Tag: Consumer credit

Consumer credit is borrowing by individuals to finance current expenditure on goods and services. Consumer credit is distinct from lending secured on dwellings (referred to more simply as ‘secured lending’). Consumer credit comprises lending on credit cards, lending through overdraft facilities and other loans and advances, for example those financing the purchase of cars. We consider here recent trends in the flows of consumer credit in the UK and discuss their implications.

Analysing consumer credit data is important because the growth of consumer credit has implications for the financial wellbeing or financial health of individuals and, of course, for financial institutions. As we shall see shortly, the data on consumer credit is consistent with the existence of credit cycles. Cycles in consumer credit have the potential to be not only financially harmful but economically destabilising. After all, consumer credit is lending to finance spending and therefore the amount of lending can have significant effects on aggregate demand and economic activity.

Data on consumer credit are available monthly and so provide an early indication of movements in economic activity. Furthermore, because lending flows are likely to be sensitive to changes in the confidence of both borrowers and lenders, changes in the growth of consumer credit can indicate turning points in the economy and, hence, in the macroeconomic environment.

Chart 1 shows the annual flows of net consumer credit since 2000 – the figures are in £ billions. Net flows are gross flows less repayments. (Click here to download a PowerPoint copy of the chart.) In January 2005 the annual flow of net consumer credit peaked at £23 billion, the equivalent of just over 2.5 per cent of annual disposable income. This helped to fuel spending and by the final quarter of the year, the economy’s annual growth rate had reached 4.8 per cent, significantly about its long-run average of 2.5 per cent.

By 2009 net consumer credit flows had become negative. This meant that repayments were greater than additional flows of credit. It was not until 2012 that the annual flow of net consumer credit was again positive. Yet by November 2016, the annual flow of net consumer credit had rebounded to over £19 billion, the equivalent of just shy of 1.5 per cent of annual disposable income. This was the largest annual flow of consumer credit since September 2005.

Although the strength of consumer credit in 2016 was providing the economy with a timely boost to growth in the immediate aftermath of the referendum on the UK’s membership of the EU, it nonetheless raised concerns about its sustainability. Specifically, given the short amount of time that had elapsed since the financial crisis and the extreme levels of financial distress that had been experienced by many sectors of the economy, how susceptible would people and organisations be to a future economic slowdown and/or rise in interest rates?

The extent to which the economy experiences consumer credit cycles can be seen even more readily by looking at the 12-month growth rate in the net consumer credit. In essence, this mirrors the growth rate in the stock of consumer credit. Chart 2 evidences the double-digit growth rates in net consumer credit lending experienced during the first half of the 2000s. Growth rates then eased but, as the financial crisis unfolded, they plunged sharply. (Click here to download a PowerPoint copy of the chart.)

Yet, as Chart 2 shows, consumer credit growth began to recover quickly from 2013 so that by 2016 the annual growth rate of net consumer credit was again in double figures. In November 2016 the 12-month growth rate of net consumer credit peaked at 10.9 per cent. Thereafter, the growth rate has continually eased. In January 2019 the annual growth rate of net consumer credit had fallen back to 6.5 per cent, the lowest rate since October 2014.

The easing of consumer credit is likely to have been influenced, in part, by the resumption in the growth of real earnings from 2018 (see Getting real with pay). Yet, it is hard to look past the economic uncertainties around Brexit.

Uncertainty tends to cause people to be more cautious. With the heightened uncertainty that has has characterised recent times, it is likely that for many people and businesses prudence has dominated impatience. Therefore, in summary, it appears that prudence is helping to steer borrowing along a downswing in the credit cycle. As it does, it helps to put a further brake on spending and economic growth.

