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Decision-making by borrowers and lenders ahead of the financial crisis

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Decision-making by borrowers and lenders ahead of the financial crisis Lessons from data on indebted UK households Peter Welch December 2009 1. Context and overview ... – PowerPoint PPT presentation

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Title: Decision-making by borrowers and lenders ahead of the financial crisis


1
  • Decision-making by borrowers and lenders ahead of
    the financial crisis
  • Lessons from data on indebted UK households
  • Peter Welch
  • December 2009

2
Contents
  1. Context and overview
  2. Growth in UK household borrowing
  3. Helping people with financial problems
  4. Consumer Credit Counselling Service (CCCS)
  5. CCCS database
  6. Research possibilities
  7. Sources and further reading
  8. Peter Welch background and contact details
  9. Appendix UK debt advice

3
1. Context and overview
4
Context
  • United Kingdom (UK) and United States (US) among
    the economies most damaged by the financial
    crisis
  • In both countries, the rapid growth and high
    level of household borrowing before the crisis
    was a major factor
  • Raises important questions about decision-making
    by borrowers and lenders
  • Why did households borrow so much?
  • Poor financial capability / lack of financial
    education?
  • And why did banks and finance companies lend so
    much?
  • Why did the sophisticated infrastructures for
    assessing consumer loans (including advanced
    credit scoring systems and credit bureaux) not
    lead to better decisions?

5
Overview of presentation
  • Focus on the UK
  • Uses data from the Consumer Credit Counselling
    Service (CCCS), the largest debt advice charity
    in the UK
  • CCCS a world leader in information systems and
    use of the internet
  • Through its management of repayment plans for
    100.000 indebted UK consumers, CCCS now has the
    largest database of its kind in the world
  • CCCS data illustrates the extent of
    over-borrowing and over-lending in the UK in the
    years before the financial crisis

6
2. Growth in UK household borrowing
7
Growth in UK consumer borrowing
  • UK consumer borrowing the highest in Europe
  • In the decade before the crisis, consumer
    borrowing grew at approximately double rate of
    growth in national income (PIL) personal
    incomes (stipendi, ecc)
  • At end 1999, outstanding mortgage (mutui)
    borrowing in the UK just under 500bn while
    outstanding unsecured borrowing (credito al
    consumo carte di credito, prestiti personali,
    prestiti per macchine, mobili, ecc) approximately
    120bn
  • During 2008, outstanding mortgage borrowing
    passed 1.2 trillion while outstanding unsecured
    borrowing passed 230bn
  • Year-end mortgage and unsecured consumer
    borrowing rose from approximately 66 of UK GDP
    (PIL) in 1999 to just over 100 by 2007
  • On some measures, household borrowing higher in
    the UK than in the United States

8
UK consumer borrowing more than 10 years of
growth
9
Regno Unito in paragone con Italia! 2007
billion (Source ECB)
10
Indebted population
  • Outcome a large indebted population in the UK
    with many people unable to repay their loans
  • Problems evident before the financial crisis
  • Arrears and defaults on credit cards and other
    unsecured loans first rose sharply during 2005
  • Bank write-offs on consumer credit rose from 3,9
    billion in 2004 to almost 5,8 billion in 2005
  • Evidence that financial problems caused by
    over-borrowing, not just a change in
    circumstances (unemployment or divorce)
  • Second phase of problems directly linked to
    financial crisis and recession
  • Rise in unemployment and reduced income (loss of
    overtime, short-time working)
  • Sharp rise in problems with mortgages, and
    further problems with unsecured borrowing

11
3. Helping people with financial problems
12
The need for debt advice
  • Many people in the UK need help with their
    personal finances
  • Often owe money to several different lenders
  • Unable to meet contractual loan repayments
  • Facing actions from lenders to recover loans
  • Need for professional help covering
  • Budgeting
  • Restructuring of loan repayments
  • Negotiations with creditors
  • Pastoral care

