Alex Brazier, executive director of financial stability at the BoE, said consumer credit had been growing at an alarming rate, noting that in the past year alone outstanding car loans, credit card balance transfers and personal loans have increased by 10% while household incomes have only risen by 1.5%.
Speaking at the University of Liverpool’s Institute for Risk and Uncertainty, Brazier said consumer credit was now too easy to obtain as lenders have become complacent by relaxing the risk assessments on loans.
He said lenders standards can go from “responsible to reckless very quickly”.
“The sorry fact is that as lenders think the risks they are facing are falling, the risks they – and the wider economy – face are actually growing,” he added.
Brazier highlighted car finance and mortgages among the areas most at risk.
He noted almost four-in-five new car purchases are currently financed by personal contract purchase (PCP) plans, compared with just one-in-five in 2006.
Meanwhile, he said competition in the mortgage market has led to increased lending at higher loan-to-income (LTI) multiples, with the share of lending at an LTI above 4 increasing from 19% to 26% in the last two years.
He added: “Household debt – like most things that are good in moderation – can be dangerous in excess. Dangerous to borrowers, lenders and, most importantly from our perspective, everyone else in the economy.”
Brazier announced the BoE is putting three “defence lines” in place to guard against this consumer credit bubble growing bigger and to protect the wider economy.
The first is proactive supervision of the banks and building societies with an obligation for the boards of all lenders to prove to the regulator that they have safeguards in place against entering this complacency ‘spiral’.
The second is regular stress testing of lenders to make sure they have the strength to deal with severe recessions without cutting back their lending.
And finally, the bank is looking to restrict high loan-to-income mortgage lending by subjecting borrowers to an affordability test that varies their LTI limit for their individual circumstances.
“Because [lenders] need to pass rigorous stress tests, the wider economy is being protected from the rapid growth of consumer debt,” he added. “But it’s important that this defence line keeps pace with the risks.”
