Britain’s banks will have to find another £10 billion to cover potential losses in their portfolios of credit card, personal loan and car finance debt, the Bank of England has said.
The central bank has completed its 2017 stress tests of lenders’ consumer credit books and found that they would lose £30 billion in a severe recession, or £1 in every £5 lent. The findings were £10 billion more than in last year’s stress test.
The Bank said that it would ensure the hole was filled on a bank-by-bank basis through targeted “top-up” capital buffers set individually. Each bank will be given its buffer in November, when the full stress tests are completed. Lloyds Banking Group and Barclays have two of the biggest consumer credit books in the UK.
The new capital treatment will apply permanently in a move that may raise household borrowing costs for consumer credit as the rules will make it more expensive for banks to lend. The Bank’s decision underlines the scale of consumer credit growth, which has expanded by about 10 per cent over the past year, and has raised concerns about unsustainable debt among some households in the UK.
Labour is proposing to limit interest payments on credit card debt so that no-one pays more in interest payments than their original loan as a means of helping the millions of households with persistent debt problems. The Financial Conduct Authority is also looking at payday lending and other high cost credit.
In a scenario where interest rates rise by 4 percentage points and unemployment hits 9.5 per cent, the Bank said credit card losses would total £15 billion, £8 billion of personal loans would be wiped out, as would £2 billion of car finance debt. The remaining £5 billion of losses would be shared between overdraft and unorthodox lending such as payday loans.
The Bank’s financial policy committee (FPC) said that there was no threat to the economy as growth was not debt driven, but they are concerned about financial stability risks in Britain’s banking sector.
Allan Monks, an economist at J P Morgan, described the FPC’s approach as “incrementalist” because it stopped short of placing direct curbs on consumer lending.
“More direct intervention in the consumer loan market is unlikely unless banks fail to comply with the BoE’s requirements,” Mr Monks added.
Consumer credit accounts for just 1.4 per cent of consumer spending and is one seventh of total household credit, with the vast majority held as mortgages, and one tenth of overall UK credit. However banks have historically suffered far greater defaults on unsecured household credit than on mortgages.
The latest measures come at a time when commercial banks already face higher capital requirements. The Bank has instructed them to raise £11 billion over the next year as the counter-cyclical buffer is increased from zero to 1 per cent, in a reflection of the resilient economic backdrop. The £10 billion for consumer credit will be on top.
Banks have £280 billion of capital. In aggregate they already hold more than they are required, so the £10 billion requirement may not increase the total capital stock by much. It may affect banks individually though.
The FPC took the decision because it believed lenders were not conducting strict enough risk assessments themselves on consumer credit. They are taking the present benign environment of unemployment at a 42-year low and record low rates as normal, which potentially under-represents the real risk on their consumer credit books.
The FPC is also addressing banks’ Brexit contingency plans, as in some events they cannot mitigate the problems themselves. Legal changes in both the UK and the European Union may be needed to ensure £20 trillion of derivatives contracts are unaffected by Brexit.
Similarly, changes in the law may be needed to ensure continuity of some insurance contracts so premiums can still be collected and claims paid. There are also issues around data transfer of client information, which could prove disruptive if mitigating measure are not put in place.