13
UK debt advice process
  • Two-stage process.....
  • First stage counselling
  • Gathering data on the clients financial
    circumstances (income, outgoings, loans, etc)
  • Recommendation based on analysis of the data
  • With some clients (those with less severe
    problems and/or seek advice early), sufficient to
    provide them with the tools and information to
    help themselves
  • But if structured debt arrangement needed
    (involving some measure of debt relief), second
    stage in the process
  • Organising the appropriate debt arrangement
    (negotiation with creditors, setting up
    arrangement, etc)
  • Ongoing monitoring and support (which may last
    for several years)
  • At both stages, accompanying pastoral care may be
    needed
  • And at both stages, specialist counselling and
    support may be needed (eg self-employed clients /
    small business owners, those with specialist
    housing and benefits issues)

14
Overview of debt advice process
15
4. Consumer Credit Counselling Service (CCCS)
16
CCCS overview
  • The largest UK debt advice charity
  • Founded in the UK in 1993 in response to growing
    need for professional debt advice
  • Based on a proven debt management system operated
    in the USA over many years
  • Offers free, confidential and impartial debt
    advice based on a repayment ethic
  • 10 centres and 1 partnership covering the UK
  • 0800 free phone helpline, available 8am to 8pm
  • Web based 24 hour virtual counselling through
    Debt Remedy (a world first)
  • Specialist advice services for self-employed
    (lavoro autonomo), mortgages, bankruptcy, welfare
    benefits
  • Recently launched an online money management
    service Money Matters for all people, not just
    those in debt

17
www.cccs.co.uk
18
CCCS 2008 key statistics
19
CCCS Debt Management Plans (DMPs)
  • CCCS introduced the Debt Management Plan (DMP) to
    the UK
  • Designed for borrowers
  • Who owe money to several different lenders
    (almost 8 on average!)
  • Can repay their loans
  • But need help (realistic repayment schedule,
    interest and charges suspended)
  • Process
  • Budget prepared for borrower
  • Debts prioritised (mortgage is a priority)
  • Surplus cash identified
  • Realistic repayment schedule for unsecured loans
    agreed
  • Lender agreement CCCS looks for
  • Interest and charges frozen or reduced
  • Repayment period extended
  • Creditor follow-up activity suspended
  • Borrower then makes a single payment to CCCS each
    month, which repays the lenders pro rata

20
CCCS Debt Management Plans
21
Debt Management Plans - 2008
New DMPs 26.000
Average level of debt (new DMPs in 2008) 28.053
Average number of debts (new DMPs in 2008) 7,6
Active DMPs 94.000 (now more than 100.000)
Payments to creditors under DMPs 223,5 million
22
5. CCCS Data Warehouse
23
Data Warehouse
  • Comprehensive demographic and financial
    information on all CCCS clients
  • Over 15 billion rows of data
  • 9 million inbound phone calls
  • 770.000 clients
  • Almost 4 million debts totalling 13,4 billion
  • Over 50 million records refreshed each day
  • Tracks every level of detail for example
  • Ages of children of each client
  • Repayment to every creditor since 1993
  • Used for
  • Management information
  • Information for creditors
  • Relations with media and Government
  • Statistics and research (annual CCCS Statistical
    Yearbook)
  • The largest and most comprehensive database on
    indebted consumers in the world

24
6. Research possibilities
25
Research possibilities borrower behaviour
  • Financial capability
  • Lack of budgeting skills / lack of understanding
    of financial concepts (such as interest rates)?
  • Behavioural finance (reasons for irrational /
    inefficient financial behaviour)
  • Self-control and hyperbolic discounting (two
    research fellows from EUI used the CCCS database
    to examine the thesis that certain kinds of
    people have self-control problems, and this will
    be evident in their DMP performance)
  • Optimistic expectations of future income
  • Vulnerability to marketing techniques (for
    example, discounts on repayments for first 6
    months / 12 months / 2 years of loan)
  • Links between financial problems and mental and
    physical health problems
  • Recent UK research by Professor Rachel Jenkins of
    the Institute of Psychiatry found around a
    quarter of people with a mental disorder are in
    debt compared with 8 of people with no disorder
    (though the causal relationships are not clear)

