Will the Edinburgh Reforms help to boost UK consumer spending?

In late 2022, the Chancellor announced a package of regulatory initiatives for the UK’s financial sector. How the so-called Edinburgh Reforms will affect consumer spending – and the country’s economic performance more broadly – is uncertain. But a ‘turbocharging’ of economic growth seems unlikely.

For the first time since the global financial crisis of 2007-09, it appears that the UK government once again sees financial services as a source of economic growth. This was the core message of the Chancellor’s recently announced Edinburgh reforms of financial regulation in the UK.

Under these reforms, the industry regulator, the Financial Conduct Authority (FCA), will receive a ‘secondary objective’ to promote growth. If this initiative is to succeed, it will need to reinvigorate growth in consumer spending. Consumption (usually defined as people paying for goods and services) is the largest single component of GDP in the UK – and yet, over the past decade, it has grown only very weakly.

What is happening with consumer spending and debt in the UK?

Prior to the global financial crisis, the UK economy had strong consumer spending growth, a low saving rate and steady increases in household debt in order to finance all that spending.

A series of UK-centric, market-facing reforms spurred consumer spending. These included the windfalls from demutualisation (where a private, member-owned company, such as a co-op, legally changes its structure to become a publicly traded company owned by shareholders) and easier credit from banks, as well as ‘right-to-buy’, giving millions of households the ability to own homes at a discount against which they could then borrow using ever more flexible mortgage products. Low global interest rates spurred growth in the value of houses and shares, increasing household wealth and further stimulating consumption.

But the past decade or more has been characterised by the opposite for the UK consumer: weak consumer spending growth, a higher savings rate and caution in the mortgage and unsecured credit markets.

UK consumers have moderated their spending and, notably, reduced their debts. According to the Bank for International Settlements (BIS), UK household debt peaked in 2008 at 108% of GDP, and has since fall back to 84% (see Figure 1). UK household debt is lower today than in Denmark, the Netherlands, Norway and Sweden. In the wake of the Covid-19 pandemic, UK consumers remain cautious in their spending behaviour, with the recovery in consumer spending lagging behind international comparators.

Figure 1: UK household debt

Source: Bank of International Statements (BIS)

Did regulation cause a fall in consumer spending growth?

Opinion is divided on the cause of this decade of sluggish consumer spending growth. Some argue that it was caused by overly prudent regulation of consumer lending. The regulatory regime introduced with the creation of the FCA in 2014 has steered mortgage and unsecured credit lenders towards more cautious lending rules, curtailing riskier lending.

Mortgage lenders are now less willing to lend at high loan-to-value ratios, and affordability checks only allow lending at rates of repayment that consumers can afford in their household budgets with headroom to spare. Payday loans, doorstep lending and home-collected credit have all seen regulatory action, effectively removing these markets for sub-prime unsecured consumer lending altogether.

The Edinburgh Reforms could remove much of this regulation, allowing consumers to increase and putting a rocket under consumer spending – in the words of the Chancellor, to ‘turbocharge’ growth.

Mortgage lenders could be asked to revert back to evaluating only creditworthiness (whether or not the mortgage holder will repay), and not evaluating affordability (whether they can afford to repay and still feed their children and pay council tax). Loan-to-value ratios could be allowed to creep back upwards towards 100%.

Would re-regulation really ‘turbocharge’ consumer spending?

The premise of this regulatory reform agenda is that consumers would react to deregulation by taking up new opportunities to borrow. But household survey data indicate that over the past decade, the UK consumer’s appetite for debt-fuelled spending may have waned.

According to the Bank of England’s annual survey of household finances, over the last decade the proportion of consumers who state they have been put off spending due to lack of access to credit has actually fallen (see Figure 2).

Figure 2: Attitudes towards spending and credit

Source: Bank of England

Why has this happened? A somewhat bleak (but possibly the most accurate) interpretation of this lack of desire to borrow in order to spend is that UK consumers do not wish to borrow because they are less confident in their future incomes.

UK consumer confidence is at an all-time low. Today’s borrowing to finance consumer spending is tomorrow’s debt to repay, and if tomorrow doesn’t look so rosy due to high inflation, declining real wages, higher interest rates, weak productivity growth and declining international competitiveness, then consumers might take a more cautious approach.

The economic confidence of the 1990s and early 2000s in the promise of technology and globalisation to deliver a high-skilled, high-wage economy seem distant to consumers facing global inflation shocks and geopolitical turbulence.

Where does this leave the Edinburgh Reforms? In short, they are unlikely to create a renaissance for the great British consumer, leaving the FCA with the challenge of designing effective interventions that will promote growth.

We may see waves of rollback in lending regulations, and fintech innovations creating new forms of credit, only for UK consumers to shy away and continue saving for an uncertain future. Only when households see a brighter economic future with real wage growth and better long-term prospects for the economy are we likely to see a recovery in the growth of consumer spending.