Households’ financial capability: debt and resilience amidst the pandemic
Georgette Fernandez Laris - Doctoral Researcher, Department of Economics, University of Sheffield
The COVID-19 pandemic burst in the midst of an already agitated geopolitical scenery punctuated by the fallout of Brexit and turbulent trade wars. This is the final blog in the series 'Studying an Uncertain Future' written by members of SPERI’s Doctoral Researchers Network.
Recognised as a health emergency, COVID-19 has also represented an unprecedented economic shock. According to Bank of England’s May Monetary Policy Report (MPR), the UK’s GDP is expected to decline by 15% in 2020. The forecasted downturn exceeds the contractions seen during the 1918 Spanish Flu, upon the return to the gold standard following World War I, and throughout the 2008 global financial crisis.
Today, as the UK tip-toes the reopening of the economy towards “back to normal”, it is still difficult to calculate unequivocally the extent of COVID-19’s socioeconomic damages, especially at the most disaggregated level: the level of households and individuals. The latter is of special interest due to the importance of household finances and of consumers’ appetite for the resumption of discretionary economic activity, both of which are influenced by plummeting expectations and risk averse behaviours during downturns.
UK policy responses
To better understand how Covid-19 has recast UK households’ financial well-being let us first briefly list the macroeconomic policies thus far undertaken to support the economy.
As the chariot of stable prices and of UK’s financial system resiliency, Bank of England (BoE) has promptly responded through: Bank Rate cuts (reduced from 0.75% to 0.1%), quantitative easing (asset purchase programme) expansions, reviving BoE’s term funding scheme to temporarily allow banks to borrow from it at close to Bank Rate (and consequently reinforce low-interest rate pass-through) and by lending directly to firms via its Covid Corporate Financing Facility. A range of fiscal policy measures have also accompanied monetary policy.
While encouraging, these measures are not completely assuring, especially in the medium to long-term because most will be phased out. Moreover, while some indicators have improved others have worsened amidst lingering uncertainty.
Through the looking glass of household finance
In the current conjuncture, many have pointed out that the most severe, deep and uneven effects of the Coronavirus crisis will be experienced by UK households. The reasons are multifaceted, including: reductions in the income households need to meet their financial responsibilities due to job loss or cessation, scarcity of new forms of employment, employees’ sorting, and increased job-contract vulnerability due to more ambiguous terms of employment seeking to maximise firms hampered profits. Consequently, already high indebtedness levels have arisen and the most underprivileged households might punitively bear the burden of increased societal debt. Data from the Office of National Statistics (ONS) show that the UK’s poorest households hold the highest debt-to-income ratio across income decile groups and rely on unarranged debt (overdrafts and unpaid bills) to make ends meet. When credit conditions tighten and unemployment surges, these patterns of debt reinforce the poverty cycle and further cement economic geographies of inequality.
As of early May 2020, more than 6 million people in the UK had already fallen behind on credit card and personal loan repayments as well as on some of the most widely paid household bills (council tax, gas, electricity, water bills):
Total people behind and expecting to fall behind on essential bills by sector
In response, a number of micro-level (short-term) measures including pauses on enforcement, eviction, or repayment holidays have been enacted to cushion people from the impact of Coronavirus-triggered debt. Nonetheless, large numbers of indebted households would potentially become financially vulnerable as temporary protections fade away.
Frugality, capability and financial well-being
Pre-Covid-19 years saw an increased interest in responsible banking and in the contribution of financial services to social inclusion. The pro-poor finance standpoint linking these discussions acknowledges that greater financial inclusion does not only entail wider and fairer access to financial services but also the cultivation of personal finance habits and behaviours leading to their effective use. A key concept of this policy paradigm is financial capability: the ability to manage money well, both day-to-day and while facing significant life events. Being financially capable means having the resilience to handle shocks and difficult times—as those arising due to the Covid-19 pandemic—by nurturing financial knowledge, reinforcing personal budgeting habits, planning and saving behaviours, and through pre-emptive attitudes toward debt and risk-taking.
Financial capability is considered a core foundation of individuals’ financial empowerment, itself a pillar of financial systems’ stability. Yet, even before the pandemic, the UK ranked well below average in several dimensions of the OECD International Survey of Adult Financial Competencies. For example, UK respondents ranked second to last when asked about the effects of inflation on purchasing power, with only 38% answering correctly vis-à-vis the average of 63% correct responses attained by other countries. UK respondents also ranked in the bottom fifth of participating countries when asked if they considered the affordability of purchases before making them as well as on questions measuring people’s endeavour to achieve their long-term financial goals.
These findings support the argument that changes in social attitudes and a retail-led culture have outpaced UK consumers’ ability to develop sound financial judgement and money management skills. Against this backdrop, Covid-19 has already begun reshaping people’s spending and saving patterns, which in turn has brought attention back to formerly praised values of frugality and thrift.
During the lockdown, UK households responded with a lot of discipline and restraint. In March, BoE reported a record monthly £13.1bn rise in UK household bank deposits. While some interpreted these figures as signs of acute financial capability, critics fear increases in household savings could hamper demand-driven recovery measures.
From a more glass-half full perspective, Fin-tech advocates propose to tap into increased pockets of savings to reallocate via novel financial vehicles the flows needed to finance pandemic and recovery responses.
By July 1st, BoE reported that retail sales and consumer spending had shown signs of recovery with respect to their April lows. The extent to which consumer demand will continue to rise is not yet known, especially given worrisome labour market figures. Unemployment has already risen to the levels of the 2008 global financial crisis and the uptake of the UK government’s furlough scheme has been higher than anticipated, with total claims encompassing about a third of the UK’s labour force. Together, such conditions are likely to abate household spending and to instil precautionary savings and risk averse behaviours – which could amplify the effects of the Covid-19 crisis or prolong their duration.
Glimmers of hope and purpose?
People in similar financial situations perceive their financial well-being differently depending on the status they compare it to and on what they would prefer it to be. Hence, households’ precautionary savings might be guided by the saliency of their pre-Covid-19 financial situation, taken as their reference point. The procedural design of post-lockdown normal-activity resumption will determine the extent to which recently observed behaviours become anchored as constructive long-term household financial practices.
If a profession’s purpose is its guide to action, we must strive to eschew finance practices which heighten the vulnerability of households to creditors under conditions punctuated by asymmetric information—like those generated through the pandemic.
In so far as new banking cultures and recovery measures set 'serving people’ as their purposeful goal rather than the opposite, it could be possible to imagine a future in which thrifty inclinations endow citizens with the sense of autonomy, self-reliance and confidence essential to re-attaining healthy and resilient financial positions.
Read the other blogs in the series here, here, here, here, here, and here.
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