The Bank has increased borrowing costs, but is personal debt bubbling over?


Following a period of double digit growth in consumer credit over the last year or so, there have been some concerns about the reappearance of a debt bubble in the UK economy. In truth though, household borrowing currently resembles less of a bubble and more of two day-old helium balloon: partially deflated and looking worse for wear, but refusing to give up entirely on its former glories. (Full disclosure, that’s a Noel Fielding gag that works much better in relation to turning 40).

This week’s rate rise will undoubtedly have some impact on household borrowing in the coming months; both in terms of changing the cost of some existing debt and in terms of modifying the flow of new borrowing.

But the rise was not about bursting a perceived debt bubble. Other parts of the Bank have highlighted specific areas of concern; the Prudential Regulation Authority (PRA) has identified a decline in the resilience of lenders’ portfolios and the Financial Policy Committee (FPC) describes a “pocket of risk” in the consumer credit market. However, Monetary Policy Committee (MPC) justification for the rate rise focused on concerns that UK growth is outpacing a “new, lower speed limit”.

Yet total net household liabilities stand at £1.9 trillion, an unquestionably large number. So how concerned should we be about debt right now?

Let’s start with the big numbers. Measured as a share of household income, that £1.9 trillion of outstanding liabilities comes in at 140 per cent. As the chart below shows, this ratio has been on an upward trajectory since the end of 2015. This reflects the fact that spending has been outpacing household income growth, with consumers famously remaining resilient following the EU referendum. The ratio remains someway below the peak of 156 per cent reached immediately before the 2008-09 recession, and the cost of servicing this debt is much reduced in an ultra-low interest rate environment. Still, the stock of household debt is much higher than anything seen before 2005.

Much of the recent growth in the debt-to-income ratio has been driven by unsecured lending, rather than by mortgages. The next chart sets out the annual growth in net lending on both an unsecured and a secured basis. The 3.2 per cent growth in lending secured on dwellings remains well below the pre-crisis average of 9.2 per cent. In contrast, consumer credit growth has topped 10 per cent over much of the past 18 months. While still below the pre-crisis average of 12.4 per cent, the gap is much narrower.

Despite the modest recent slowdown recently, double digit credit growth at a time of stagnant incomes sounds like a bad idea. And there is evidence to suggest that robust growth has prompted some problems.

As the next chart shows, roughly one-third of working-age households in Britain said their unsecured debts were a financial burden in the second half of 2016. For one-in-ten households that burden was described as “heavy”. Thursday’s Inflation Report suggested that this figure increased further in the 2017 version of the survey, reversing a five-year period in which the proportion had been flat or falling.

We can identify signs of potentially risky behaviour. The next chart shows 13 per cent of British households making no more than the minimum repayment on their credit cards in the second half of last year. For the 6 per cent of households not being charged interest on their balance, that might be defensible. But for the 7 per cent who do pay interest, it appears to be a dangerous strategy.

Once again the evidence suggests that things have got worse rather than better since this data was collected. The Bank of England’s Credit Conditions Survey shows a net balance of agents reporting an increase in the number of customers making minimum repayments in each of the last seven quarters of data.

That same survey also highlighted recent increases in the number of customers defaulting on unsecured debt in recent quarters, as the next chart shows.

Individual insolvencies are up too. Insolvency regime reform – with eligibility for Debt Relief Orders being broadened from October 2015 and the courts being removed from the bankruptcy process from April 2016 – is likely to explain some of the recent increase in consumer credit defaults. The sharpest increase in personal insolvencies has come in relation to Individual Voluntary Agreements however. The number increased by 16.8 per cent year-on-year in Q3 2017, reaching a record high.

Yet while there is much that might concern us, there is evidence too that the credit market has started to shift. Faced with significant uncertainty about the direction of the UK economy, banks have reported a tightening of their unsecured lending criteria over the past three quarters. And, as the next chart shows, unsecured credit availability is expected to tighten further still in the fourth quarter of the year.

It’s not just credit supply that’s changed either. Bank of England agents reported subdued household demand for borrowing in the third quarter, with an expectation that this persists.

So what to make of all this? One reading is that the mini-credit boom of 2016 was entirely rational. Household confidence was high following two solid years’ of income growth and record high employment. Demand for big ticket items was likely to be elevated following a sustained period of belt-tightening. Given the easing in credit conditions and record low interest rates on some products (though by no means all, as the next chart shows), borrowing more made sense.

Both lenders and borrowers appear to have subsequently responded to the growth in associated problems this mini-boom in borrowing provoked by cutting back the supply of, and demand for, credit. That should be taken as an encouraging sign. The market may not be self-regulating – the aforementioned activity of the PRA and FPC is likely to have played a role – but it at least appears more self-aware than the one which prevailed on the eve of the financial crisis.

Of course, none of this takes away from the potential for individual households to encounter some form of debt stress. After all, the majority of households who find themselves struggling with debt can cite a change in circumstance – rather than over-commitment – as the catalyst. In the midst of a renewed squeeze on wages, with sizeable cuts to working-age welfare due over the coming years and the uncertainty of Brexit still looming, the risk of such circumstantial changes is perhaps heightened.

At the macro level through, the implication is that there isn’t a fresh debt bubble. That’s undoubtedly good news, and the Bank should take some credit for acting through a range of regulatory channels to get ahead of the curve. A slowdown in credit growth is desirable, not least because much of the stock of debt built up ahead of the financial crisis remains in place. But it also has clear implications for the wider pace of economic expansion. In this sense, our partially deflated helium balloon serves as a reminder that the post-party debt hangover remains firmly in place.