Risk Waiver: Closing the protection gap and easing the flow of credit

Lending to UK consumers and businesses has stagnated over the last five years. The credit our businesses and households rely upon to prosper is simply not as available as it needs to be.

Recent polls illustrate that consumer confidence has been running at low levels since the recession and have remained stubbornly low since. This lack of confidence ultimately bears out in consumer spending levels, which are currently still 3.9 per cent down on pre-recession levels. Also, taken as an average, workers are in real terms earning no more than they were ten years ago. Given that consumer spending in total comprises 65 per cent of UK GDP, a relaxation of credit constrains would have a substantial impact on economic growth and household earnings.

However, it would be irresponsible to simply expand consumer credit without commensurably increasing the levels of consumer protection. It is a worrying fact that 83 per cent of those with a loan are unprotected against the inability to make payments. This huge ‘protection gap’ is down to a general lack of trust in protection products, mostly brought about the PPI mis-selling scandal. Since then, this gap has widened significantly and presents an obstacle to the expansion of consumer markets. This issue too needs to be addressed if future lending is to be responsible and secure.

Lending levels to UK businesses are in an equally dire situation. Latest Bank of England figures suggest that, despite numerous initiatives by the Government, corporate credit supply is still below its 2008 levels. This paucity of credit disproportionately affects smaller firms, which lack large cash reserves to fall back on.

SMEs classified as a single group represent 99.9 per cent of all private businesses, 59.1 per cent of private sector employment and 48.8 per cent of private sector turnover. Disturbingly, since 2009 lending to SMEs has fallen by 25 per cent and loan rejection rates in the UK are twice what they are in France and Germany. SMEs are the workhorses of the British economy, credit conditions unfavourable to SMEs inevitably result in problems with GDP and jobs growth.

The Government has not been idle on these issues. The Enterprise Finance Guarantee, Funding for Lending and historically low interest rates have all attempted to increase consumer and business spending. But each have met with little success. This is because these solutions simply ignore the underlying causes for decreased spending – credit markets shackled by overbearing credit risk.

The Government’s plan to boost growth through the Local Enterprise Partnerships and Enterprise Zones, whilst admirable, will ultimately fail for those same reasons. Current Government pump-priming initiatives are akin to transplanting the heart of a sick patient, while it is the circulatory system that is damaged. The Government needs a new approach to spending that tackles the underlying causes of the credit slowdown.

Credit Protection products provide a valuable means of safeguarding consumer and business loans. One particularly innovative product not currently available in the UK are debt waiver products. These products, common place in the US, offer a waiver facility to their customers that guarantees that the lender, rather than the borrower, covers the loan in the eventuality of illness, sickness or injury. This shifts the burden of default away from customers.

The history of debt waiver in the US shows that waiver products could provide a fair and transparent means by which to safeguard loans. In the US, these products have consistently been shown to improve the lenders’ financial results. Shoring-up the credit market with protection products in such a way could be a way of closing the ‘protection gap’ whilst at the same time encourage lending by reducing the impact of excessive credit risk.

The US Federal Reserve Board found that tougher credit conditions reduce the level of core lending capacity. They surmised that a 5 per cent decrease in credit growth over a five year period translates into a 1.6 per cent decrease in GDP growth over that same period. Translated to the UK situation, tougher credit conditions have cost the UK economy 8.52 per cent in GDP growth over the last five years. This amounts to £30.83 billion in today’s money and is equivalent to the average wages of 1.1 million private sector workers.

Protection products like debt waiver could both secure loans and get lending going again.

Key recommendations of this report are:

• HM Treasury should immediately conduct a review of the state of consumer protection in credit markets. This review needs to determine a comprehensive plan of action that seeks close the ‘protection gap’ as quickly as possible.
• Following the example of the car insurance market, the Government should consider making it compulsory for lenders to provide protection insurance on the loans that they issue. This will both safeguard customers and protect lenders’ loan books.
• The ABI and other relevant member bodies should develop a Code of Conduct for protection products that goes beyond OFT/FCA proposals to ensure that scandals like the PPI mis-selling scandal do not reoccur. The ABI should also consider supporting this Code with a ‘kite mark’ system of accreditation in order to highlight ‘safe’ lenders.
• The FCA and OFT should immediately commission a comprehensive review of best practice and lending policy from the experience of debt waiver in US. This will ensure the speedy adoption of waiver and cancellation products in the UK – to the benefit of customers and lenders.

·      In order to ensure that products like debt waivers can be introduced to the UK market as quickly as possible in the future, the regulators should adopt a ‘fast track’ policy for the regulatory testing of innovative financial insurance products that have a proven track record of success in developed economies. This should, for financial institutions, reduce all those costs associated with the development of new products.

Current Government attempts to increase lending to consumers and businesses are clearly failing. Providing protection on the loans lenders issue would shore up the beleaguered lending sector by creating an economy where credit is both widely available and inherently more secure.

Download the full green paper here.

Email me at alastair.t.marke@gmail.com