secure finances, you should still be able to borrow and your financial provider should be safer once the new rules are in place. But if your finances are a bit dodgy, you should get in there quick before lenders are forced to become more conservative with their loans.