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February 28, 2010

Debt levels cause alarm bells to ring

Forewarned is forearmed, as the saying goes and nowhere is this more relevant than in the credit card industry, where eye-watering levels of bad debts and record losses on credit card portfolios have forced issuers to overhaul their risk management and lending activities.

By Verdict Staff

Rising unemployment, insolvencies and strain on household finances have led to an increase in the level of credit card-related bad debts and delinquencies in card-saturated markets worldwide, with industry practices under intense scrutiny. But the scale of the problem is disputed by competing interests, as Victoria Conroy reports.


Forewarned is forearmed, as the saying goes and nowhere is this more relevant than in the credit card industry, where eye-watering levels of bad debts and record losses on credit card portfolios have forced issuers to overhaul their risk management and lending activities.

Responsible lending is the catchphrase on all issuers’ lips, as they seek to shake off the popular image of them capitalising on consumers’ misfortune by ramping up interest rates and fees, and reposition themselves as consumer-friendly champions.

Issuers are also mindful of the increasing scrutiny coming from industry regulators and governments, which in the US has led to the introduction of swingeing laws (most notably the CARD Act, which takes effect this month) which severely restricts issuers’ ability to levy fees and charges.

Amid the financial turbulence of the past two years, it has become apparent that rising consumer indebtedness was directly caused by the ease of lending restrictions on unsecured credit, which enabled consumers to gain access to credit lines that far surpassed their ability to repay. And the consequences are all too clear.

UK debt levels

The UK may have come out of recession in the first quarter of 2009, but by no means does this signal that the UK’s personal debt levels are not a cause for concern. As the most saturated credit card market in Western Europe, the UK’s debt levels stand far above those of markets in continental Europe. According to the Bank of England, at the end of December 2009, total UK personal debt stood at £1.46 trillion ($2.25 trillion) – a growth rate of 0.7 percent from 2008.

Total consumer credit lending to individuals at the end of December 2009 was £226 billion, reflecting the stagnation of the market, with the annual growth rate of consumer credit remaining at -0.5 percent. Excluding mortgages, the average household UK debt in December 2009 was £9,000 and the average owed by every UK adult is £30,252 (including mortgages). This is 129 percent of average earnings.

Britain’s interest repayments on personal debt were £66 billion in the last 12 months. The average interest paid by each household on their total debt is approximately £2,620 each year, much higher than in previous years.

According to the British Bankers Association (BBA), as of December 2009 total credit card outstandings stood at £63.9 billion, £0.4 billion higher than November but around £2.4 billion lower than a year earlier. The proportion of balances bearing interest fell by 0.2 percent to 66.2 percent. There were 60.4 million cards in issue at the end of December, relating to 49.7 million accounts, 69.4 percent of which were active or had a balance outstanding.

Such high indebtedness levels have caused a surge in the number of people reporting financial difficulties, a problem which has been exacerbated by the recent fall in UK house prices which has affected consumers’ ability to refinance existing debt by remortgaging. Add to this rising unemployment levels and it’s clear to see that UK consumers are sharply exposed to financial stress.

Further evidence of the financial strain on UK consumers came from the Office of National Statistics’ Wealth and Assets Survey, which showed that one in ten of all UK households (2.5 million) were in arrears on at least one credit commitment in the period between 2006 and 2008. This increased to 13 percent among households with any borrowing commitments. The figure was higher still among those with non-mortgage borrowing (17 percent.)

Consumer indebtedness

UK credit card repayment behaviours, 2003-2008








Full (%)







Partial (%)







Revolvers (%)







Minimum (%)







Notes: full payers always repay the fill balance on all of their cards; partial payers occasionally do not repay the full balance on at least one of their cards; revolvers pay more than the minimum payment but less than the full payment on at least one of their cards; minimum payers pay only the minimum payment on at least one of their cards (this could include those borrowing on an introductory 0% interest rate) Source: Consumer Payments Survey 2003-2008

There was more bad news from global business consultancy PricewaterhouseCoopers (PwC) in its 2010 Precious Plastic report, which estimated that the average borrowing per credit card has increased by 5 percent in 2009, surpassing £1,000 for the first time.

According to the report, the UK’s debt levels stagnated over the past year to amount to £230 billion, in stark contrast to 2008 when unsecured lending grew by 6 percent. PwC’s report, widely acknowledged as a barometer of the UK lending market, states that UK credit card borrowing fell by 3 percent in 2009 to £64 billion, while the number of credit cards in circulation fell by 8 percent.

ConsumerAverage household debt stands at £60,000 per house made up of £50,000 in secured debt and £10,000 in unsecured debt. The average household will need to spend approximately 15 percent of net income just to service interest payments arising from this debt.

Also, there was a striking drop in new lending, with unsecured and secured lending falling by 39 percent and 79 percent respectively. According to PwC, this contraction is being driven both from the supply side as lenders continue to reduce the availability of credit, and from the demand side, with consumers less willing to take on more debt.



Cautious outlook

However, with the UK now officially out of recession and economic recovery gaining momentum, PwC believes demand for consumer credit will begin to return. But lenders will be unable – or unwilling – to increase supply sufficiently to match demand, leaving consumers with rising costs of credit and increasing difficulty in gaining access to it.

