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11-05-2018 | POINT OF VIEW
Future-proofing consumer lending against the monetary policy dilemma

It was just a few weeks ago that a hike in interest rate by the Bank of England seemed inevitable to financial markets. Yet the Monetary Policy Committee (MPC)’s decision yesterday to keep the rate on hold at 0.5% came as no major surprise on the back of recent weak economic data and easing inflation concerns.

The Bank’s decision to keep the rate on hold will deepen its own policy dilemma; the need to build momentum in the economy is key, but so is an orderly exit from a decade of ultra-loose monetary policy. As Parker Fitzgerald pointed out in a recent report, a prolonged period of cheap money has had its consequences: it has led to markets not pricing properly for risk. Low rates have brought down the price of borrowing and contributed to an increase in debt. There has been a misallocation of resources, as forbearance has allowed zombie companies to be kept alive. The list of side effects continues.

A particularly worrying aspect relates to the build-up of household debt, which has not been helped by products such as interest-free balance transfer credit cards, car lease arrangements, and mortgages with record low interest rates. While some of the larger lenders have started to address this situation by applying sensible “stressed” rates to their applicants’ affordability assessments, many more financial institutions continue to drive rates below sustainable levels to originate new loans.

Both regulators and lenders are keeping a keen eye on the potential outcome of interest rate hikes against the backdrop of increasing household debt. In June last year, Mark Carney, the Governor of the Bank of England, warned the “overall picture does bear watching” in relation to car loans – which account for around 90% of new car purchases. In addition, lenders began to restrain credit card lending in Q4 last year by increasing their application decline rates and shortening the length of interest-free periods.

In terms of the mortgage market, whilst lenders appear well-capitalised against defaults, both banks and regulators are acutely aware of the implications of rate hikes. If mortgage rates were to rise, and indeed were to double in the next few years, it would leave consumers less-equipped to service other unsecured debt and would undermine their disposable incomes – all to the effect of slowing and shortening any economic upturn in the UK.

Prudent consumer lending is pivotal to the resilience of the UK economy – particularly at a time of significant uncertainty over the future of both Brexit and monetary policy. The policy dilemma faced by the Bank of England puts a greater onus on a closer collaboration between financial institutions and regulators, as well as across the regulatory community, to contain the risks associated with UK household debt.

Three approaches could be key to de-risking consumer lending in view of the current monetary policy conundrum.

  1. Explore areas outside of monetary policy to help contain household debt. Examples may include introducing mandatory minimum stressed rates on credit scoring; a limit to interest-free period lengths (e.g. a 2-year cap), a limit to the number of interest-free products that can be held by one consumer, and car finance that protects the consumer against residual value depreciation.
  2. Intimate coordination with the Financial Conduct Authority to ensure that product restrictions, consumer advice, and product illustration literature are calibrated with Bank of England objectives, including those set out by the MPC and the Prudential Regulation Authority.
  3. Closer alignment with consumer agencies in the development of advice that is disseminated to inform and educate consumers on the risks associated with borrowing. One example is the Government’s Money Advice Service, which helps consumers understand the future dynamics of the household debt they currently hold, and considerations to taking on more.

The impact of the above measures could be further explored and evolved in the absence of monetary policy tightening, but continued exploration into other areas of non-traditional containment measures of household debt are crucial in this period of economic uncertainty.




For more information contact:

James Clark
James Clark
Partner
Email: jclark@pfg.uk.com
Phone: +44 (0) 207 100 7575

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