26
Research possibilities lender behaviour
  • Quality and accuracy of lending decisions
  • Accuracy and reliability of credit scoring
    systems?
  • In theory, credit scoring is the most objective
    approach to assessing the risk of non-repayment
    on consumer loans
  • To develop a credit scoring system or model, a
    creditor or insurance company selects a random
    sample of its customers, or a sample of similar
    customers, and analyzes it statistically to
    identify characteristics that relate to risk.
    Each of the characteristics then is assigned a
    weight based on how strong a predictor it is of
    who would be a good risk. (US Federal Trade
    Commission)
  • Credit scoring is most advanced in the UK and US.
    Why did lenders credit scorecards fail to
    assess risk accurately?
  • Did lenders fail to allow for changes in
    macro-economic conditions (they assumed house
    prices would stay high, economic growth would
    continue)?

27
Research possibilities lender behaviour (2)
  • Balance of knowledge between lenders and
    borrowers for example
  • In March 2008 an executive of Bank of America
    mentioned in an almost off-hand manner during the
    course of his testimony before Congress that last
    year the bank had conducted more than 500
    experiments and sent out 111 million pieces of
    mail to test consumer behavior with credit cards
    ...... The information was used to redesign
    aspects of the credit product in order to tease
    more dollars out of consumers pockets and place
    them in the pockets of Bank of America. (Balance
    of Knowledge, Elizabeth Warren, Harvard Law
    School, April 2008)

28
7. Sources and further reading
29
Sources and further reading
  • CCCS 2008 Statistical Yearbook http//www.cccs.co.
    uk/research/CCCSReports.aspx
  • The WORLD WIDE WINDOW Developing Credit
    Counselling and Advisory Services in a Digital
    Age, Produced for the Fourth International
    Invitational Seminar on Credit and Counselling,
    Magdalene College, Cambridge, 14th 16th
    September 2008, Gordon Bell, Chief Executive,
    CCCS
  • Understanding Consumer OverIndebtedness Using
    Counseling Sector Data Scoping Study, Richard
    Disney John Gathergood, University of
    Nottingham, Report to the UK Department for
    Business, Innovation and Skills, October 2009
  • Self-control and debt evidence from data on
    credit counselling, Nur Ata and Alena Bicakova,
    European University Institute, May 2007
  • Balance of Knowledge, Elizabeth Warren, Harvard
    Law School, April 2008
  • Science of Spending, Jonah Lehrer, RSA Journal,
    Spring 2009 http//www.thersa.org/fellowship/jour
    nal/archive/spring-2009/features/science-of-spendi
    ng
  • Debt, income and mental disorder in the general
    population, Professor Rachel Jenkins et al,
    Psychological Medicine, 2008
  • All the above documents available from
    pwelch_at_bankecon.com

30
8. Peter Welch background and contact details
31
Peter Welch
  • Peter Welch is an independent management
    consultant. Peter specialises in market and
    competitor analysis, with a focus on personal
    banking, cards and payments.
  • Peter is an adviser to the Consumer Credit
    Counselling Service.
  • Peter has a long-standing research interest in
    performance metrics in banking. His research
    include Rethinking Banking Efficiency, which
    challenges the validity of the cost/income ratio
    and other widely-used measures of bank
    efficiency.
  • Peter has conducted research with a number of
    academics. With Professor Steve Worthington of
    Monash University, he has analysed the move into
    financial services by leading retailers such as
    Tesco and Auchan. He is currently working with
    Professor Paul Klumpes of Imperial College
    Business School on various aspects of banks
    reporting following the financial crisis. Peter
    maintains a website, www.bankecon.com, that
    includes details of research bulletins and
    reports.
  • To contact pwelch_at_bankecon.com

