Rise in consumer defaults!

In recent news, the rise in consumer default rates has the Bank of England (BOE) as well as the high street banks concerned about the health of the UK economy. The BOE has attributed this to the rising cost of living that is outpacing the increases in wage growth. However, this is only considering the short term problem as does not address the larger underline picture.  

Last month I wrote a piece called the “Irrational borrower” which examined why so many consumers decide to take out costly short-term credit to pay for goods rather than save the money themselves and forgo the interest. The main conclusion from this is that we all desire instant gratification when it comes to purchasing goods and as such have a lack of self-control. Therefore, many consumers feel they need a “nudge” to help them save money. This, therefore, leads to many consumers expending most their income in a specific time period and then resorting to high-cost credit to feed their purchasing needs.

The FCA in recent years has made leaps forward to try and reduce the number of consumers getting into financial distress and limit irresponsible lending by increased regulation on credit products. This has shown to be somewhat effective, however, as we have seen with the rise in default rates this year, this doesn’t solve the problem but merely slows it down. It is, therefore, my opinion that continued stridency in regulation by the FCA will only make it harder for consumers to gain access to capital and will not alter human behaviours when it comes to our own spending habits. As such a reduction in supply rarely leads to a reduction in demand and therefore, increases in regulation that limit some consumers access to credit may lead to the growth of more illegal sources of finances to fund their spending.

A paper published by the American Real Estate Society (P. Elmer and Steven Seelig) called the “Insolvency, Trigger Events, and Consumer Risk Posture in the Theory of Single-Family Mortgage Default” also found that insolvency is a “primary motivation for default” and that “adverse shocks to income and house prices, but not interest rates, also affect default and insolvency through the erosion of personal wealth". This demonstrates that if government can encourage consumers to save a larger proportion of their income we may see a reduction in consumer defaults through saving, not regulation.

So what might be a better approach?

There are plenty of ways government can increase consumer savings. One thing that has been introduced recently is that banks in the UK are now offering cash prices on savings accounts. Halifax now offers 3 winners a tops price of £100,000 each month just for saving with them. This comes after a Shawn Cole, a professor at Harvard Business School, co-wrote the study of “Can Gambling Increase Savings? Empirical Evidence on Prize-linked Savings (PLS) Accounts”. The study showed that banks in South Africa that offered price draws on savings accounts achieved a 38% increase in annual savings and “that large prizes generate a local “buzz” which lead to an 11.6% increase in demand for PLS at a winning branch.”

Can Gambling Increase Savings?

In a separate study named “Financial Training for Mineworkers in South Africa", Cole also found that by providing financial training to mineworkers showed that they planned their expenses better and even cut spending on gambling and social actives.

By merely enforcing more stringent regulation without increases in consumer savings programs or financial education, we may see increases in illegal lending due to the shortfall in the supply of money being picked up by unauthorised and unregulated lenders. Though the right regulation can be effective, I believe that the UK government should continue to increase and promote saving programs with one of the aims being to lower the number of consumers entering financial distress, which intern would provide a more stable growing economy.