The Bank of England has told banks, credit card companies and car loan providers that they risk fresh action against reckless lending as it warned of a looming “spiral of complacency” about mounting consumer debt.
In its toughest warning yet about the possibility of a rerun of the financial crisis that devastated the economy 10 years ago, Threadneedle Street admitted it was alarmed about the increase in the amount of money being borrowed on easy terms over the past year.
“Household debt – like most things that are good in moderation – can be dangerous in excess”, Alex Brazier, the Bank director for financial stability, said in a speech in Liverpool. “Dangerous to borrowers, lenders and, most importantly from our perspective, everyone else in the economy.”
Brazier’s said there were “classic signs” of lenders thinking the risks were lower following a prolonged period of good economic performance and low losses on loans.
The first signs of the Bank’s anxiety about consumer debt came from its governor, Mark Carney, a month ago, but Brazier’s comments marked a ratcheting up of Threadneedle Street’s rhetoric.
“Lenders have been the lucky beneficiaries of the benign way the economy has evolved. In expanding the supply of credit, they may be placing undue weight on the recent performance of credit cards and loans in benign conditions,” Brazier said.
The willingness of consumers to take on more debt to fund their spending helped the economy grow strongly in the six months after the EU referendum, a period when the Bank expected growth to fall sharply.
Over the past year, Brazier said, household incomes had grown by just 1.5% but outstanding car loans, credit card balances and personal loans had risen by 10%.
He added that terms and conditions on credit cards and personal loans had become easier. The average advertised length of 0% credit card balance transfers had doubled to close to 30 months, while advertised interest rates on £10,000 personal loans had fallen from 8% to around 3.8%, even though official interest rates had barely changed.
The past decade has seen the number of cars bought with a personal contract purchase (PCP) plan – under which the car is effectively leased – increase from one in five to four in five. Companies risk losing money if used car prices fall and Brazier said banks involved and the shareholders of car companies would “want to think very carefully about the risks”.
He added that developments in mortgage debt had been much less striking than those in consumer debt and car finance, with lending for home loans up by just 3% over the past year. “But even here there are some tentative signs of boundaries being pushed,” he said.
Strong competition for business was resulting in more lending at higher loan-to-income (LTI) multiples, with the share at an LTI above 4 increasing from 19% to 26% over the past two years.
“Lenders have not entered, but they may be dicing with the spiral of complacency,” Brazier said, noting that as credit became cheaper it was taken up more widely and was serviced more easily.
“The spiral continues, and borrowers rack up more and more debt. Lending standards can go from responsible to reckless very quickly. The sorry fact is that as lenders think the risks they face are falling, the risks they – and the wider economy – face are actually growing,” Brazier said.
The Bank director said banks and building societies were being supervised and had to prove to the regulator that they had safeguards in place against entering the spiral of complacency. Lenders were also being regularly stress tested to ensure that they could deal with very severe recessions without cutting back on their lending.
In addition, the Bank had forced lenders to hold more capital in order to make them more resilient to losses on their loans.
“By September we will have assessed whether the rapid growth has created any gap in the line. If it has, we’ll plug it,” Brazier said.
Brazier said the defence lines did “not eliminate the risks that borrowers and lenders take on when entering into a loan” but that they “safeguard everyone else – the wider economy – from collateral damage. They mean there’s every prospect that we can make the economy a safer place than it has been in the past and that we can stop watching endless repeats of Debt Strikes Back.”
His speech came just a fortnight before the 10th anniversary of the start of the global financial crisis in August 2007.
“Ten years ago, an unsafe financial system caused financial crisis and economic disaster”, he said. “The western banking system had expanded rapidly. Banks – and their regulators – had been blind to the basic fact that more debt meant greater risk of loss.
“Complacency gave way to crisis. Companies and households were unable to refinance their debts. The result was economic disaster. In this country alone, close to a million jobs were lost and more than 100,000 businesses failed. Too much debt made the financial system, and the economy, unsafe. Too many people paid the price when those risks materialised.”