It warned that as a result in a severe recession “the UK banking system would, in aggregate, incur UK consumer credit losses of around £30bn, or 20% of UK consumer credit loans”.
Brokers and other industry representatives have been growing increasingly uneasy about the volume of unsecured consumer credit being issued and it appears the Bank of England is starting to recognise these issues.
However, the Bank of England also noted that it was happy with current mortgage lending which was in a stable position and broadly comparable to the last 20 years.
This is according to the latest notes from the Bank’s Finance Policy Committee (FPC) in which it stated: “Within a benign overall domestic credit environment, there is a pocket of risk in the rapid growth of consumer credit.
“This is not a material risk to economic growth, as consumer credit represents only 11% of overall household debt. It is a risk to banks’ ability to withstand severe economic downturns, because this asset class is disproportionately more likely to default.
“Although the overall credit quality of consumer credit has improved significantly since the financial crisis, the FPC judges that lenders overall are placing too much weight on the recent performance of consumer lending in benign conditions as an indicator of underlying credit quality. As a result, they have been underestimating the losses they could incur in a downturn,” it added.
Pocket of risk
The findings arose from stress tests that are regularly carried out by the Bank of England to model the reaction of different scenarios. The worst case scenario incorporated a UK economic downturn that has the unemployment rate rising to 9.5%, and Bank Rate rising to 4%.
The £30bn losses in this stress test comprised impairment rates of around 25% on credit cards, 15% on personal loans and 10% on car finance. These overall credit impairments on consumer credit represent 150 basis points of the aggregate capital ratio of the UK banking system.
Despite this “pocket of risk”, the FPC stated that: “In domestic credit markets, risk-taking is currently judged to be at a standard level overall. Domestic credit has grown broadly in line with nominal GDP over the past two years. Lending spreads on new owner-occupier mortgages are in line with their average since 1997.
“The share of households with mortgage debt-servicing costs exceeding 40% of their income (the percentage beyond which historical evidence suggests that households are materially more likely to experience repayment difficulties) is just 1%. And the aggregate debt-servicing ratio for UK non-financial corporations is below its average since 1999.”