The Old Lady of Threadneedle Street cautioned that the UK’s growing £200bn consumer debt pile threatens some to damage the capital positions of some of Britain’s biggest banks should a sharp downturn in the economy take place, reports the Telegraph.
In a sombre statement from the central bank’s Financial Policy Committee, the burgeoning consumer credit market was described as a “pocket of risk.”
Although the Bank, led by Governor Mark Carney, asserted that rising consumer debt defaults would be unlikely to materially damage economic growth, it did warn that they would not be without cost.
Britain’s banks need to set aside an extra £10bn to cover possible lossess on personal loans, credit cards and car loans, the Bank confirmed.
The share prices of some of the UK’s biggest banks fell on the warning, with shares in Lloyds Banking Group and Barclays down by more than 1 per cent respectively in mid-morning trading.
The FPC acknowledged that although the quality of consumer credit has improved – with fewer customers defaulting as a percentage – “lenders overall are placing too much weight on the recent performance of consumer lending in benign conditions as an indicator of underlying credit quality.”
The Bank argues that because of this over-reliance on relatively low default rates, in part due to strong economic conditions including low levels of unemployment, banks are underestimating the losses they might incur should the economy turn.
Research from the Bank’s 2016 stress test shows that losses on unsecured credit to major banks were 60 per cent greater than those on mortgages.
Recent figures show that the annual rate of growth for unsecured consumer borrowing through credit cards, overdrafts and personal loans still stood at 9.8 per cent in July. At the end of July, total unsecured personal borrowing stood at £201.5bn, the highest since December 2008.
The Bank warns that, in the first three years of its so-called severe stress scenario – a recessionary environment, in laymans terms – “the UK banking system would, in aggregate, incur UK consumer credit losses of around £30bn, or 20pc of UK consumer credit loans.”
In turn this would knock 150 basis points from aggregate common equity Tier 1 capital ratio of the UK banking system.
As a result of its warnings, which comes ahead of December’s annual stress test, the Bank said it expects lenders to begin to factor in its concerns on consumer credit into their own capital plans, a move which is likely to see banks begin to rein in the amount of unsecured credit available to consumers.
The so-called counter-cyclical capital buffer, which tells banks to hold more capital in good times so they can absorb more losses in bad times, was raised from 0 per cent to 0.5 per cent in June, indicating that lending conditions are improving. Officials confirmed in their latest statement, which follows a meeting of the FPC last week, their plans to raise it to 1 per cent in November.
The warning will not come as a surprise to the bosses of Britain’s banks, as it follows a series of cautionary comments from Bank officials since the start of the year.
The Bank also disclosed that all lenders regulated by its Prudential Regulation Authority (PRA) have been told to detail what measures they are taking against placing too much weigh on recent performance of unsecured credit.
Paul Hollingsworth, of Capital Economics, said that the extra £10bn capital requirement “is not especially large” compared to the £280bn of core capital already held by banks.
“With inflation likely to fall back after peaking around October, and some acceleration in wage growth in prospect, the foundations for spending growth next year should be stronger, so concerns about consumer credit are likely to diminish, rather than build further,” he continued.
The FPC also said it is keeping an eye on the effects of Brexit on Britain’s financial services sector, particularly the impact on insurance and derivatives.
“The FPC continues to assess the risks of disruption to financial services arising from Brexit so that preparations can be made and action taken to mitigate them,” it advised.
As well the impact on discontinuing cross-border contracts in insurance and derivatives, it the committee is also looking closely at restrictions on the sharing of personal data between the European Union and the UK, and restrictions after Brexit on cross-border banking and central clearing.