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What role does credit have in the cost-of-living crisis?
Credit is traditionally used to smooth out income and expenditure pressures, but increased risk and affordability concerns make it unlikely that commercial lenders will be riding to the rescue of low-income households in the cost-of-living crisis any time soon.
Whilst expanding subsidised lending and/or bill payment flexibility to individuals may help – as would improved social security protections for those most affected - Executive Director, Damon Gibbons, argues that the focus should shift to holding down prices in the first place and for HM Treasury and the Bank of England to create a new, subsidised, lending facility for service providers to achieve this.
A grim prospect
The economic outlook is looking increasingly grim. Last month, the Bank of England Governor, Andrew Bailey, wrote[i] to the then Chancellor Rishi Sunak, with his forecasts for inflation. At 9% when writing, the Consumer Prices Index measure of inflation was expected to rise to “slightly above” 11% by October. The Governor’s letter went on to add that we should expect it to take around two years before inflation returns to the Bank’s target of 2%. Over that period, Bailey wrote, we can also expect low to no growth, and rising unemployment.
Despite the recent package of support for households, the squeeze on incomes will continue to press hard for a considerable time to come and it should be noted that the Governor’s letter also highlighted the household support package was itself slightly inflationary, adding 0.1% to headline inflation, with “upside risks” to this assessment.
How will households respond?
Faced with a significant and sustained squeeze on their incomes, affected households have four main options: cutting back on consumption; falling into arrears with household bills, borrowing, and/or defaulting on existing credit agreements[ii].
Each individual household seriously impacted by the cost-of-living crisis will select different options, or combinations of options, from these available strategies. The Joseph Rowntree Foundation[iii] has highlighted this well, reporting that 7 million households have cut back spending on essentials, including food and heating; low-income families have fallen behind on payments by an average of £1600; 1.3 million low-income households have used credit to pay for essentials, and over 2 million households are in debt to high interest lenders.
It is not difficult to predict how the crisis will impact on societal outcomes, such as for health inequalities and homelessness. Things will get much worse, not only because of the severity of the cost-of-living ‘shock’ that households are now facing, but because we are starting from such a poor position.
As Michael Marmot pointed out in February[iv], health inequalities have been getting worse for a decade and the cost-of-living crisis is arriving on top of a pre-existing housing emergency, with Shelter reporting[v] that 17.5 million people are living in overcrowded, dangerous, unstable, or unaffordable housing.
We also know that, for many households, there is very little room for manoeuvre left. Even prior to the war in Ukraine, and its impact on energy prices, discretionary consumption for many had already been pared back to the bone. The Trussell Trust reported a 14% rise in food bank usage in the financial year to March 2022[vi], and, looking further back, Citizens Advice reported in October 2020 that 40% of people using their service to access debt advice had a ‘negative budget’: unable to meet their essential living costs. They also noted increasing arrears levels on household bills, something which was further confirmed by the Department for Levelling Up, Communities and Local Government when it reported towards the end of June, that there had been a 12% increase Council Tax arrears in the year to March.
Borrowing through the crisis?
The ability of consumer credit lenders to help households through this crisis is severely constrained. Firstly, because many households simply cannot afford to borrow and will fail any reasonable affordability assessment, and secondly, because lenders are also facing increased defaults amongst their existing customer base. In some cases, this has led to their entering administration. Earlier this year, we published our evaluation of Fair4All Finance’s Covid-19 Resilience Fund, which had provided £3.9 million of support to thirty-one community-based lenders during the pandemic. That support was likely critical in maintaining affordable credit to low-income households, but as we noted:
“The sector is not ‘out of the woods’ yet. Underlying risk has increased, and loan books and revenues have not recovered to pre-pandemic levels. Many of the challenges faced by community finance lenders remain the same to those at the start of the lockdown and a refresh of support needs is urgently required.”
Since writing that in February, several credit unions have entered administration.
Could credit help or are other mechanisms more appropriate?
Credit is often considered an appropriate tool to smooth out fluctuations in income and expenditure over time, and the Governor’s indication of a two-year timeframe for the current inflationary pressures to abate (if accurate) therefore poses the question, whether it is possible for credit to be used to help households navigate this crisis?
In our view, due to increased risk and affordability concerns, purely commercial products are unlikely to come to the rescue. In fact, we (and the history of lending in recent crises) predict the opposite. Most commercial lenders are likely to undertake a ‘flight to quality’, and, in that process, off-load an increasing volume of bad debt onto the secondary debt market. For those lenders determined to continue to provide responsible products to low income households in this crisis, more will be needed to better link them to sources of support - whether to help with benefit take-up or to provide access to wider help with health and housing.
But for most of those now struggling with repayments, we should expect rising interest rates, or exclusion from credit altogether. The policy focus is therefore likely to move to forbearance requirements, debt management, and debt relief.