Articles

Questions

  1. What is the difference between gross and net lending?
  2. Consider the argument that we should be worried more by excessive growth in consumer credit than on lending secured on dwellings?
  3. How could we measure whether different sectors of the economy had become financially distressed?
  4. What might explain why an economy experiences credit cycles?
  5. Explain how the growth in net consumer credit can affect economic activity?
  6. If people are consumption smoothers, how can credit cycles arise?
  7. What are the potential policy implications of credit cycles?
  8. It is said that when making financial decisions people face an inter-temporal choice. Explain what you understand this by this concept.
  9. If economic uncertainty is perceived to have increased how could this affect the consumption, saving and borrowing decisions of people?

The Christmas and new year period often draws attention to the financial well-being of households. An important determinant of this is the extent of their indebtedness. Rising levels of debt mean that increasing amounts of households’ incomes becomes prey to servicing debt through repayments and interest charges. They can also result in more people becoming credit constrained, unable to access further credit. Rising debt levels can therefore lead to a deterioration of financial well-being and to financial distress. This was illustrated starkly by events at the end of the 2000s.

The total amount of lending by monetary financial institutions to individuals outstanding at the end of October 2018 was estimated at £1.61 trillion. As Chart 1 shows, this has grown from £408 billion in 1994. Hence, indivduals in the UK have experience a four-fold increase in the levels of debt. (Click here to download a PowerPoint of the chart.)

The debt of individuals is either secured or unsecured. Secured debt is debt secured by property, which for individuals is more commonly referred to as mortgage debt. Unsecured debt, which is also known as consumer credit, includes outstanding debt on credit cards, overdrafts on current accounts and loans for luxury items such as cars and electrical goods. The composition of debt in 2018 is unchanged from that in 1994: 87 per cent is secured debt and 13 per cent unsecured debt.

The fourfold increase in debt is taken by some economists as evidence of financialisation. While this term is frequently defined in distinctive ways depending upon the content in which it is applied, when viewed in very general terms it describes a process by which financial institutions and markets become increasingly important in everyday lives and so in the production and consumption choices that economists study. An implication of this is that in understanding economic decisions, behaviour and outcomes it becomes increasingly important to think about the potential impact of the financial system. The financial crisis is testimony to this.

In thinking about financial well-being, at least at an aggregate level, we can look at the relative size of indebtedness. One way of doing this is to measure the stock of individual debt relative to the annual flow of GDP (national income). This is illustrated in Chart 2. (Click hereto download a PowerPoint of the chart.)

The growth in debt among individuals owed to financial institutions during the 2000s was significant. By the end of 2007, the debt-to-GDP ratio had reached 88 per cent. Decomposing this, the secured debt-to-GDP ratio had reached 75 per cent and the unsecured debt-to-GDP ratio 13 per cent. Compare this with the end of 1994 when secured debt was 46 per cent of GDP, unsecured debt 7 per cent and total debt 53 per cent. In other words, the period between 1994 and 2007 the UK saw a 25 percentage point increase in the debt-to-GDP ratio of individuals.

The early 2010s saw a consolidation in the size of the debt (see Chart 1) which meant that it was not until 2014 that debt levels rose above those of 2008. This led to the size of debt relative to GDP falling back by close to 10 percentage points (see Chart 2). Between 2014 and 2018 the stock of debt has increased from around £1.4 trillion to the current level of £1.61 trillion. This increase has been matched by a similar increase in (nominal) GDP so that the relative stock of debt remains little changed at present at around 76 per cent of GDP.

Chart 3 shows the annual growth rate of net lending (lending net of repayments) by monetary financial institutions to individuals. This essentially captures the growth rate in the stocks of debt, though changes in the actual stock of debt are also be affected by the writing-off of debts. (Click here to download a PowerPoint of the chart.)

We can see quite readily the pick up in lending from 2014. The average annual rate of growth in total net lending since 2014 has been just a little under 3½ per cent. This has been driven by unsecured lending whose growth rate has been close to 8½ per cent per annum, compared to just 2.7 per cent for secured lending. In 2016 the annual growth rate of unsecured lending was just shy of 11 per cent. This helped to fuel concerns about possible future financial distress. These concerns remain despite the annual rate of growth in unsecured debt having eased slightly to 7.5 per cent.

