LONDON – The Bank of England warned Monday of “a pocket of risk” in the rapid growth of consumer credit in the British economy, and is compelling lenders to hold an extra 10 billion pounds ($13.5 billion) in capital to cover themselves against potential losses.
The fast rise in credit like car loans or credit card debt may not be a threat to the overall economy, accounting for just 11 per cent of household debt, but it represents a risk to “banks’ ability to withstand severe economic downturns, because this asset class is disproportionately more likely to default,” the Bank of England’s Financial Policy Committee said.
The committee said lenders have placed too much weight on the recent performance of consumer lending in benign conditions, which has seen default rates fall. As a result, the committee said, lenders “have been underestimating the losses they could incur in a downturn.” Though growth in consumer credit has slowed in recent months, it’s still high — up 9.8 per cent in the year to July 2017.
“Growth of consumer credit remains well above the rate of growth in household disposable income,” the committee said in a report on a meeting held Sept. 20.
Banks, the committee added, could end up incurring 30 billion pounds worth of losses in the event that interest rates and unemployment rise sharply. That’s around 20 per cent of their outstanding loans and 10 billion pounds more than previously thought under a “very deep recession” scenario.
The extra capital they require is relatively small compared with the 280 billion pound that banks already have to keep back against potential losses, a buffer that the regulators hope will prevent a repeat of the financial crisis of a decade ago.
Individual banks will be evaluated later this year in so-called stress tests, in which banks’ finances are put through a simulation of economic duress.
The warning from the committee, which assesses the financial risks to the British economy on a quarterly basis, comes on the day that Britain’s main opposition Labour Party is calling for limits on credit card interest rates so that no one pays back more than twice the amount of their original borrowing.
Though consumer credit has increased over the past year amid low interest rates, Paul Hollingsworth, U.K. economist at Capital Economics, noted the recent slowdown. And with inflation likely to fall back in coming months, and wages set to rise, he said “the foundations for spending growth next year should be stronger, so concerns about consumer credit are likely to diminish, rather than build further.”
On Brexit, the committee voiced concerns about the potential financial impact on British firms, saying Britain and the European Union would need an agreement.