If purely commercial lenders are unlikely to provide the answers, then perhaps some form of subsidised lending (such as being piloted through the No Interest Loans Scheme[vii]) could be beneficial? So too, our own innovative FlexMyRent project, which provides for social housing tenants to use flexible rent payments to manage cash-flow pressures, or low cost loans to help people buy essentials such as have recently been piloted by Fair for You.
Rapidly scaling up these forms of low cost, short-term, facilities for households may well help some of those who have been badly impacted by the crisis. But the growing intensity of the financial pressures on low-income households suggests that any repayment in the near term is going to prove increasingly difficult, regardless of a low, or even zero, interest rate. Households will also need longer-term support to get them through not just this year, but at least the next as well.
This raises the question as to whether other longer-term forms of deferred payment loans could be provided? For example, a product with similar features to student loans – with repayment deferred for up to 36 months, and subject to an earnings threshold. Such a product would, as with student loans, face large potential write-offs over time. It would also need Government to commit both the up-front capital to create it, and enable repayments to be collected through PAYE.
Whilst it is not impossible to imagine such a ‘cost-of-living loan’ being mooted in some quarters, the approach is, however, questionable on the same grounds as student loans themselves: namely that the same (or better) results can be achieved more effectively through other mechanisms (e.g., improved social security or grants for those on lower-incomes, financed through the tax system by those whose earnings are higher). We have previously argued for increased social security and grant entitlements for low-income households, and for Government to be clearer in defining the boundaries between the social security and credit systems. We have had, for many years now, a problem where many people are ‘not poor enough’ to qualify for grants, but are also ‘too risky’ to access, or ‘not able to afford’, credit. The lines between 'welfare' (a state responsibility) and credit (an individualised responsibility) have become far too blurred over the past four decades.
Which brings us to the question of whether credit in any form can provide an adequate response to declining real incomes, or whether other forms of assistance are more appropriate?
In our view, despite being advocates of responsible credit provision and having noted its potential to make some difference at the margins of this crisis, the solution to a severe squeeze on incomes lies not in expanding credit to individuals to cope with rising prices, but in providing it to the suppliers of services, so that they can hold down prices in the first place.
For example, faced with an inflation rate of 11% in October, many social housing landlords will inevitably be under pressure to pass on costs to their residents next April. But, if they are able to take the Bank at its word, inflation should reduce thereafter, potentially to as little as 2%. And it should remain there. Credit could therefore be used to smooth the liquidity pressures on social landlords over a three-to-five-year period, avoiding the need for severe hikes in rents next April.
The same challenges are evident for energy providers, and potentially many others, and a long-term funding facility, which would allow price setting at the expected long-term average, is needed, albeit with safeguards attached to prevent profiteering.
A call on the Bank
The Bank of England has provided similar, cheap, funds to encourage banks to lend to businesses in the past, such as through the Funding for Lending Scheme and Term Funding Scheme[viii]. These typically provided four-year loan facilities to banks at, or very close to, the base rate in return for their evidencing increased lending to businesses and households. What is needed now is a ‘Funding for Price Restraint Scheme’ to encourage banks to provide cheap liquidity to service providers in return for clear, and binding, commitments to hold down prices.
In his letter to the recently replaced Chancellor, the Bank of England Governor focused on only one potential tool to address inflation - the setting of the base rate. However, other more imaginative monetary approaches are available, and should now be explored. With mortgage rates now rising on the back of a prolonged rise in house prices, it may not be long before we see an increase in mortgage arrears and repossessions. Such an event could threaten the stability of the financial system. But even without this, the Bank should recognise that, right now, households need time and support. If it trusts its own forecasts, it should be working with HM Treasury to hold down prices to their long-term expected average, rather than sparking a recession through further base rate rises.
Notes
[i] https://www.gov.uk/government/publications/open-letters-between-hm-treasury-and-bank-of-england-june-2022
[ii] A further option is the sale of assets.
[iii] https://www.jrf.org.uk/press/new-evidence-%E2%80%98year-financial-fear%E2%80%99-being-endured-uk%E2%80%99s-low-income-families
[iv] https://www.health.org.uk/publications/reports/the-marmot-review-10-years-on
[v] https://england.shelter.org.uk/support_us/campaigns/what_is_the_housing_emergency
[vi] https://www.trusselltrust.org/2022/04/27/food-banks-provide-more-than-2-1-million-food-parcels-to-people-across-the-uk-in-past-year-according-to-new-figures-released-by-the-trussell-trust/
[vii] https://fair4allfinance.org.uk/news/learning-from-our-no-interest-loan-scheme-proof-of-concept/
[viii]See, for example, https://www.bankofengland.co.uk/quarterly-bulletin/2012/q4/the-funding-for-lending-scheme
