FCA and Bank disagree over debt risk

FCA and Bank disagree over debt risk

The Bank of England’s Financial Policy Committee (FPC) has said that consumer debt levels in the UK are at below average levels and are not a threat to economic growth.

The role of the Financial Policy Committee of the central bank is to monitor the risks to the UK economy, and the stability of the financial system.  

The Financial Conduct Authority (FCA) has previously warned about risks to the economy from consumer debt levels, and Alex Brazier, who is actually a member of the FPC, warned in July about rising debt levels.

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But the FPC stated in a paper that “in domestic credit markets, risk-taking is currently judged to be at a standard level overall. Domestic credit has grown broadly in line with nominal GDP over the past two years.”

The central bank said: “This is not a material risk to economic growth, as consumer credit represents only 11 per cent 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.”

Debt growing in line with GDP means the level of wealth in the economy is rising in line with the level of debt, which should mean repayments don’t take up an ever greater part of the wealth of the economy to the point where it becomes less affordable.

The Bank of England took particular interest in the mortgage market, stating “The share of households with mortgage debt-servicing costs exceeding 40 per cent of their income (the percentage beyond which historical evidence suggests that households are materially more likely to experience repayment difficulties) is just 1 per cent.”

The Bank added that corporate debt outside the banking sector is also at a level in line with long-term averages.

Rob James, banks analyst at Old Mutual, said history showed mortgage arrears only really become prevalent in the economy when unemployment starts to increase, and at present UK employment is near record low levels. 

The benign outlook described by the Bank is in line with the analysis of fund manager Neil Woodford, who said debt levels are not a worry for him as an investor, and that the UK economy is performing much better than the consensus forecasts suggest.

The report did express caution about valuations in the commercial property market, stating investors appear to be pricing assets as though the present era of record low interest rates will continue for the long-term, while the commitee's view is interest rates will rise soon.

The central bank also expressed concern about how prepared UK banks are if consumer credit conditions were to weaken starkly.

UK banks as a whole could suffer losses of £20bn if consumer credit tightened.

Simon Gergel, who runs the £687m Merchants Investment Trust, said the debt levels in the economy will become an increasing problem as inflation rises, and repayments become less affordable. 

John Greenwood, chief economist at Invesco Perpetual, said the inflation that has happened in the UK this year is "almost entirely" the consequence of the fall in the value of sterling, and he expects this to fall out of the data soon, and inflation to move downwards.