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UK banks told to justify consumer credit as risks mount

Jul 04 2017 12:15
John Glover, Bloomberg

London - The Bank of England (BoE) told UK banks to prove that their policies on credit cards, personal loans and other types of consumer lending won’t leave them weaker in a downturn.

The BOE’s Prudential Regulation Authority said on Tuesday that firms need to show that they’re not underestimating the risks of consumer credit given the current “benign economic environment.”

“The PRA judges that the resilience of consumer-credit portfolios is reducing due to the combination of continued growth, lower pricing, falling average risk weights (for firms using internal-ratings based models) and some increased lending into higher-risk segments,” the supervisor said in a statement.

The BOE last month took steps to tackle risks to the UK banking system posed by the recent rapid growth in consumer credit and the uncertain outcome of Brexit talks. It set the countercyclical capital buffer at 0.5% of risk-weighted assets for UK loans effective in June 2018, and if nothing material changes the central bank plans to increase the level again to 1% in November.

While consumer credit makes up less than 10% of UK banks’ lending to individuals and non-financial companies, it’s far more volatile than mortgages, with total write-offs 10 times higher since 2007, according to the BOE.

Consumer credit has been growing at more than 10% a year, much faster than household incomes and mortgages, the central bank said. For comparison, loans to companies grew by 2.9%.

Credit scoring

To help restrain potential risks from this credit boom, banks must show that their consumer lending isn’t based on excessively optimistic assumptions, the PRA said in presenting the results of a review of firms’ asset quality and underwriting practices.

This means their credit-scoring should adequately capture medium-term risk, and their stress-testing mustn’t “underestimate potential downturn risk,” the supervisor said.

BoE Governor Mark Carney said last month that UK banks may be forgetting “the lessons of the past” by relying too heavily on their own estimates of the risks on their books, understating threats and leaving them more vulnerable to stress.

He said some banks may be relying too much on internal risk models instead of “layering enough judgment on top of models.” Banks’ risk estimates are used in calculating their capital requirements. To make these calculations, larger firms are allowed to use their own statistical models with supervisory approval.

The UK Financial Conduct Authority also weighed in on consumer credit on Tuesday with proposals for how firms should manage risks related to how they pay staff and manage performance.

‘Key driver’

“The way firms pay and manage the performance of their staff is a key driver of culture and customer outcomes, and a continuing priority for the FCA,” said Jonathan Davidson, the supervisor’s executive director of supervision – retail and authorisation.

For zero-percent interest credit card offers, the PRA told firms to justify the “assumptions and time periods used for forecasting the net present value of new business.” Credit cards make up 34% of the stock of consumer credit, according to the BoE, and interest-free periods now stretch to longer than 40 months in some cases.

Banks should take into account customers’ “motivation for borrowing” and total indebtedness when issuing unsecured personal loans, the PRA said.

For motor finance, which accounts for 30% of consumer credit, guaranteed future values “should be set in a prudent manner compared with the expected future value of the car,” the PRA said.

The PRA told banks to measure the “impact on financial performance and capital from a fall in used car prices” and share the results with the supervisor.

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boe  |  uk  |  financial services  |  credit  |  loans  |  credit cards
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