UK banks must bolster defences against consumer loan defaults -Bank of England

(Adds economist reaction)

By David Milliken and Huw Jones

LONDON, Sept 25 (Reuters) - British banks have

underestimated the risks from a surge in consumer borrowing and

need to hold an extra 10 billion pounds of capital to guard

against future dangers, the Bank of England said on Monday.

Unsecured consumer lending is growing at nearly 10 percent a

year, far faster than incomes, and the BoE (Shenzhen: 000725.SZ - news) said the low rate of

defaults at present had more to do with strong employment growth

than prudent long-term lending.

Last month the BoE forecast the economy would slow next

year, partly due to Britain's looming departure from the

European Union, and earlier this month it said it was likely to

start raising interest rates in the coming months.

"Lenders overall are placing too much weight on the recent

performance of consumer lending in benign conditions as an

indicator of underlying credit quality. As a result, they have

been underestimating the losses they could incur in a downturn,"

the BoE said in a statement.

If there was a sharp downturn that pushed unemployment up to

9.5 percent - more than double its current rate - and caused the

Bank of England to raise rates to 4 percent from a current 0.25

percent, British lenders could face 30 billion pounds in losses.

On average, 20 percent of consumer loans would need to be

written off over a three-year period, compared with a 2 percent

write-off rate at present, the BoE said.

Last year, the BoE only estimated a 13 percent write-off

rate, based on a scenario which did not include a big increase

in interest rates as well as a different make-up of lending.

Monday's warning is part of a fuller assessment of bank

risks which the BoE will publish on Nov. 28. After that, it will

tell banks how much extra capital they need to hold based on the

individual riskiness of their lending.

For example, credit card lending has an expected write-off

rate of 25 percent in a crisis, while car finance would only see

a 10 percent loss, even if second-hand car prices fall as well.

The extra 10 billion pounds is small in the context of the

280 billion pounds of core capital held by British lenders, but

the BoE said it expected banks to take the greater risks into

account in their future lending plans.

INCREMENTAL?

J.P. Morgan (Other OTC: MGHL - news) economist Allan Monks said Monday's announcement

represented an "incrementalist" approach from the BoE's

Financial Policy Committee, as it stopped short of placing

direct curbs on consumer lending.

By contrast, in 2014 the BoE limited lenders' ability to

issue mortgages that were worth more than 4.5 times a borrower's

income, and a separate regulator has tightened affordability

checks further.

"More direct intervention in the consumer loan market is

unlikely unless banks fail to comply with the BoE’s

requirements," Monks said.

Unsecured consumer lending is only an eighth of the size of

mortgage lending, and does not play a big role in overall

consumer spending growth, the BoE said.

But unlike mortgage lending, there is a high risk of

defaults during sharp economic downturns.

The BoE said it still intended to raise a separate

counter-cyclical risk buffer to 1 percent in November from 0.5

percent.

As well as setting interest rates, the BoE is responsible

for financial stability and much regulation, though conduct and

consumer protection is mostly the job of a separate body, the

Financial Conduct Authority.

Britain's opposition Labour Party proposed capping credit

card interest payments in a major speech on Monday.

FCA chief executive Andrew Bailey told Reuters that other

measures to help heavily indebted borrowers should be given time

to work first.

Separately, the BoE said Brexit posed big legal challenges

for about a quarter of derivatives contracts, which businesses

use to hedge against interest rate and currency moves, and

either new legislation or the redrafting of thousands of

contracts would be needed.

(Editing by Andy Bruce and Catherine Evans)