Borrowing should raise ‘red flags’ as losses can be sudden and sharp and could worsen if interest rate rises, rating agency says

The rapid rise in UK consumer debt to £200bn from car finance, personal loans and credit cards is unsustainable at current growth rates and should raise “red flags” for the major lenders, ratings agency Standard & Poor’s has warned.

In detailed analysis of the sector, S&P warned that losses from this form of lending suffered by banks and other financial institutions could be “sharp and very sudden” in an economic downturn and may be exacerbated if the Bank of England increased interest rates.

It also warned that it could downgrade banks’ credit ratings if the high growth rate persisted or banks took on too much risk in this sector. But it did not fear any system-wide impact from consumer credit.

“Loose monetary policy, cheap central bank term funding schemes and benign economic conditions have supported consumer credit supply and demand,” S&P said.

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Annual growth rates in UK consumer credit of 10% a year have outpaced household income growth, which is closer to 2%, and become a focus for the Bank which is scrutinising lenders’ approach to the sector.

“We believe the double-digit annual growth rate in UK consumer credit would be unsustainable if it continued at the same pace,” S&P said.

The warning came as research by data firm Moneyfacts showed that credit card rates were at their highest level in 10 years at 23% and warned that customers might not be able to keep hopping from one interest rate-free period to another.

S&P’s analysis said these interest rate-free periods had increased to 28 months and had been “contributing to overall household indebtnesss”.

Last month, the Bank said UK lenders could incur £30bn of losses on their lending on credit cards, personal loans and for car finance if interest rates and unemployment rose sharply, and told them they would need to hold £10bn more capital to protect against losses. Next month, each lender will find out how much extra capital the Bank will expect them to hold against these type of losses.

S&P said those lenders which had relaxed the criteria on how they grant loans or expanded their lending rapidly “have the potential to be overexposed when supportive economic conditions deteriorate”.

The Bank’s monetary policy committee will meet next week and could raise interest rates for the first time since July 2007, before the onset of the financial crisis when rates were eventually cut to 0.5%. In the aftermath of the Brexit vote, rates were cut to 0.25%.

S&P said that amid fierce competition in the consumer credit market, banks had not had to grapple with the consequences of higher rates and the need to pull back lending growth, particularly in the credit card sector. “Banks’ discipline in constraining risk appetite for new underwriting and risk-based pricing in a hot market has not been seriously tested since the financial crisis,” S&P said.

A rate rise could put further pressure on the consumer credit sector if it pushes up mortgage rates as “an individual is more incentivised to meet mortgage repayments relative to an unsecured personal loan or credit card”.

While lending for car financing has been growing faster than the overall consumer credit sector, S&P said it was less risky to lenders than personal loans or credit cards. Much of the lending also takes place outside the banking sector, where Lloyds is the largest player but still has less than 3% of its overall loan book exposed to car finance, S&P said.

There are also signs it is slowing after the warning on Monday by Pendragon, the UK’s biggest car dealer, that demand for new cars was sliding and the market had peaked.