32
9. Appendix UK debt advice
33
Types of structured debt arrangement (England
Wales)
Type Level of debt repayment Duration Client payment? Interest charges
Debt Management Plan (DMP) Informal Full Depends on the amount of debt and level of repayment Free to client (CCCS) or client pays (fee chargers) No obligation, but normally frozen or reduced
Individual Voluntary Arrangement (IVA) Formal Partial Normally 5 years (3 years in Scotland) Client pays fee Suspended
Bankruptcy Formal Partial / total write-off Usually discharged after 1 year (though may be regular payment for up to 3 years) Client pays fee (fixed in statute) Suspended / not applicable
Debt Relief Order (from April 2009) Formal Partial / total write-off Order lasts for 1 year Client pays fee (fixed in statute) Suspended / not applicable
Notes Protected Trust Deeds, Sequestration and LILAs are the Scottish equivalent of IVAs, bankruptcy and DROs respectively, though with some differences compared to the arrangements in England and Wales. There are other debt relief options If one or more of a borrowers creditors has obtained a court judgment against him, the county court may make an ADMINISTRATION ORDER. Administration is a court-based procedure whereby the borrower makes regular payments to the court to pay towards what he owes to his creditors. The total debts must not be more than 5,000. In Scotland, DEBT ARRANGEMENT SCHEMES (DAS) have been introduced. These sit between DMPs and IVAs. A borrower can apply for a Debt Payment Programme (DPP) to repay all of his debts. During the DPP, the borrower is protected from further legal action from his creditors, and interest and charges are frozen and then written off on successful completion of the DPP. Notes Protected Trust Deeds, Sequestration and LILAs are the Scottish equivalent of IVAs, bankruptcy and DROs respectively, though with some differences compared to the arrangements in England and Wales. There are other debt relief options If one or more of a borrowers creditors has obtained a court judgment against him, the county court may make an ADMINISTRATION ORDER. Administration is a court-based procedure whereby the borrower makes regular payments to the court to pay towards what he owes to his creditors. The total debts must not be more than 5,000. In Scotland, DEBT ARRANGEMENT SCHEMES (DAS) have been introduced. These sit between DMPs and IVAs. A borrower can apply for a Debt Payment Programme (DPP) to repay all of his debts. During the DPP, the borrower is protected from further legal action from his creditors, and interest and charges are frozen and then written off on successful completion of the DPP. Notes Protected Trust Deeds, Sequestration and LILAs are the Scottish equivalent of IVAs, bankruptcy and DROs respectively, though with some differences compared to the arrangements in England and Wales. There are other debt relief options If one or more of a borrowers creditors has obtained a court judgment against him, the county court may make an ADMINISTRATION ORDER. Administration is a court-based procedure whereby the borrower makes regular payments to the court to pay towards what he owes to his creditors. The total debts must not be more than 5,000. In Scotland, DEBT ARRANGEMENT SCHEMES (DAS) have been introduced. These sit between DMPs and IVAs. A borrower can apply for a Debt Payment Programme (DPP) to repay all of his debts. During the DPP, the borrower is protected from further legal action from his creditors, and interest and charges are frozen and then written off on successful completion of the DPP. Notes Protected Trust Deeds, Sequestration and LILAs are the Scottish equivalent of IVAs, bankruptcy and DROs respectively, though with some differences compared to the arrangements in England and Wales. There are other debt relief options If one or more of a borrowers creditors has obtained a court judgment against him, the county court may make an ADMINISTRATION ORDER. Administration is a court-based procedure whereby the borrower makes regular payments to the court to pay towards what he owes to his creditors. The total debts must not be more than 5,000. In Scotland, DEBT ARRANGEMENT SCHEMES (DAS) have been introduced. These sit between DMPs and IVAs. A borrower can apply for a Debt Payment Programme (DPP) to repay all of his debts. During the DPP, the borrower is protected from further legal action from his creditors, and interest and charges are frozen and then written off on successful completion of the DPP. Notes Protected Trust Deeds, Sequestration and LILAs are the Scottish equivalent of IVAs, bankruptcy and DROs respectively, though with some