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Inflation and the rocketing cost of living are putting a strain on spending, creating issues for consumers and firms alike. Analysis by Charlotte Pope-Williams.

Data from the Bank of England shows that consumers have been rapidly increasing their borrowing using credit cards. This is a result of record-high inflation and the cost of living crisis in which wages are lagging behind the cost of goods and services. Energy bills, while now capped, are dramatically higher than they were in the past. 

The economic outlook for UK consumers at present is not particularly positive. And further, the crisis is having specific impacts on banks, pension funds, asset managers, and debt management firms.

Pension problems

In the short and medium term, consumers will have to find funds to service credit card debt. Sacrifices must be made, and consumers are likely to cut back on what they perceive to be discretionary spending. 

For those in the pension fund and asset management space, this development means that consumers are likely to consider significantly reducing or else ceasing pension contributions and/or investments altogether. Instead, they will seek to deploy funds for more immediate needs such as fuel and food. Certain consumers may seek to cash out their pensions to pay for the cost of living now, including servicing credit card debt.

Pensions administrators regulated by the Financial Conduct Authority (FCA) should think carefully about what this means when construing the retirement risk warnings set out in COBS 19.7 in the FCA Handbook. This outcome is arguably storing up problems for the longer term with the ageing population in the UK, some of whom will no longer have adequate retirement savings because they have been deployed to deal with the cost of living today.

Conduct risk

Retail banking businesses and retail financial services providers more generally will need to be particularly mindful of the FCA’s vulnerable customer guidance and its “treating customers fairly” requirements. A large number of customers who were not previously vulnerable will now become so, driven by life events such as income shocks. The economic environment is likely to give rise to income shocks for individuals who have not experienced them before. 

Based on the findings of the 2020 Financial Lives survey, those who were already vulnerable are likely to become even more so as a result of these developments. For example, according to the survey, as of February 2020, 5.1 million people (one in 10) were “constantly or usually” overdrawn and 2.8 million people (one in 20) had persistent credit card debt.

These trends are likely to continue through the implementation period of the FCA’s new consumer duty, which puts increased pressure on firms to deliver good outcomes for retail customers. From July 31, 2023, the FCA’s new consumer duty will apply to existing products and services that consumers can buy or renew.

Debt management issues

The pressures and stress arising from additional credit card borrowing, coupled with the likelihood of a worse-than-usual flu season, the probable resurgence of Covid-19 over winter, together with rising heating and food costs, present the very real possibility of higher rates of mental health issues.

Some firms may not be aware of the Covid-era legislation known as the Breathing Space Regulations. In short, the rules give consumers respite from problem debt for up to 60 days. In circumstances where a person’s mental health is impacted, this buffer lasts as long as treatment continues and a further 30 days after treatment ends. Broadly speaking, creditors cannot take enforcement action in relation to a debt while a breathing space moratorium is in place. 

Increased credit card borrowing is likely to lead to a corresponding increase in problem debt, which in turn leads to greater use of debt relief breathing space and mental health moratoriums. Financial services firms must be mindful of the operation of this statutory instrument in conjunction with the FCA Handbook.

Financial stability impacts

The reduction in consumer spending power and resilience, which is in part consequent on increased credit card borrowing, may also have an underlying effect on firms’ profit and loss. This may lead smaller firms, in particular, to consider their solvency and resilience from a prudential perspective. 

Firms must prepare for the fact that increased credit card borrowing is having and will have direct tangible impacts on firms in relation to conduct and litigation risk. Consumers will have a reduced ability to make discretionary purchases relating to financial services, and there will be potential prudential and financial stability impacts for others.

Charlotte Pope-Williams is a senior associate (barrister) at law firm Pinsent Masons.

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