The ‘sweatbox’ model of credit card lending was set out in a well-known article by Ronald Mann in 2007 (here) . Credit card companies through the use of sophisticated data could make substantial profits from individuals who had difficulties in repaying or were financially distressed. Although certain of these accounts would be written off, the overall profits from the various fees and costs levied on individuals who are locked in to an existing lender and struggling to repay were substantial. This sweatbox model benefited from the 2005 reforms to US bankruptcy law which delayed the ability of individuals to file for bankruptcy, extending the time an individual was in the sweatbox of increased financial distress.
Recent studies by the Financial Conduct Authority suggests that the sweatbox model is alive and well in the UK (here and here). The Authority highlighted two issues. First a significant group of borrowers carry potentially problematic debt for a number of years with some making repeated minimum payments. Second, they identified a higher risk group who move swiftly from acquiring a credit card into potentially problematic personal debt. A quarter of cards opened in 2013 in this market segment were in serious or severe arrears a year later. Over 20 percent with serious arrears did not have an active card in 2012 suggesting a ‘rapid descent into arrears’. The FCA noted in an understatement that these data raise problems about the affordability assessments which companies are required to undertake of potential customers. A product which results in a failure rate of 25 percent would normally not be permitted on the market.
These findings on the use of credit cards must be set in the economic context of the UK with relatively stagnant real wages for many, insecure employment and currently the lowest savings level (3.3 percent) since 1963. Many writers have underlined how loans may substitute for stagnant wages but that this cannot be a long term fix for the economy.
The FCA propose several behavioural remedies for consumers and earlier intervention by creditors to address persistent arrears. However the ability to write-off debt swiftly would provide a way out for debtors and complement other techniques such as responsible lending. Unfortunately the complexity of current debt write down procedures (IVAs, debt management programmes, bankruptcy, Debt Relief Orders) in England and Wales make this more difficult. A damning report by the FCA on the debt advice industry (here) indicates that advisors often did not give balanced information about insolvency alternatives.
Credit card use raise wider questions about the contemporary role of credit in the UK. The governor of the Bank of England introduced a recent financial stability report with a concern about existing vulnerabilities from high and rising UK household indebtedness. On April 4 the Bank of England Financial Policy Committee noted the continuing rapid growth in consumer credit (here). At the same time the respected Institute for Fiscal Studies reports that based on the Autumn 2016 budget statement real wages will, remarkably, still be below their 2008 levels in 2021. One cannot stress enough how dreadful that is – more than a decade without real earnings growth. We have certainly not seen a period remotely like it in the last 70 years’
The Institute of Fiscal Studies concluded also that middle income families with children are no longer so different from the poor: almost half middle income families are now renters (home ownership in the UK has reduced from 72 % in 2007 to 64% in 2016 ) and middle income families with children get 30% of their income from benefits and tax credits. This means that credit use is likely to increase as middle to lower income earners use it as a defensive strategy to maintain living standards . Austerity also means individuals having difficulties with current commitments such as utilities and council tax, described by the Institute of Fiscal Studies as a tax ‘deliberately regressive in design’.
These conditions fuel the growth of sweatbox lending and the resulting household misery for some. Solutions may require action at micro- and macro- level. But there is no doubt that action is necessary.