differences compared to the arrangements in England and Wales. There are other debt relief options If one or more of a borrowers creditors has obtained a court judgment against him, the county court may make an ADMINISTRATION ORDER. Administration is a court-based procedure whereby the borrower makes regular payments to the court to pay towards what he owes to his creditors. The total debts must not be more than 5,000. In Scotland, DEBT ARRANGEMENT SCHEMES (DAS) have been introduced. These sit between DMPs and IVAs. A borrower can apply for a Debt Payment Programme (DPP) to repay all of his debts. During the DPP, the borrower is protected from further legal action from his creditors, and interest and charges are frozen and then written off on successful completion of the DPP. Notes Protected Trust Deeds, Sequestration and LILAs are the Scottish equivalent of IVAs, bankruptcy and DROs respectively, though with some differences compared to the arrangements in England and Wales. There are other debt relief options If one or more of a borrowers creditors has obtained a court judgment against him, the county court may make an ADMINISTRATION ORDER. Administration is a court-based procedure whereby the borrower makes regular payments to the court to pay towards what he owes to his creditors. The total debts must not be more than 5,000. In Scotland, DEBT ARRANGEMENT SCHEMES (DAS) have been introduced. These sit between DMPs and IVAs. A borrower can apply for a Debt Payment Programme (DPP) to repay all of his debts. During the DPP, the borrower is protected from further legal action from his creditors, and interest and charges are frozen and then written off on successful completion of the DPP.
34
Main debt advice providers
SECTOR FUNDING SOURCE OF CLIENTS DELIVERY MAIN SERVICES
FEE-CHARGING COMPANIES Private Fees to clients Advertising, Yellow Pages, Internet Phone Sale of IVAs, DMPs
PAYPLAN Private FSC (creditors) and fees for IVAs Referrals, word of mouth, press Phone Counselling ? Self-help, DMPs, IVAs, etc
CCCS Third Mainly FSC (creditors) Referrals, word of mouth, press Internet, Phone Counselling ? Self-help, DMPs, IVAs, etc
NATIONAL DEBTLINE Third Creditor Govt grants Referrals, word of mouth, press Phone Counselling ? Self-help, refers clients needing DMPs, etc
CITIZENS ADVICE Third Mainly Govt grants Public awareness, press Face-to-face Counselling ? Self-help, refers clients needing DMPs, etc
Notes Simplified overview. Concentrates on main private and third sector providers. FSC Fair Share Contribution which creditors pay to CCCS and Payplan. Notes Simplified overview. Concentrates on main private and third sector providers. FSC Fair Share Contribution which creditors pay to CCCS and Payplan. Notes Simplified overview. Concentrates on main private and third sector providers. FSC Fair Share Contribution which creditors pay to CCCS and Payplan. Notes Simplified overview. Concentrates on main private and third sector providers. FSC Fair Share Contribution which creditors pay to CCCS and Payplan. Notes Simplified overview. Concentrates on main private and third sector providers. FSC Fair Share Contribution which creditors pay to CCCS and Payplan. Notes Simplified overview. Concentrates on main private and third sector providers. FSC Fair Share Contribution which creditors pay to CCCS and Payplan.
35
Main debt advice providers
  • THIRD SECTOR (CHARITIES)
  • Services are free
  • Other than CCCS, mainly funded by grants from
    Government and creditors
  • Two best-known
  • CITIZENS ADVICE National network of advice
    agencies, largely funded by Govt grants,
    generalist agency, face-to-face delivery, bureaux
    often staffed by volunteers but supported by
    employed debt advice specialists
  • NATIONAL DEBTLINE Specialist agency, largely
    funded by creditor grants, telephone delivery of
    services
  • Client recruitment ... mainly public awareness,
    internet, referrals (eg creditors, Government
    agencies and local authorities, other charities),
    word-of-mouth, press
  • FOR-PROFIT COMPANIES
  • Clients pay a fee for services
  • Normally, combination of up-front and ongoing
    monthly fees for IVAs and DMPs
  • For example, fee-charging companies offering DMPs
    normally charge 15 or more of the total monthly
    payment as a fee, with additional set-up fees at
    the start of the plan or over the first few
    months
  • Marketing-driven recruitment model, with heavy
    use of internet, Yellow Pages (Pagine Gialle) and
    TV/press advertising

36
Fee-charging companies example of advertising
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