Bank of England warns UK banks are 'underestimating' risks of growing consumer debt
UK banks will need to put aside an extra £10 billion to help protect them from consumer credit losses after the Bank of England warned that lenders are "underestimating" the risks of growing household debt.
The Financial Policy Committee (FPC) said that while climbing debt levels do not pose immediate risks to the British economy, banks are in a more precarious position.
"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," the FPC said in a statement following its meeting on September 20.
It said that while the quality of consumer credit has "improved significantly" since the financial crisis, lenders are using the wrong benchmarks.
"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 added.
The FPC said it now believes that commercial banks are collectively exposed to potential losses of around £30 billion, representing about 20% of UK consumer credit loans.
That is £10 billion more than previously outlined.
New capital buffers requirements will be set for individual lenders after the next set of stress test results are published on November 28 ,"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 Bank's stress test exercises are meant to measure how UK lenders would fare in an economic downturn and under difficult market conditions.
"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," the committee said.
The move is likely to increase the cost of borrowing.
Separately, the FPC said it was likely to raise the countercyclical capital buffer, which is meant to provide cash padding in the event of a banking crisis, later this autumn.
"Absent a material change in the outlook, the FPC expects to increase the rate to 1% at its November meeting, with binding effect a year after that."
The Bank will also continue to monitor the effects of Brexit, particularly in light of the potential disruption to the financial services industry.
It raised concerns over the loss of cross-border contracts for insurance and derivatives, restrictions on sharing personal data between the UK and EU, as well as cross-border banking, central clearing and asset management.
"In areas where it would be complex and difficult for firms themselves to mitigate risks fully, such as the continuity of contracts between UK and EU27 counterparties, the FPC is exploring other mitigating actions."