The Bank of England’s (BoE) Financial Policy Committee (FPC) has said that lenders are creating pockets of risk by placing too much weight on recent benign conditions.
In a statement from its policy meeting on 20 September 2017, the BoE said that the overall credit quality of consumer credit has improved significantly since the financial crisis. Here is an overview of the statement:
Within a benign overall domestic credit environment, there is a pocket of risk in the rapid growth of consumer credit. This is not a material risk to economic growth, as consumer credit represents only 11% of overall household debt. It is a risk to banks’ ability to withstand severe economic downturns, because this asset class is disproportionately more likely to default. Although the overall credit quality of consumer credit has improved significantly since the financial crisis, the FPC judges that lenders overall are placing too much weight on the recent performance of consumer lending in benign conditions as an indicator of underlying credit quality. As a result, they have been underestimating the losses they could incur in a downturn.
The FPC has responded to this risk by accelerating its analysis of credit losses that banks could incur in the very deep recession encapsulated in the 2017 annual stress test scenario. The FPC and PRC judge that, in the first three years of that severe stress test scenario, the UK banking system would, in aggregate, incur UK consumer credit losses of around £30 billion, or 20% of UK consumer credit loans, representing 150 basis points of the aggregate common equity Tier 1 capital ratio of the UK banking system. This is just one element of the overall stress test and should not be used as a guide to lenders’ overall results, which will be published as planned on 28 November.
Regulatory capital buffers for individual firms will be set following the full stress test results so that each bank can absorb its losses on consumer lending, alongside all the other effects of the stress scenario on its balance sheet. The FPC also expects that banks will begin to factor these market-wide levels of stressed losses on consumer credit into their overall lending and capital plans.
Commenting on the Bank of England statistics Karl Werner Chief Executive of Moto Novo said “There can be little doubt that the consumer credit market is set to face major change, with an increase in interest rates now firmly on the cards and the Bank of England signalling for increased lending prudence. Following virtually a decade of upward growth for our sector, the motor finance sector needs to be prepared for what for many will be a new experience, rising interest rates and tighter credit conditions.”
“Within a benign overall domestic credit environment, there is a pocket of risk in the rapid growth of consumer credit. Although the overall credit quality of consumer credit has improved significantly since the financial crisis, the FPC judges that lenders overall are placing too much weight on the recent performance of consumer lending in benign conditions as an indicator of underlying credit quality. As a result, they have been underestimating the losses they could incur in a downturn.”
“The winds of change in consumer credit have been building for a while now; it is time to re-calibrate in certain areas, notably risk management and pricing. As a business, our success and that of our dealers has come from a long-term approach and seizing ‘first mover advantage’ in areas such as innovation and technology. To secure long-term success and to support customer retention, we will not be afraid to move first to help secure the long-term future of dealer finance, no dealer benefits from choosing a lender with a model which proves unsustainable.”
