Consumers are taking longer mortgages and spending more on credit cards in an attempt to adapt to higher interest rates and living costs, potentially storing up debt troubles in future, the Bank of England has said.
The central bank’s financial policy committee (FPC), which keeps tabs on the health of the UK financial system, has seen evidence over the last three months of some households increasingly relying on credit cards to make ends meet.
Consumer spending was under pressure as higher borrowing costs, due to the continued rise in interest rates, and cost of living pressures meant many were having to find other ways to pay for everyday purchases.
While the annual rate of credit card spending growth was relatively stable – holding steady at 11.8% – the committee said the trend “could lead to greater debt vulnerability for households in the near term”.
Prospective homebuyers have also been adapting to financial pressures by taking out longer-term mortgages. In total, the proportion of mortgages lasting 35 years or more had increased from 4% in the first three months of the year to 12% in the second quarter.
The UK has a relatively short-term mortgage market compared with some countries, including the US, where the average mortgage term is 23.3 years.
“While longer mortgage terms and other forbearance measures could reduce pressures on borrowers in the short term, they could increase debt burdens over the long term,” the committee said.
The FPC also noted an increase in borrowers falling into arrears – albeit from low levels – and expected the number of customers falling behind on their debts to increase.
Banks had simultaneously started to tighten their lending, amid fears over the economic outlook. But overall, the UK banking system was broadly in good health and asset quality remained “relatively stable”, the FPC said.
However, it said the potential risks were “somewhat” offset by rules set by the Financial Conduct Authority (FCA), which require banks to be responsible lenders.
Meanwhile, the Bank announced it would pause its normal stress tests, which ensure that the UK’s largest high street lenders can withstand severe financial shocks and an extreme downturn in the UK and global economy.
Instead, it would run a “desk-based scenario” – similar to checks conducted during the Covid crisis – which would measure the health of the banking system as a whole, without having to publish the results of individual lenders.
The committee said this would allow it to test banks’ balance sheets against more than one scenario, including whether interest rates stayed higher for longer, or suddenly dropped and affected banks’ incomes.
This would also give policymakers an opportunity to review the normal stress-testing regime, which was implemented after the financial crisis and could end up including a broader range of lenders, including smaller banks.
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The Bank runs annual tests on the largest lenders: Barclays, Lloyds, HSBC, NatWest, Santander UK, Standard Chartered, Nationwide and Virgin Money.
The Bank is preparing separate stress tests for the “shadow” banking sector, which includes hedge funds, to measure the risk of amplifying shocks to the financial system. The terms of that test will be released in November.
Separately, on Tuesday, an International Monetary Fund global stress test found that up to 30% of 900 banks across 29 countries would be vulnerable in the event of a prolonged period of stagflation – when growth is weak and prices are rapidly rising.
In its global financial stability report, the IMF said only 5% of banks would face difficulties if its forecasts for steady 3% growth came to pass, but said the outlook would be much grimmer in the event of its “adverse scenario” in which the global economy shrank by 2%.
In the meantime, the FPC called for stricter rules on how quickly money market funds, which invest solely in cash or cash equivalents like government and short-term corporate bonds, could sell off their assets.
The call follows the panic sparked by the dash for cash at the start of the pandemic in 2020, which resulted in investors pulling their money at speed, as well as the UK’s pension fund crisis in September 2022 that was originally prompted by the government’s disastrous mini-budget, but caused UK bond prices to plunge at a record rate.
The FPC is urging the FCA, which regulates the sector, to rule that 50-60% of money market fund assets should be able to be liquidated and sold off within seven days.