With consumer credit approaching its 2008 peak there are increasing concerns about what will happen if there’s an economic downturn. According to Jonathan Davidson of the Financial Conduct Authority (FCA), there are a significant number of households for whom “the slightest sign of rough weather could see them in over their heads”. It’s still only a decade since the last financial crisis, and yet by ignoring the severe risk posed by excessive debt, we’re in danger of repeating the same mistakes that caused the 2008 crash.
According to the Bank of England, consumer credit grew by 9.3% last year and household debt is high relative to incomes. UK Finance data shows that the value of outstanding loans since 2013-14 increased by 25% whereas according to the Office of National Statistics the pay increase for the typical full-time worker has been 6.5%.
This puts many people in a precarious position where they can just about manage their current debt repayments. Data from the FCA’s Financial Lives Survey shows that 10% of all UK adults would struggle if monthly payments for their mortgage or rent rose by less than 50 pounds. A third of them would face increased difficulty with payment rises of as low as one or two pounds. It’s not hard to see that difficulties in one area could easily spill over to other credit repayments.
With the cost of living rising, many have had to resort to debt in order to make ends meet. Prices for food, transport and energy have grown faster than wages over the past year. The largest increases in unsecured personal loans have been observed in UK regions that have experienced the lowest increases in median pay. Currently, 39 million people rely on consumer credit to finance big purchases such as cars or to bridge the gap in their finances. There has been a particularly pronounced growth in borrowing to finance vehicle purchases; the number of contracts has increased from 1.2m in 2008 to 2.3m in 2017.
According to Davidson, one in five mortgages are only interest bearing, having been “made at the height of the credit boom to borrowers with little equity in their homes and not a lot of disposable income”. This pattern of precarious lending seems to be repeating itself – the Bank of England put banks on notice having found that a fifth of new mortgage lending has been directed to people barely meeting its affordability rules. An increased appetite for risk among banks could once again put the financial system in jeopardy. It’s no surprise that arrears and default rates, although still low, are beginning to rise. These risks “stemming from rapid consumer credit growth… household indebtedness and mortgage underwriting standards”, have also been noted by the FPC.
Household debt is not necessarily a bad thing; it depends on whether the cost of borrowing is affordable, and how the credit is being used. If new debt ends up in pre-existing assets such as already-built homes, then it does very little to boost productive investment and therefore incomes. It also drives up prices, making it harder for families and individuals to get on the housing ladder without taking on more debt. On the other hand, if new debt fuels the real economy, output and wages will increase, making repayment far less problematic.
With interest rates set to climb further, the servicing cost of debt is bound to rise. What we must hope is that those who issue it have been prudent with its issuance, in spite of knowing from the moral hazard inherent in the banking system, that commercial banks have insufficient incentives for prudence. Otherwise there will be adverse effects – which, once again, will mostly be felt by those who can least afford it.