Presentation by Resolution Foundation's Matt Whittaker.

1. Causes and Consequences:The role of
household debt in 21st Century Britain
Dr GertjanVlieghe, Member of the Monetary Policy Committee
SianWilliams, Director of the Financial Health Exchange atToynbee Hall
Toby Nangle,Global Co-Head ofAsset Allocation at ColumbiaThreadneedle
MattWhittaker, Chief Economist at the Resolution Foundation
Torsten Bell, Director of the Resolution Foundation
@resfoundation #debt
Wifi: 2QAG_guest p: W3lc0m3!!
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2. An Unhealthy Interest?
Debt distress and the consequences of raising rates
Matt Whittaker
February 2018
@MattWhittakerRF @resfoundation
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3. REASONS TO BE FEARFUL
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Why we might be facing a debt-bust

4. Reasons to be fearful
1)There’s a lot of it about; nearly £1.9 trillion in total
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Debt-to-income ratio
peaked at 156 per cent in
2008, before falling to 133
per cent by the end of 2015
Its current level of 138 per
cent is broadly in line with
the 2004 ratio, but well
above anything which
came before
Source: ONS, National Accounts

5. Reasons to be fearful
2)There’s been a recent surge; 10% year-on-year growth
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Annual growth in consumer
credit reached 10.9 per cent
towards the end of 2016 – its
highest rate since 2005. By
December 2017 it had fallen
back to a still-elevated 9.5 per
cent
Three-quarters of the growth
in the stock of consumer credit
since 2012 has been associated
with dealership car finance,
but loans and credit cards
have accounted for half of the
growth in the last 12 months
Source: Bank of England

6. Reasons to be fearful
3) People are talking tough; interest rates are about to rise
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“The Committee judges that, were the economy to evolve broadly in line with
the February Inflation Report projections, monetary policy would need to be
tightened somewhat earlier and by a somewhat greater extent over the
forecast period than anticipated at the time of the November Report”
Bank of England, Inflation Report, February 2018
“Consumer credit has been growing rapidly, creating a pocket
of risk… lenders overall have been attributing too much of the
improvement in consumer credit performance in recent years
to underlying improvement in consumer credit quality and too
little to the macroeconomic environment”
Bank of England, Financial Stability Review, November 2017

7. REASONS TO BE CHEERFUL
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Why we should all chill out

8. Reasons to be cheerful
1) It’s still very cheap; servicing ratios are back to ’90s levels
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Repayments have fallen
to 7.7 per cent of
disposable income,
down from 12.3 per cent
at the start of 2008 and
an all-time high of 12.9
per cent in 1990
Taking the period as a
whole, the average debt
servicing ratio has been
9 per cent – some way
higher than today
Source: Bank of England

9. Reasons to be cheerful
2)We’ve improved the flow; lending criteria has tightened
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The proportion of new
mortgages advanced without
any verification of the
borrower’s income plummeted
from 46 per cent in 2007 to less
than 1 per cent in 2017
Loan-to-values have fallen too,
with the share of mortgages
provided at more than 90 per
cent falling from 9 per cent to 3
per cent over the same period.
New loans of more than 95 per
cent of the value of the
property have all but
disappeared
Source: FCA

10. 10
Source: Bank of England
Reasons to be cheerful
3) People aren’t so tough; rate rises will be limited and gradual
“Any future
increases in Bank
Rate are expected
to be at a gradual
pace and to a
limited extent”
Bank of England,
Inflation Report,
February 2018
Market expectations at the
time of last week’s Inflation
Report suggested rates
might rise to 1.2 per cent
by 2021.These
expectations might shift
following the Bank’s
statement, but we are
unlikely to get anywhere
near the rates prevailing
pre-crisis

11. THE REAL REASONS TO BE FEARFUL
(AND MAYBE A BIT CHEERFUL)
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Why it’s the distribution of debt that matters

12. The good news is recent credit growth has been driven by higher
income households
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While the aggregate debt
servicing ratio picked-up a
little over the course of 2017,
the pattern has varied across
the income distribution
Increases in the top three
quintiles imply that most of
the growth has occurred here
– a pattern that fits with the
fact that such households
hold more of the dealership
car finance, loan and credit
card products that have
underpinned the recent surge
in consumer credit
Source: RF analysis of NMG Consulting Survey

13. But the bad news is debt ‘distress’ is already a reality for a sizeable
minority of households
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6 per cent (1.2 million of
working-age households
display at least three
measures of ‘distress’, with
4.3 million having difficulty
paying for their
accommodation, 3.4 million
saying they are “very”
concerned about their debt
and/or find unsecured debt
repayments to be a “heavy”
burden, and 2.2 million have
been in arrears at some point
in the past 12 months
Source: RF analysis of NMG Consulting Survey

