12.1 Borrowing and lending problems in nancial intermediation

12.1.4The nancial system and household indebtedness

If inadequate saving has been a problem for some households in recent years, for

others it has been indebtedness which has increased considerably. Although this in-

debtedness has largely been in the form of secured debt (largely mortgage borrowing

to nance home ownership), there have also been large increases in unsecured debt

(personal loans, overdrafts, credit cards, etc.). Nonetheless, the 2005 NMG Research

Survey into the state of household nances commissioned by the Bank of England

showed that secured debt continued to make up almost 90 per cent of all household

debt.

The increases in household debt have led to a widespread perception that a grow-

ing proportion of middle-income families has been having trouble meeting debt

repayments, once thought to be a problem principally of the poor and unemployed.

This view was conrmed in research carried out by the Consumer Credit Coun-

selling Service, a charity set up to provide advice to households with debt problems.

(see Box 12.3).

Box 12.3

Debt hits more middle-class homes

A growing proportion of middle-income families is struggling to manage its debts, according

to research by the Consumer Credit Counselling Service. The research on unsecured debt...

shows that households earning a net £30,000 a year and more account for 4.7 per cent of the

clients of the debt advice charity, up from 1.4 per cent in 2003. Helen Saxon of the CCCS and

the author, said low-income households used credit to pay for essentials but middle-income

families resorted to loans and credit cards to fund consumption.

‘Accepted wisdom suggests that a take-home income of £30,000 a year should be enough

to allow most families to be able to manage the demands on their incomes,’ she said. ‘But large

mortgages, rising school fees, keeping up with the Joneses and the increasing availability of credit

have made debt a normal part of life for many of the middle class.’ Mark Allen, partner at Grant

Thornton, the professional services rm, said the average salary of those going into insolvency had

risen to £28,000 a year from £24,000 in the past year. ‘The general perception is that personal

insolvencies relate to people on relatively low incomes struggling to make ends meet. But we are

also seeing greater numbers of individuals earning good salaries but borrowing proportionally

more than people on lower incomes,’ he said. ‘We’ve even seen stockbrokers earning £100,000

going for insolvency.’...

Steve Treharne, head of personal insolvency at KPMG, the professional services rm, said:

‘Overborrowing is affecting all income scales, up to a limit. Some people on higher incomes think

they can spend with impunity, forgetting they have to pay it back...’ The CCCS, which advises

1,000 people a week, said its report, based solely on its clients, showed that those earning more

than £30,000 ran up an average unsecured debt of £70,000. Households with net income of less

than £10,000 a year had an average of £20,000 in unsecured borrowings. Middle-income families

were able to run up big debts because credit was more easily available. ‘A lender sees less risk

in lending to someone with a high income,’ according to the report that found that middle-income

families had on average 13 credit commitments compared with seven for those with annual

earnings of less than £10,000.

Source: Scheherazade Daneshku, ‘Debt hits more middle-income homes’, Financial Times, May 2006

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Chapter 12 • Financial market failure and nancial crises

The growth in consumer spending nanced by increased debt has played an

important part in the relatively high rates of economic growth and low levels of

unemployment in the UK economy. This has led some economists and nancial

journalists to express fears that consumers, worried by their indebtedness, were likely

to cut back on consumption and push the economy into recession.

However, this view is not shared by the Bank of England. The 2005 survey of house-

hold nances suggests that although total household indebtedness had increased over

the previous year, the percentage of households with no debt at all remained at

40 per cent and the increase in debt was not notably in the form of unsecured debt.

Indeed, the fraction of households with unsecured debt had fallen from 46 per cent

to 41 per cent whereas the fraction with secured debt had risen from 39 per cent to

41 per cent in the year to September 2005. More importantly, from a macroeconomic

view, household indebtedness remained heavily skewed towards the poor and the

consumption of households with serious debt problems made up only a very small

percentage of aggregate consumption. The Bank of England report acknowledges

that the sample of households surveyed was quite small and that there are other

problems in interpreting the results. Nevertheless, there is no suggestion of a serious

immediate problem for the economy as a whole.

This, of course, does not remove household indebtedness as a problem. There

clearly is a sufcient number of households nding indebtedness a serious burden

for us to take the issue seriously. The next question to address is the extent to which

the nancial system can be held to be at fault. There are three issues here – whether

or not it is too easy for households to go into ill-advised debt, the quality of advice

consumers receive from nancial institutions and the charges made by banks and

other nancial institutions on outstanding loans.

The information that, on average, middle-income families seeking advice from the

CCCS (see Box 12.3) had thirteen debt commitments provides an indication of the

number of opportunities there are in a modern economy for households to borrow.

Despite the great amount of information that is now collected on consumers, there

still appears to be little indication that new lenders take strongly into consideration

the overall position of households seeking to make further borrowings. Rules of

thumb followed for agreeing to major loans such as house mortgages have steadily

been relaxed and frequently the nancial institutions appear to make the most rosy

assumptions possible in assessing future ability to pay.

This leads us to the question of consumer education. The principal problems are,

as always, inadequate information and lack of foresight. Borrowers might commit

themselves on assumptions of unchanging interest and continued employment only

to nd that they are over-committed when interest rates turn upwards or when the

economy turns downwards and unemployment rises. Many poor households also

appear to lack information even about the amount they have borrowed and their

future liabilities. This can occur particularly when borrowers are offered loans on which

no interest is to be paid for the rst year or two of a loan – arrangements that are

common in the purchase of motor vehicles and household consumer durables. Things

are made worse by the extent to which advertising by the nancial industry emphasises

the ease with which credit can be obtained and encourages people into debt.

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