UK regulator cracks down on risky loans

The Bank of England has given UK banks two months to examine lending standards as the regulator moves to crack down on risky consumer lending.

The Prudential Regulatory Authority warned that the consumer credit market appears to have deteriorated and said it was concerned that some lenders have been offering credit to customers who may be unable to repay the debt when interest rates rise.

“In an environment of rapid growth in consumer credit, interest margins have fallen and there was evidence of weakness in some aspects of underwriting, so lenders are more vulnerable to losses in stress,” the regulator said on Wednesday in a statement.

While the watchdog did not find evidence that risky lending is the main driver of a 10.3 per cent  jump in consumer credit, it clearly wants to curb lenders overly-zealous growth targets.

Higher-risk segments 

Importantly, the PRA believes that banks' business plans for annualised growth rates over the next three years of 8 per cent for personal loans, 4 per cent for credit cards and 5 per cent for car finance are likely only achievable if underwriting is relaxed and/or if pricing is cut.

The regulator has decided that the resilience of consumer credit portfolios is reducing, due to “continued growth, lower pricing, falling average risk-weights (for firms using internal-ratings based models), and some increased lending into higher-risk segments".

“The short maturities of consumer credit mean that the asset quality of the stock of lending can deteriorate quickly,” the PRA said.

The review of the consumer credit market was released just one week after the central banks re-introduced counter-cyclical capital buffers to ensure banks have reserves to cope with any sudden shock.

UK analysts seem non-plussed by this thinly-veiled threat of tougher new lending rules and widely expect banks to react to these concerns with tighter underwriting, firmer pricing and consequently slower loan growth, which should protect returns.

Positively surprised?

Most analysts think this early action by the central bank will dampen consumer credit growth leading to higher margins and most importantly protect the banks from rising impairment charges.

"UK domestic banks have underperformed since the Brexit referendum, in part because investors worry about the risk of bad debt write-offs on UK consumer credit loans as rising inflation erodes real incomes,” said one banking specialist.

“We think these fears may be too bearish and the market is likely to be positively surprised by the asset quality of major UK banks with consumer credit loss rates contained to 200 basis points.”

At the same time as the PRA issued the banks a deadline, the Financial Conduct Authority said it planned to tighten bonus scheme rules for consumer credit firms amid fears the incentives could lead to mis-selling.

“The FCA has long been interested in the impact that sales remuneration has on the risk of mis-selling financial products to customers. This latest consultation shows that the FCA's focus has now expanded from the banks and asset managers to include other firms providing financial products,” said Jon Terry, financial services partner at PwC.

"The proposals, while relatively succinct, have been drafted very broadly. Firms within scope will need to establish ways of identifying the risk of mis-selling but more importantly will need to put in place measures to manage this risk. 

“Additional guidance suggests that firms could be expected to make significant changes to the design of incentives, the way in which the performance of sales staff is assessed and the way in which these arrangements are governed and controlled. For a large number of firms, the extent of change is likely to be significant.”

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