Consumers are taking out lengthier mortgages and spending more on credit cards to adjust to increasing interest rates and living costs, potentially storing up debt problems in the future, according to the Bank of England.
The central bank’s financial policy committee (FPC), which monitors the soundness of the UK financial system, has observed indications of certain households increasingly relying on credit cards to make ends meet over the previous three months.
Consumer spending was under pressure as rising borrowing costs, as a result of the ongoing rise in interest rates, and cost of living constraints forced many to find alternative methods to pay for ordinary expenditures.
While the annual rate of credit card expenditure growth remained relatively consistent, at 11.8%, the committee warned that the trend “could lead to greater debt vulnerability for households in the near term.”
Prospective homebuyers have also adapted to financial constraints by obtaining longer-term mortgages. Overall, the proportion of mortgages with terms of 35 years or longer climbed from 4% in the first three months of the year to 12% in the second.
In comparison to certain nations, particularly the United States, where the average mortgage duration is 23.3 years, the UK has a very short-term mortgage market.
“While longer mortgage terms and other forbearance measures could reduce pressures on borrowers in the short term, they could increase debt burdens over the long term,” the committee said.
The FPC also highlighted an increase in borrowers falling behind on their payments – albeit from low levels – and predicted that the number of consumers falling behind on their payments would rise.
Banks had begun to tighten lending at the same time, due to concerns about the economy’s prospects. However, the UK banking sector was generally in good shape, with asset quality remaining “relatively stable,” according to the FPC.
However, it stated that the potential risks were “somewhat” countered by Financial Conduct Authority (FCA) requirements requiring banks to be responsible lenders.
Meanwhile, the Bank of England announced that it would suspend its standard stress tests, which guarantee that the UK’s major high street lenders can withstand significant financial shocks and a catastrophic downturn in the UK and worldwide economies.
Instead, it would perform a “desk-based scenario” – similar to the inspections carried out during the Covid crisis – to assess the overall health of the banking system, without having to publicize the results of individual lenders.
The committee stated that this would allow it to test banks’ balance sheets against multiple scenarios, such as whether interest rates remained higher for longer or decreased suddenly, affecting banks’ earnings.
This would also provide policymakers with an opportunity to revisit the standard stress-testing system, which was put in place during the financial crisis and may wind up encompassing a broader range of institutions, including smaller banks.
Annual examinations are conducted by the Bank on the main lenders, including Barclays, Lloyds, HSBC, NatWest, Santander UK, Standard Chartered, Nationwide, and Virgin Money.
To assess the risk of magnifying shocks to the financial system, the Bank is developing separate stress tests for the “shadow” banking industry, which includes hedge funds. The details of the test will be made public in November.
Separately, an International Monetary Fund global stress test released on Tuesday indicated that up to 30% of 900 banks in 29 countries might be vulnerable during a lengthy period of stagflation – when growth is poor and prices are fast rising.
The IMF claimed in its global financial stability report that only 5% of banks would encounter difficulties if its estimate of stable 3% growth came true, but that the situation would be much grimmer if its “adverse scenario” of 2% global economic contraction came true.
Meanwhile, the FPC has asked for stronger limits on how quickly money market funds, which invest purely in cash or cash equivalents such as government and short-term corporate bonds, can sell their assets.
The call follows the panic caused by the rush for cash at the start of the pandemic in 2020, which resulted in investors withdrawing their money at a rapid pace, as well as the UK’s pension fund crisis in September 2022, which was prompted by the government’s disastrous mini-budget but caused UK bond prices to plummet at an unprecedented rate.
The FPC is requesting that the FCA, which oversees the sector, decide that 50-60% of money market fund assets be liquidated and sold within seven days.