The Bank of England has a credit card problem

by Shaun Richards

This morning has brought a development in two areas which are of high interest to us. So let us crack on with this from the Financial Times.

The Bank of England has issued a warning about the sort of risky lending practices particularly important to Virgin Money, at a critical time in the bank’s negotiations over a £1.6bn takeover by rival CYBG.

When one reads about risky lending it is hard not to think about the surge in unsecured consumer lending in the UK over the past couple of years or so.

The 12-month growth rate of consumer credit was 8.8% in April, compared to 8.6% in March ( Bank of England)

That rate of growth was described a couple of months ago as “weak” by Sir Dave Ramsden. Apparently such analysis qualifies you to be a Deputy Governor these days and even gets you a Knighthood. Also if 8% is weak I wonder what he thinks of inflation at 2/3%?

However the thought that the Bank of England is worried about the consumer fades somewhat as we note that yet again the “precious” seems to be the priority.

In a letter sent to bank chiefs last week seen by the FT, the Prudential Regulation Authority, BoE’s supervisor of the largest banks and insurers, said “a small number of firms” were vulnerable to sudden losses if customers on zero per cent interest credit card offers then leave earlier or borrow less than expected.

How might losses happen?

Melanie Beaman, PRA director for UK deposit takers, wrote that banks with high reliance on so-called “effective interest rate” accounting should consider holding additional capital to mitigate the risks.

The word effective makes me nervous so what does it mean?

EIR allows lenders that offer products with temporary interest-free periods to book in advance some of the revenues they expect to receive once the introductory period ends.

That sounds rather like Enron doesn’t it? I also recall a computer leasing firm in the UK that went bust after operating a scheme where future revenues were booked as present ones and costs were like that poor battered can. Anyway there is a rather good reply to this on the FT website.

I am expecting to win the lottery. Can l  bank the anticipated income now please?  ( TRIMONTIUM)

There is more.

Optimistic assumptions about factors such as customer retention rates and future borrowing levels allow banks to report higher incomes, but increase the risk of valuation errors that could lead to a reversal and weaken their balance sheets, according to the PRA.

Are these the same balance sheets that they keep telling us are not only “resilient” but increasingly so? We seem to be entering into a phase where updating my financial lexicon for these times will be a busy task again. Perhaps “Optimistic” will go in there too?

Moving on one bank in particular seems to have been singed out.

Almost 20 per cent of Virgin Money’s annual net interest income in 2017 came from the EIR method. Industry executives said any perceived threat to capital levels could strengthen CYBG’s (Clydesdale &Yorkshire) hand in negotiations. Virgin Money declined to comment on the PRA’s letter or the merger discussions. CYBG and the PRA also declined to comment.

This is a little awkward as intervening during a takeover/merger raises the spectre of “dirty tricks” and to coin a phrase it would have been “Fa-fa-fa-fa-fa-fa-fa-fa-fa-far better” if they have been more speedy.

FPC

We do not mention this often but let me note this from a speech from Anil Kashyap, Member of the Financial Policy Committee. Do not be embarrassed if you thought “who?” as so did I.

The statute setting up the FPC also makes the committee responsible for taking steps (here I am
paraphrasing) to reduce the risks associated with unsustainable build-ups of debt for households and
businesses. This means that the FPC is obliged to monitor credit developments and if necessary be
prepared to advocate for policies that may lead some borrowers and lenders to change the terms of a deal
that they were otherwise willing to consummate.

Worthy stuff except of course if we move to the MPC and go back to the summer of 2016. This was Chief Economist Andy Haldane in both June and July as he gave essentially the same speech twice.

Put differently, I would rather run the risk of taking a sledgehammer to crack a nut than taking a miniature
rock hammer to tunnel my way out of prison – like another Andy, the one in the Shawshank Redemption.

Seeing as monetary policy easings in the UK had invariably led to rises in unsecured borrowing you might think the FPC would have been on the case. However Andy was something of a zealot.

In my personal view, this means a material easing of monetary policy is likely to be needed, as one part of a
collective policy response aimed at helping protect the economy and jobs from a downturn. Given the scale
of insurance required, a package of mutually-complementary monetary policy easing measures is likely to be necessary. And this monetary response, if it is to buttress expectations and confidence, needs I think to be
delivered promptly as well as muscularly.

Not only had Andy completely misread the economic situation the credit taps were turned open. He and the Bank of England would prefer us to forget that they planned even more for November 2016 ( Bank Rate to 0.1% for example) which even they ended up dropping like it was a hot potato.

My point though is that the cause of this below was the Bank of England itself. So if the FPC wanted to stop it then it merely needed to walk to the next committee room.

Consumer credit had been growing particularly rapidly. It had reached an annual growth
rate of 10.9% in November 2016 – the fastest rate of expansion since 2005 – before easing back
somewhat in subsequent months. ( FPC Minutes March 2017)

As some like Governor Carney are on both committees they could have warned themselves about their own behaviour. Instead they act like Alan Pardew when he was manager of Newcastle United.

“I actually thought we contained him (Gareth Bale) quite well.”

He only scored twice…..

Credit Card Interest-Rates

Whilst the Bank of England is concerned about 0% credit card rates albeit for the banks not us. There is also the fact that despite all its interest-rate cuts,QE and credit easing the interest-rate charged on them has risen in the credit crunch era.

Effective rates on the stock of interest-charging credit cards decreased 22bps to 18.26% in April 2018.

I remember when I first looked back in the credit crunch day and it was ~17%.

Comment

You may be wondering after reading the sentence above whether policy has in fact been eased? I say yes on two counts. Firstly it seems to be an area where there is as far as we can tell pretty much inexhaustible demand so the quantity easing of the Bank of England has been a big factor eventually driving volumes back up. Next is a twofold factor on interest-rates which as many of you have commented over the years a lot of credit card borrowing is at 0%. It may well be a loss leader to suck borrowers in but it is the state of play. Next we can only assume that credit card interest-rates would be even higher otherwise although of course we do not know that.

What we do know is that unsecured lending of which credit card lending is a major factor has surged in th last couple of years or so. Accordingly it was a mistake to give the Bank of England control over both the accelerator and the brake.

Me on Core Finance TV

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