Cicero Policy Briefer

Issue 6, November 2006

Consumer frenzy:
Where does responsible lending fit into the UK’s credit culture?

By John Rowland

Abbey’s decision to lend couples five times their joint salary for certain mortgages filled a lot of column inches earlier in the week. Some argued that this was irresponsible and encouraging excessive debt; others thought the critics of high income multiples should get real. But while ‘debt’ is often talked about, the distinction between secured debt (such as mortgages) and unsecured debt (credit cards, store cards) is not often made sharply enough. At this time of rising house prices, underpinned by lack of housing supply, most people with a mortgage face a fairly modest risk. But, with the financial pressures of Christmas coming, we should not lose sight of the issues around unsecured borrowing.

Unsecured debt forms around one fifth of the total household debt of £1 trillion. There were 26,021 individual insolvencies in England and Wales in the second quarter of 2006[1]: an increase of 10 per cent on the previous quarter, and of 66.3 per cent on the same period the year before. The figures for the third quarter, due out this Friday, are likely to show a further rise. Recent press coverage would suggest that the country is in the grip of a spending spree with money it doesn’t have.

Of course, insolvencies are only the most extreme cases, and many more people are struggling to make payments. With the National Institute for Economic and Social Research positing that a 50 basis point rise in interest rates will be necessary in the coming months if inflation is to fall back to target by the end of next year, the chances are that many households will be feeling the pinch that little bit more.

With increasing numbers of people in deep water, it is no surprise that they are looking for a way out of their debt. The furore over the as yet unregulated Individual Voluntary Agreements (IVAs)—which offer the seriously indebted the opportunity to pay a fixed amount each month to creditors rather than service their actual debt—has markedly raised the volume around the issue of personal debt. Their increasing popularity has led to dramatic increases in the bad-debt provision by lenders, with internet bank Egg seeing a 40 per cent rise in the number of loan customers turning to IVAs in Q3 of this year as compared to Q2.

This trend has not gone unnoticed by those who take an interest in financial services in Parliament. Liberal Democrat Treasury spokesperson Vince Cable MP, for example, has for some time expressed concern about personal indebtedness, particularly unsecured debt such as credit and store cards.

So to what extent can lenders be held responsible for the increase in personal insolvencies and general indebtedness? The industry might well be open to criticism. Some promotions have undoubtedly encouraged a ‘buy now, worry later’ attitude to life. But while the industry has not covered itself in glory in recent years, the truth is that those credit card bills do not rack up on their own, and there are plenty of PIN-happy consumers on Britain’s high streets. In short, consumers must take personal responsibility for their finances and cannot simply blame industry for their spending.

However, industry must also face up to the fact that the lending decisions they make can have profound effects on families and individuals, particularly those who are close to the edge. At Cicero Consulting, we believe the concept of responsible lending will climb further up the political and media agenda in coming months. There is some excellent practice in the industry already: some firms offer provision of early intervention debt-counselling, while others have been scrupulously careful about adjusting their lending criteria to reflect wider concerns about indebtedness. However there are legitimate concerns too, and forward-looking firms will look to engage with these head-on, answering their critics and proving that they are serious about treating their customers fairly in the process. It will be interesting to see where we are in Q1 2007, after a highly probable rate rise—and when the post-Christmas statements hit doormats.

The positive news is that Britons do appear to be showing at least some signs of losing their appetite for consumer frenzy. According to statistics from APACS, spending on credit cards fell during the first six months of 2006, compared to the same period last year. Meanwhile, Bank of England figures showed that in August shoppers paid back more on their credit cards than they received in advances for the first time since 1994. These tentative hints of a slowdown in borrowing on credit cards might mean that finally, consumers are becoming concerned about affordability.

[1] Seasonally adjusted

John Rowland can be contacted on +44 (0)20 7665 9530 or click here to email.

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