Banks Face Brexit Squeeze as Consumers Max Out on Debt

Confident consumers are borrowing to spend, but pressures are building

By Paul J. Davies

Packed pavements outside the Harrods department store, in central London in December. Photo: Zuma Press

U.K. consumers are untroubled by potential disruption from any Brexit-induced economic slowdown or inflation pressures. That looks like storing up trouble for lenders.

Confidence among consumers remains high, the British economy is performing better than expected since the June vote to leave the European Union and retail sales finished the year strongly. The trouble is these three elements are explicitly related: Britain’s growth is increasingly consumption-led and that consumption is increasingly debt-funded.

Banks such as Lloyds Banking Group, Virgin Money and Royal Bank of Scotland have been happy to fund this. But the obvious risk is that once consumers are maxed out on borrowing once more, the economic conditions that make such lending seem sensible could retrench rapidly.

This is important for banks’ profits because people default on personal debt much more than on mortgages. As analysts at Berenberg note, consumer credit historically accounts for more than 90% of all household loan losses even though such debt makes up less than 10% of household loans.

Consumer borrowing grew nearly 11% in the year to November 2016, according to the Bank of England. Mark Carney, the Bank governor, said that was the fastest pace since 2005. The acceleration moderated slightly immediately after the Brexit vote, but has picked up dramatically in the fourth quarter.

Unsecured personal debt has hit an all-time high of £270 billion, PwC said Friday. It expects household debt to income ratios to exceed their precrisis peak of 169% by 2020.

People are also saving less to fund consumption. U.K. savings rate as a proportion of disposable income has dropped to 5%, near its lowest levels of the past 20 years.

A good chunk of the consumer credit expansion is for car finance, where growth rates have been fairly constant at more than 4% for the past three years. The additional growth has come from an increase in credit card borrowing and even more so from other consumer credit, according to the Bank of England.

The trouble with this picture as Mr. Carney said is that demand in the economy becomes much more sensitive to income and employment levels. UBS economists are predicting that real wage growth will turn negative in coming months and stay that way beyond the end of 2018 as nominal wage growth slow and inflation kicks in.

This risks creating a vicious spiral where weaker spending hurts the economy further, which could further weaken the pound, the main cause of inflation and real wage declines in the first place.

For banks that spells more bad loans. Default rates have already been increasing from their recent low levels this year, especially for unsecured personal loans, although losses in the event of default haven’t grown.

Bank investors should be wary: at best, earnings from new lending are going to slow; at worst they’ll be wearing the bill.

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