In August 2016, the Financial Conduct Authority (FCA) published an updated version of its study entitled ‘Can we predict which consumer credit users will suffer financial distress?’

Lenders of all types, as well as firms who operate peer-to-peer lending platforms, need to be aware of the need to lend responsibly. Only clients who pass rigorous credit and affordability assessments should be allowed to borrow. However, beyond this, predicting exactly who will have difficulty meeting their repayment obligations can be very difficult.

This report by John Gathergood, Associate Professor of Economics at the University of Nottingham; and Benedict Guttman-Kenney of the regulator’s own Behavioural Economics & Data Science Unit attempts to provide some answers to that difficult question.

In part of course, financial distress can be predictable if consumers take on debts that they were never likely to be able to repay. However, financial distress can also be unpredictable as an individual who was able to service the debt when the credit product was taken out may then experience an unforeseen event, such as becoming divorced, unwell or unemployed.

The report suggests that there is a strong correlation between having a high debt to income (DTI) ratio and suffering financial distress. Although firms should note that no FCA rules have been altered yet as a result of this report, the authors suggest that an applicant’s DTI ratio should be a key part of any lender affordability assessment.

The 10% of individuals with the highest outstanding consumer credit debts have debts equivalent to 31% of their gross annual household income, whereas if we look at all individuals with credit debts, this figure is just 12%.

The research finds that individuals who experience financial distress as a result of debt problems are different from the average member of society in that they are: typically younger, less likely to be employed and more likely to hold higher cost credit items (such as payday loans).

Those whose debt levels include a high proportion of high cost credit debt are also at greater risk of suffering financial distress. People with higher proportions of their debts in high cost credit items are 80% more likely to suffer future financial distress when compared to individuals in debt in general. Those with debts to pawnbrokers were actually slightly more likely to experience distress than payday loan borrowers, although both types of borrower were significantly more likely to experience distress than those holding personal loans.

The paper also acknowledges that it may be financially attractive for lenders in certain areas of the credit sector to take on clients who are likely to default on their repayments.

People in financial distress were also found to be significantly more likely (37%) to experience anxiety problems, and were 14% less likely to say they were satisfied with life in general.

The information shown in this article was correct at the time of publication. Articles are not routinely reviewed and as such are not updated. Please be aware the facts, circumstances or legal position may change after publication of the article.