Bank of England governor Carney sounds alarm on £30bn UK debt bubble

Banks could take a £30 billion hit if one in every five consumer loans turns sour in a severe recession, the Bank of England warned on Monday.

The latest Financial Policy Committee statement underlined Threadneedle Street’s alarm at “rapid growth” in consumer credit, which has been rising at near double-digit rates.

The FPC described consumer lending as a “pocket of risk” and warned financial institutions were underplaying the dangers, ordering them to cover potential losses with an extra £10 billion in capital.

“Lenders overall are placing too much weight on the recent performance of consumer lending in benign conditions as an indicator of underlying credit quality,” it said. “As a result, they have been underestimating the losses they could incur in a downturn.”

The committee, chaired by Bank Governor Mark Carney (pictured), brought forward the consumer lending results of its stress tests, which will be published on November 28.

It reckons the UK banking system would take total credit losses of around £30 billion, or 20% of all UK consumer credit loans, under its new “severe” scenario, which sees the unemployment rate spike up to 9.5% and interest rates shoot to 4% from the current record low 0.25%.

That would trigger write-offs of around 25% on credit cards, 15% on personal loans and 10% on car finance, the FPC said.

The financial damage to the lenders is greater this year because of a “more rigorous” assessment of their loans. Under the previous stress test, banks were asked to plan for interest rates being cut to zero rather than raised sharply.

The FPC’s latest comments come after a stark warning from the Bank’s executive director for financial stability Alex Brazier, who said in July that he saw “classic signs” that lenders may be underestimating risks. The Prudential Regulation Authority has demanded that all lenders with large consumer credit risk provide details of the safeguards they have made against placing too much weight on recent loan performance when assessing customers.

The FPC also warned banks “will need to accompany any expansion of consumer lending with sufficient resilience to the losses it would add in the stress scenario”, including higher capital.