Despite the aggregate debt-to-GDP ratio having been relatively stable of late, the recent growth in debt levels is clearly not without concern. It has to be viewed in the context of two important developments. First, there remains a ‘debt hangover’ from the financial distress experienced by the private sector at the end of the 2000s, which itself contributed to a significant decline in economic activity (real GDP fell by 4 per cent in 2009). This subequently affected the financial well-being of the public sector following its interventions to cushion the economy from the full effects of the economic downturn as well as to help stabilise the financial system. Second, there is considerable uncertainty surrounding the UK’s exit from the European Union.

The financial resilience of all sectors of the economy is therefore of acute concern given the unprecedented uncertainty we are currently facing while, at the same time, we are still feeling the effects of the financial distress from the financial crisis of the late 2000s. It therefore seems timely indeed for individuals to take stock of their stocks of debt.

Articles

Questions

  1. How might we measure the financial distress of individuals?
  2. If individuals are financially distressed how might this affect their consumption behaviour?
  3. How might credit constraints affect the relationship between consumption and income?
  4. What do you understand by the concept of ‘cash flow effects’ that arise from interest rate changes?
  5. How might the accumulation of secured and unsecured debt have different effects on consumer spending?
  6. What factors might explain the rate of accumulation of debt by individuals?
  7. What is meant by ‘financial resilience’ and why might this currently be of particular concern?

We have reported frequently in our blogs about concerns over rising debt levels among UK households. We previously noted the concerns expressed in July 2014 by the Prudential Regulation Authority (PRA) that the growth in consumer credit (unsecured lending) was stretching the financial well-being of individuals with implications for the resilience of lenders’ credit portfolios. Now the Chief Executive of the Financial Conduct Authority (FCA), Andrew Bailey, in an interview to the BBC has identified the growing problem of debt among young people.

In his interview Mr Bailey stresses that the growth in debt amongst younger people is not ‘reckless borrowing’ and so not borne out of a lack of willpower or ‘present bias’ (see John’s blog Nudging mainstream economists). Rather, it is borrowing simply to meet basic living costs.

In his interview Mr Bailey goes on to identify generational shifts in patterns of wealth and debt. He notes:

There are particular concentrations [of debt] in society, and those concentrations are particularly exposed to some of the forms and practices of high cost debt which we are currently looking at very closely because there are things in there that we don’t like.

There has been a clear shift in the generational pattern of wealth and income, and that translates into a greater indebtedness at a younger age. That reflects lower levels of real income, lower levels of asset ownership. There are quite different generational experiences.

Mr Bailey goes on to echo concerns expressed back in July by the Prudential Regulation Authority in relation to the growth in consumer credit. The chart illustrates the scale of the accumulation of consumer credit (unsecured lending) across all individuals in the UK. In August 2017 the stock of unsecured debt rose to £203 billion, the highest level since December 2008 when the financial crisis was unfolding. (Click here to download a PowerPoint of the chart).

In concluding his BBC interview, Mr Bailey notes that credit should be available to younger people. Credit helps individuals to ‘smooth income’ and that this is something which is increasingly important with more people having erratic incomes as the gig-economy continues to grow. However, he notes that credit provision needs to be “sustainable”.

BBC Interview

Financial regulator warns of growing debt among young people BBC News (16/10/17)

Articles

Young people are borrowing to cover basic living costs, warns City watchdog Guardian, Julia Kollewe (16/10/17)
Britain’s debt time​bomb: FCA urges action over £200bn crisis Guardian, Phillip Inman and Jill Treanor (18/9/17)
FCA warning that young are borrowing to eat shames Britain Independent, James Moore (16/7/17)
Young people are ‘borrowing to cover basic living costs’ and increasing numbers are going bankrupt, warns financial watchdog Daily Mail, Kate Ferguson (6/10/17)
More and more young people are falling into debt – but it’s not their fault Metro, Alex Simpson (20/10/17)

