The Bank of England, the UK’s central bank, has given the strongest indication yet it’s about to interrupt the consumer debt fuelled party that has been warming up across the UK for the last 18 months and may soon, like a disapproving parent, be sending credit card companies and other financial institutions home.
This is sometimes described as the traditional role of the central Bank: to take away the punch bowl, just before the party gets going. It’s a role the Bank of England seems determined to perform, telling UK banks and financial institutions this week they will need to find another £11.4 billion to protect themselves against bad loans.
The Bank’s Financial Policy Committee have expressed their concerns that lenders are again becoming overly complacent about borrowing levels. The Governor of the Bank of England, Mark Carney, did, however, stop short of accusing financial institutions of “gaming” the system, but said he believed financial institutions were placing too much weight on recent experiences of low missed payments and defaults, and forgetting the lessons of the past.
The Bank of England, he said, were now concerned about heavily indebted consumers and the resilience of financial institutions to suffer losses.
The brakes are being applied
This isn’t the first time the Bank has raised its concerns, however. It’s been making unhappy noises since the end of last year, after the UK saw the fastest growth in consumer debt since October 2005, and has been expressing its concerns about not only credit cards, but sharp increases in the number of second secured loans and car finance agreements.
In financial terms, this week’s announcement is the equivalent of the neighbours no-longer just banging on the door during a party or an angry parent phoning to ask when you are coming home; but the police turning up at your door with your irate dad.
The problem is, the Bank of England, feel lenders may be making too many assumptions, such as when interest rates do go up (which looks likely by the end of the year) they may not pass any additional costs onto the borrower. A highly unlikely scenario, but this is allowing them to sidestep some of the affordability tests they are now required to make before lending, which is leading to the Bank of England fearing they are lending more than they should and to consumers who have weaker credit ratings.
As a response, the Bank of England is now bringing forward it’s consumer credit stress test of financial institutions, which is aimed to test whether banks and financial institutions can suffer any losses they may incur from bad loans.
It is also giving the banks just six months to find the first £5.7 billion to safeguard against losses, with another £5.7 billion having to be in place by the end of 2018.
The effect of this will not only ensure the banks are “safer”, in that taxpayers will not have to bail them out again, but also if the banks have more money tied up in reserves, they will have less money to lend, meaning the Bank of England is already applying the brakes to the lending machine that has been gaining momentum over the last 18 months.
The Governor of the Bank of England, however, has also called for consumers to play a role. He has said they should consider whether the debts they are borrowing could be repaid in more adverse circumstances: effectively “stress test” themselves.
Stress testing now can prevent stress later
So, what is stress testing? Basically, it involves examining your finances and commitments and thinking, if things got worse, would you still be able to make your re-payments. The Bank of England states lenders should do this as part of their affordability test before lending money, by thinking if interest rates rose by 3%, would the borrower still be able to repay their debts?
This is not something people need banks to do. They should learn how to do it themselves. The days of trusting your financial health and well-being to a financial institution are long gone.
By simply adding an extra 3% onto all your monthly household expenditure, including your utilities and housing costs and food and travel, it should be possible to see what you are left with to pay your debts. Then add 3% onto your monthly debt payments.
If you cannot make your debt re-payments, then although you may currently be getting by, the danger is you are vulnerable to an economic income shock, such as one that could come with Brexit. That is any drop in your household income.
It may also mean you could be what is known as an iceberg bankrupt. That is a term used by the University of Wales, after it carried out research into the aftermath of the last credit crunch. It described the 2 million people they found, at that time, who were just keeping their head above water making minimum payments, but likely to sink if they experienced an income shock.
If this is the position you are in, you should seek advice. Just because many financial institutions appear to be suffering from long term memory loss, doesn’t mean you should. As the American economist, John Kenneth Galbraith, wrote in the foreword to his book on the Great Depression: “as a protection against financial illusion or insanity, memory is far better than law”.
But where your bank’s memory has failed you, it doesn’t mean the law will.
Pearse Flynn, CEO of Creditifix.