Predicting financial distress – the debt to income ratio

The FCA is considering whether changes are required to the creditworthiness and affordability rules in the Consumer Credit Sourcebook (CONC).

On 3 August 2016 the FCA published an Occasional Paper for discussion purposes entitled 'Can we predict which consumer credit users will suffer financial distress?'

Estimating the volume of financial distress

Financial distress occurs when people face difficulties (financial and non-financial) repaying their debts. This may be assessed objectively and subjectively.

The research found that 26% of people in Great Britain hold outstanding debt on a consumer credit product. 2% of those people could be objectively classed as being in financial distress because they are two or more payments in arrears on one product.

By contrast, the research found that 34% of people with outstanding consumer credit debt regarded keeping up with their repayments to be somewhat of a burden.

When these subjective and objective measures were combined, the research found that 17% of people with outstanding consumer credit debt (approximately 2.2 million) were in moderate or severe financial distress.

The research showed that those in financial distress tend to be younger, with lower income, less likely to be employed and have higher a debt-to-income ratio than people who have consumer credit debt but are not in financial distress.

Predictors of financial distress

The research then considers whether financial distress may be predicted for individuals with certain characteristics. The predictors used are:

•               the number of consumer credit products held

•               the total value of outstanding consumer credit debt

•               the level of individual and household income

•               debt-to-income ratio

The research finds that debt-to-income ratios may be a strong predictor of future financial distress whereas other predictors do not improve the ability to predict financial distress.

Additionally, the research identifies a correlation between debt-to-income ratio and type of consumer credit product at predicting financial distress. Borrowers with debts largely composed of high cost short term products are at a greater risk of experiencing financial distress than lower cost products.

The paper concludes that, while it is not possible to determine which individuals will suffer financial distress, firms could consider whether cohorts with certain characteristics are particularly vulnerable to financial distress and so whether lending to those cohorts may be predictably unaffordable. As a result, the paper suggests that firms' affordability policies should be tailored to particular products and to applicants' circumstances, especially their debt-to-income ratio.

See the Occasional Paper here.


Under CONC, firms are required to carry out a creditworthiness and affordability assessment before lending to customers. In performing this assessment firms should already consider whether customers will be able to meet their repayments in a "sustainable" manner.

We will have to see whether the FCA considers further changes are required in light of this paper.

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