Data

Bankstats (Monetary and Financial Statistics) – Latest Tables Bank of England
Statistical Interactive Database Bank of England

Questions

  1. What does it mean if people are financially distressed?
  2. What do you think Mr Bailey means by ‘sustainable credit’?
  3. In what ways might levels of debt impact on the macroeconomy?
  4. How does credit help to smooth spending patterns? Why might this be more important with the growth in the gig-economy?
  5. What is meant by inter-generational fairness?
  6. Of what relevance are changing patterns in wealth and debt to inter-generational fairness? What factors might be driving these patterns?
  7. What sort of credit is unsecured credit? How does it differ from secured credit?
  8. Are there measures that policymakers can take to reduce the likelihood that flows of credit become too excessive?

An economy that becomes dependent on credit can, in turn, become acutely volatile. Too much credit and there exists the potential for financial distress which can result in an economic slowdown as people cut back on spending. Too little credit and the growth in aggregate demand is subdued. Some argue that this is what now faces a financialised economy like the UK. Even it this overstates the significance of credit, there is no doubt that UK credit data is keenly followed by economists and policymakers.

Recent rates of credit accumulation by individuals have raised concern. In July 2014 the Prudential Regulation Authority (PRA) of the Bank of England issued a statement voicing its concern that the growth in consumer credit, also known as unsecured lending, was stretching the financial well-being of individuals and that the resilience of lenders’ consumer credit portfolios was therefore reducing.

Chart 1 illustrates the scale of the flows of both consumer credit (unsecured lending) and mortgages (secured credit) from banks and building societies to individuals. It shows the amount of credit net of repayments lent over the last 12 months. In the 12 months to July 2017 the net accumulation of consumer credit was £18.2 billion while that of secured borrowing was £40.8 billion. Although the 12-month level of consumer credit accumulation was down from its recent peak of £19.2 billion in November 2016, total net lending (including secured lending) to individuals of £59.0 billion was its highest since September 2008. (Click here to download a PowerPoint of the chart).

To help put in context the size of flows of net lending Chart 2 shows the annual flows of consumer credit and secured debt as percentages of GDP. In this case each observation measures net lending over the past four quarters as a percentage of annual GDP. The latest observation is for 2017 Q2 and shows that the annual net flow of consumer credit was equivalent to 0.94 per cent of GDP while that for secured borrowing was 1.78 per cent of GDP. While the flows of consumer credit and secured borrowing as shares of national income have eased a little from their values in the second half of last year, they have not eased significantly. (Click here to download a PowerPoint of the chart).

Despite the recent strength of borrowing, levels are nothing like those seen in the mid 2000s. Nonetheless, we need to see the current accumulation of debt in the context of two important factors: debt already accumulated and the future macroeconomic environment. Chart 3 gives some insight to the first of these two by looking at stocks of debt outstanding as shares of GDP. The total debt-to-GDP ratio peaked 90 percent in 2009 before relatively slower growth in credit accumulation saw the ratio fall back. The ratio has now been at or around the 78 per cent level consistently for the past two or so years. (Click here to download a PowerPoint of the chart).

The ratio of the stock of consumer debt to GDP peaked in 2008 at 13.3 per cent. It too fell back reaching 9.05 per cent in the middle of 2014. Since that time the ratio has been rising and by the end of the second quarter of this year was 10.1 per cent. The PRA appears not only to be concerned by this but also the likely unwinding of what it describes as the ‘current benign macroeconomic environment and historically low arrears rates’.

Going forward, we might expect to see ever closer scrutiny not only of the aggregate indicators referred to here but of an array of credit indicators. The PRA statement, for example, refers to the number of , ‘0% interest credit card offers’, falling interest rates on unsecured personal loans and the growth of motor finance loans. The hope is that we can avoid the costs of financial distress that so starkly affected the economy in the late 2000s and that continue to cast a shadow over today’s economic prospects.