As an example, bad debt levels are continuing on an upward trajectory. According to PwC, bad debts have reached historic highs, with total credit card write-offs standing at 5.8 percent of outstanding balances in 2008. PwC estimates that write-offs will continue to increase and could reach 9 percent of outstanding balances by the end of 2010 – something that would significantly hurt issuer profits at a time when they are already struggling.

And according to PwC’s Credit Confidence survey, there is a continuing erosion regarding consumers’ ability to handle personal debt. Only 32 percent of survey respondents strongly agreed with the statement: “I am able to make repayments on all the outstanding credit I have.” This compares with 56 percent in the previous year.

And a separate report by price comparison website shows that two out of five credit cardholders are using their credit cards to buy basic everyday items such as food and fuel – which the industry considers a clear sign of financial distress.

Further worrying signs come from UK personal finance website Moneyfacts, which stated that interest rates on credit cards have gone up by more than a quarter in four years, with almost seven million cardholders seeing their rates increase in 2009 alone. Moneyfacts added that the average rate of interest has risen to 18.8 percent, the highest level since 1998.

However, UK industry body, the UK Cards Association, refutes this by saying that “there is no direct correlation between base rates and credit card APRs. Even when base rates fall, the costs of fraud and bad debt and the cost of operating an unsecured open-ended line of credit continue, so standard credit card rates may not come down”.

It added that between January and October 2009, of the 66 million credit card accounts in the UK, 10.6 million accounts were repriced, with around 40 percent of these having their interest rate lowered – and that 61 percent of customers do not pay any interest at all as they pay in full every month.

Industry fights back

The UK Cards Association has taken a leading role in debunking many misconceptions around credit card industry practices and galvanising opposition to the implementation of CARD Act-style legislation being implemented in the UK.

It is quick to argue that far from the industry suffering under the collective weight of consumer anger, by and large UK credit cardholders are generally satisfied with industry practices.

In a paper published in January 2010 as a response to the UK Department for Business Innovation and Skills (BIS) consultation A Better Deal for Consumers: Review of the Regulation of Credit & Store Cards, which was published in October 2009, the association commissioned a series of UK credit cardholder attitudes, stating that “there is a very high level of consumer satisfaction, with 79 percent of those questioned expressing satisfaction with their cards and 95 percent showing no level of dissatisfaction.”

Furthermore, the association said that the current practice relating to unsolicited credit limit increases does not lead to increased debt, but customers in practice may use them in the same way that they generally use credit, to bring forward spending. And when it comes to repricing, the current practice relating to risk-based repricing of debt leads to changes in customer behaviour to reduce spending on credit cards, which benefits both customers and credit card issuers.

Relating to minimum payments, the association stated that the minimum payments regime is used rationally by customers, and customers who make minimum payments pay off debt over the long-term at the same speed as customers who do not make minimum payments. The regime does not increase debt, although changes to the regime may well do so.

Additionally, customers make significant use of the balance transfer deals on offer, which are made possible through the practice currently operated by most credit card issuers on allocation of payments.

The association argues against the imposition of further restrictions on the ability of credit card issuers to offer “flexible and innovative” products, which would significantly reduce the profitability of the industry. The association quotes figures which suggest that the scale of the loss from the most far-reaching options suggested by BIS could be as much as £2.5 billion per annum. Also, any changes imposed would likely restrict favourable consumer offerings; raise interest rates generally; and begin charging for credit card usage.


Policy proposals for UK credit cards

Policy Area

Industry proposals

Allocation of payments

  • Move to a high-to-low allocation for anything above the minimum payment (for example, where any payment above the minimum is allocated first to the card balance bearing the highest rate of interest and then to each successive balance bearing the next highest rate of interest) with the minimum payment allocated at the discretion of the card issuer

Unsolicited credit limit increases

  • Provide for a 30-day notice period ahead of a limit increase
  • Provide clarity on the multiple channels by which the customer can opt out
  • Provide clarity that the customer can opt out of an individual increase and/or permanently using an industry standard document/format
  • Provide cardholders with a means to decrease their limit without a need for personal interaction – for example, online and automated telephone
  • Incorporate an exclusion relating to habitual minimum payers
  • Incorporate the three core exclusions as set out in the risk-based repricing principles
  • Commitment that customers will find it simple to decline the higher limit

Minimum payments

  • Contact habitual minimum payers (for example, those that are doing so with no obvious reason or benefiting from a promo rate) every 6 months to remind them of the implications
  • Commitment to work with BIS in reviewing the output from Warwick University

Simplicity and transparency

  • Industry is happy to consider further the merits of all three suggestions post consultation closing date
  • Annual statement
  • Stakeholder lending product (‘vanilla’) credit card
  • Standardised product labelling/benchmarking

Repricing of existing debt

  • Continuation of the existing Statement of Principles
  • Produce a generic leaflet/fact sheet entitled “Risk-based Pricing Explained”, covering both increases and decreases. Needs to cover what are ‘high risk’ indicators; factors that are NOT used; how to appeal etc. Delivery options must be flexible
  • A commitment to further promotion and explanation of the opt-out

Source: UK Cards Association

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