14. With outcomes tending to vary across the income distribution
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The proportion of working-
age households reporting
having been in arrears in
the past 12 months is much
higher among those in the
bottom 20 per cent of the
income distribution
Here 16 per cent of adults
reported arrears – mainly
on consumer credit –
double the rate reported in
quintile 4
Source: RF analysis of NMG Consulting Survey

15. Lower income households are especially likely to be in the ‘at risk’
group of borrowers spending 30%+ of their income on debt
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Levels of arrears rise sharply
among households with
debt servicing ratios of 30
per cent and above,
meaning we can think of
such households as
comprising an ‘at risk’ group
of borrowers
Lower income households
are much more likely to fall
into this ‘at risk’ group, even
though fewer members of
the bottom quintile hold
any debt than elsewhere in
the distribution
Source: RF analysis of NMG Consulting Survey

16. SOME REASONS TO BE MINDFUL
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Why policymakers need to tread carefully

17. Given the scale of our debt, even modest increases in the effective
interest rate will cause servicing costs to spike
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The relationship between the
debt-to-income ratio and the
debt servicing ratio is
determined by the ‘effective
interest rate’.This is more than
just the base rate, because it
depends on the composition of
products within the credit
market
During periods of higher
effective interest rate,
relatively small increases in the
debt-to-income ratio result in
sharp increase in debt servicing
Source: RF analysis of Bank of England

18. Given the scale of our debt, even modest increases in the effective
interest rate will cause servicing costs to spike
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We can hold income
constant at the level
recorded in Q2 2017 and
then draw a schedule
showing how the
relationship between the
debt-to-income ratio and
debt servicing ratio that
would hold in a scenario in
which the effective
interest rate matched the
average recorded during
the pre-crisis era
Source: RF analysis of Bank of England

19. Given the scale of our debt, even modest increases in the effective
interest rate will cause servicing costs to spike
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Given the debt-to-income ratio
prevailing in Q2 2017, this
schedule would imply that the
debt servicing ratio would rise to
just below 12 per cent – only a
little way off the peaks recorded
at the start of the financial crisis
and in 1990
This would be associated with
significant financial difficulty for
households, with any higher rates
of effective interest pushing
servicing costs above anything
seen before
Source: RF analysis of Bank of England

20. An overnight increase in mortgage rates of 2 percentage points would
leave 1.1 million households ‘at risk’ across Great Britain
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This rate rise scenario is for illustrative
purposes only. In practice, an increase
in the base rate would work through
to the real economy in a number of
complex and interacting ways
We can also expect any increases in
mortgage costs to be gradual and to
be accompanied by income rises
This illustrative approach is useful for
determining the scale of fall-out we
might encounter following an
economic shock, however
Source: RF analysis of NMG Consulting Survey

21. And 275,000 households in this ‘at risk’ group might have difficulty
insulating themselves against such rate rises
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Our proxy approach to capturing
potential mortgage ‘prisoners’ includes
those who have very little equity in their
home, those who have very high loan-to-
income ratios, the self-employed and
those with interest only mortgages.We
remove mortgagors with less than £50k
left to pay and all those who have taken
out a mortgage since the introduction of
the Mortgage Market Review in 2014
Altogether, this group of ‘potential
prisoners’ comprises 11 per cent (810,000)
of all mortgagor households in Great
Britain.The number of prisoners also
sitting in the ‘at risk’ group drops to
275,000 (or 4 per cent of all mortgagors)
Source: RF analysis of NMG Consulting Survey

22. • Concerns about the recent surge in borrowing and prospects for rate rises
might be overdone
• Recent borrowing has been driven by higher income households
• Rate rises are still set to be modest and will take time to feed through
• But we should be concerned that significant numbers of households are already
in debt ‘distress’, with many ‘at risk’ following even modest rate rises
• Lower income families look especially exposed, and those with ‘atypical’
characteristics might struggle to refinance
• Need to tread carefully on scale of rate rises and think about what more we can
do (lender support, govt. action) to support the sizeable minority set to suffer
Some conclusions
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23. A REASON TO BE THANKFUL
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I’ve finished

24. Causes and Consequences:The role of
household debt in 21st Century Britain
Dr GertjanVlieghe, Member of the Monetary Policy Committee
SianWilliams, Director of the Financial Health Exchange atToynbee Hall
Toby Nangle,Global Co-Head ofAsset Allocation at ColumbiaThreadneedle
MattWhittaker, Chief Economist at the Resolution Foundation
Torsten Bell, Director of the Resolution Foundation
@resfoundation #debt
Wifi: 2QAG_guest p: W3lc0m3!!
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