PRA Statement

PRA Statement on Consumer Credit PRA, Bank of England (4/7/14)

Articles

Bank of England demands consumer credit vigilance; construction growth slows – as it happened Guardian (4/7/14)
Bank of England warns more defences may be needed against consumer credit Telegraph (24/7/17)
Beware the bubble: Bank of England clamps down on credit Telegraph, Tim Wallace (1/7/17)
Bank of England raises capital requirements on UK lenders amid concerns about excessive consumer borrowing Independent, Ben Chu (27/6/17)
Bank of England tightens mortgage borrowing rules amid fears of debt boom Express, Lana Clements (27/6/17)
Rise in personal loans dangerous, Bank of England official says BBC News (25/7/17)
Bank of England takes action over bad loans BBC News (27/6/17)

Data

Bankstats (Monetary and Financial Statistics) – Latest Tables Bank of England
Statistical Interactive Database Bank of England

Questions

  1. What does it mean if people are financially distressed? What responses might people take in response to this distress?
  2. How can financial distress affect the economy’s growth path?
  3. How would you measure the financial well-being of an individual? What about the financial well-being of firms?
  4. What role mights banks play in affecting levels of financial distress in the economy?
  5. What does it mean if credit conditions are pro-cyclical?
  6. Why might banks’ lending be pro-cyclical?
  7. Are there measures that policymakers can take to reduce the likelihood that flows of credit become too excessive?
  8. Why do some economists refer to the economic downturn of the late 2000s as a balance sheet recession? How likely is another balance sheet recession in the short term? What about in the longer term?

Household borrowing on credit cards and through overdrafts and loans has been growing rapidly. This ‘unsecured’ borrowing is now rising at rates not seen since well before the credit crunch of 2008 (click here for a PowerPoint of the chart below). Should this be a cause for concern?

Household confidence is generally high and, as a result, people continue to take out more loans and so household debt continues to increase. Saving rates are falling and, at 5.1% of household disposable income, are the lowest rate since 2008, mirroring the high levels of spending and borrowing.

But as long as the economy keeps growing and as long as interest rates stay at record low levels, people should be able to continue servicing this rising debt. Indeed, with generous balance transfer offers between credit cards and many people paying off their full balance each month, only 56.6% are paying any interest at all on credit card debt, the lowest level on record.

But there could be trouble ahead! Secured borrowing (i.e. on mortgages) is at record highs as house prices have soared, limiting the amount people have to left to spend, even with ultra low interest rates. Student debt is growing, putting a brake on graduate spending.

With economic growth set to slow and inflation set to rise as the effects of the lower pound filter through into retail prices, this could initially boost borrowing further as people seek to maintain levels of consumption. But then, if unemployment starts to rise and consumer confidence starts to fall, real spending could decline, putting further downward pressure on the economy.

Confidence could then fall further and we could witness a repeat of 2008–9, when people became worried about their levels of borrowing and cut back on consumption in an attempt to claw down their debt. The economy was pushed into recession.

The Bank of England is well aware of this scenario and wants banks to ensure that their customers can afford loans before offering them.

Articles

Bank governor Mark Carney warns on household debt BBC News, Brian Milligan (30/11/16)
Credit crunch: Household debt is rising just as the economy’s future is uncertain The Telegraph, Tim Wallace (10/12/16)

Bank of England publication
Financial Stability Report, November 2016 Bank of England (30/11/16)

Data

Money and lending Bank of England Interactive Database
United Kingdom Households Debt To GDP Trading Economics
Household debt OECD Data

Questions

  1. What determines the amount people borrow?
  2. What would cause people to cut back on the amount of debt they have?
  3. Distinguish between secured and unsecured borrowing and debt.
  4. Why has secured borrowing risen? Does this matter?
  5. What is meant by the term ‘re-leveraging’? What is its significance in terms of household borrowing?
  6. Find out what the affordability tests are for anyone wanting to take out a mortgage.
  7. What are the greatest risks to UK financial stability?