On 3 August 2016, the FCA published its Occasional Paper 20 which considers whether it is possible to predict which consumer credit users will suffer financial distress.  The authors of the Paper have also written an article on the topic entitled, ‘Can financial distress be predicted or is it just life (events)?’.

Key points include:

  • Distribution: The majority of individuals in the UK hold at least one consumer credit product, with about a quarter of all individuals holding outstanding debt. Borrowing is unevenly distributed, with the median consumer credit debt being £1,900 and the top 10% of consumer credit holders holding at least £10,300.
  • Estimating financial distress: Financial distress can have a variety of drivers. Objective measures of financial distress include missing two payments.  Subjective measures of financial distress include the impact on well-being and regularly running out of money each month. Approximately 2% of individuals holding consumer credit debts are in financial distress if objective measures are used.  However, when also looking at subjective measures this rises to 17%.
  • Predicting financial distress: Unpredictable life events such as divorce or unemployment cannot be gauged at the point of assessing creditworthiness. Lenders must base their decision on known or predictable elements. There is a strong correlation between high debt to income (DTI) ratios and the likelihood of financial distress. The DTI ratio is a more reliable predictor than, for example, using the total number of credit products.  In addition, there is a higher incidence of financial distress in younger individuals with higher DTI ratios.

The report concludes that affordability policies should be tailored to the products that people apply for and to applicants’ circumstances, especially their DTI ratio.