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Low unemployment and forbearance by lenders set to keep the lid on individual insolvencies

Figures for the second quarter published in July showed total personal insolvencies of 22,772 - nearly 10% lower than in the first quarter of the year and some 40% below the level seen in 2009 and 2010. Data for the third quarter of 2017, to be published this Friday, are likely to show a continuation of the downward trend line in personal insolvencies seen since 2010.

Concerns voiced by the Bank of England about the growth of consumer credit - which was running at an annual rate of 7.7% in the year to August - can be viewed as presenting a risk of higher insolvencies. This may be the case in the coming years but for the near term insolvency numbers are likely to remain close to the levels seen recently.

Why is this?

A continuation of the downward trend-line seen since 2010 is likely as the background economic conditions have been benign. With unemployment at its lowest rate for 42 years (4.3% of the labour force) most households are generating sufficient income to juggle their debt obligations successfully. So even with household incomes being squeezed with price inflation now running above average earnings inflation the key driver to remaining solvent is employment income.

Helpful, but of less significance, is the low level of official interest rates. Sure a Bank Rate of 0.25% is not unhelpful for borrowers but the reality is that those in difficulties with debts are borrowing via products like credit cards whose interest rates are more reminiscent of the 1970s and 1980s rather than the 2010s!

Note that the recent peak in personal insolvencies occurred in 2009 and 2010 when the financial crisis pushed the economy into recession with the result that the unemployment rate rose from just over 5% to 8% of the workforce. Note that at the same time interest rates were being cut to record low levels. This highlights that unemployment rather than interest rates is the more potent driver of individual insolvency levels.

In looking at the downward trend line in insolvencies acknowledgement should be given to the role played by the financial services regulators - principally the Financial Conduct Authority (FCA) - and the lenders themselves. Recent years have seen active encouragement for lenders to apply ‘forbearance’ when it comes to dealing with their customers with debt problems. Forbearance is not the forgiveness of debts but rather action to work with those in difficulty to manage down their debts in an orderly way. These procedures are set out in the FCA’s Consumer Credit sourcebook, making it completely clear what is expected of lenders when dealing with those experiencing debt problems.

So what does all this tell us about the likely trend in insolvencies in the next two or three years? Well official interest rates will rise, but not by much. This will still be enough for lenders to put up rates on their debt products including mortgages, loans and card debt. But this alone will not lead to a surge in insolvencies. The next material upturn will be driven by higher unemployment - an event which is virtually inevitable as the economy slows as the UK goes through Brexit. Projections for UK growth have already been lowered by forecasting bodies and private sector investment is already stalling as a result of the uncertainties about what the post-Brexit economic landscape will look like. Earlier this week the EEF announced that investment in plant and machinery in the UK has dropped to 6.5 per cent of turnover from 7.5 per cent last year with few companies planning to update their production capacity in the coming years.

So the next three years will see pressure on UK household incomes – to a degree from higher interest rates and to a degree from a fall in real incomes but principally from higher unemployment. And it will be increased unemployment that will lead to higher insolvencies.

The downtrend in personal insolvencies since 2010 has been good news but a turnaround looks inevitable in the coming years in tandem with higher unemployment.

Martin Upton

Director, True Potential PUFin

24th October 2017

About True Potential PUFin

True Potential PUFin is based at the Open University Business School in Milton Keynes, UK

True Potential PUFin is the first and only personal finance research centre in the UK that has an active teaching programme freely available to the public. Supported by the University’s excellence in delivering distance learning, the Centre is uniquely positioned to develop the public’s financial capability and to research the impact and effectiveness of its education programme.

 

 

 

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