Household Debt is Up. What does that Mean for Financial Stability?

Author(s): Central Bank Of Barbados

Created 16 Oct, 2020
Tags Financial Stability Report
Categories General Press Release
Views: 495

Barbadians’ household debt has increased by more than 220 percent in just over 20 years, moving from $1.9 billion in December 2000 to $6.1 billion in March 2020. This is according to an article in the recently-released 2019 Financial Stability Report, an annual analysis of the health of Barbados’ financial system that is published jointly by Central Bank of Barbados and the Financial Services Commission (FSC).

The article focused solely on the debt Barbadians have at deposit taking financial institutions (DTIs) – commercial banks, trust and finance companies, and credit unions – and did not include money owed to retailers that offer hire purchase or to other types of lenders.

At its current level, household debt, also referred to as personal sector debt, accounts for about 55 percent of the debt owed to these financial institutions. It is also the equivalent of 58 percent of Barbados’ GDP (gross domestic product – a calculation of the value of goods and services produced by residents of an economy in a given period). It notes though, that this percentage is slightly lower than the average household debt-to-GDP ratio for the sample of medium- to high-income countries analysed in the study.

And while many of us would assume that people who take out loans only do so because they cannot afford to buy the item without them, the article reveals two additional reasons people borrow: they do not want to cut back on their current spending to cover the new expense, or they prefer to take out a loan rather than dip into their savings.

But even understanding why people borrow, the question remains, what is the money used for?

Breaking Down Household Debt

The authors divided household debt into three categories: mortgages, consumer loans and credit card debt. The largest percentage of household debt is from mortgages, which on average account for 58 percent of the total value of all loans to individuals in recent years. The trend of mortgages taking up the lion’s share of debt goes back to 2007, which the article says corresponds with an increase in the cost of property.

The second category is consumer loans – loans Barbadians’ take out to purchase vehicles, do repairs, and for other general uses. These account for over a third of household debt.

The third source of debt is credit cards. While we tend to think of credit cards as simply another payment option, they differ from cash and debit cards because they are in fact short-term loans. Credit card debt as at March 2020 totalled approximately $295 million.

The Flipside: Savings

Interestingly, even with the increase in household debt, Barbadians are actually net savers, with deposits at financial institutions topping $7.2 billion at the end of March 2020, an increase of more than $1 billion from the same period in 2012. The bulk of this money is held in transferable deposits – savings accounts that holders can withdraw from at any time.

The article suggests, however, that despite Barbadians collectively having more money in financial institutions than they owe to them, it is not likely that the people who are saving are the same ones who are borrowing.

Should We Be Concerned?

While the article says that the increase in personal debt is not in itself cause for alarm, it also notes that “the fallout from the subprime mortgage crisis of 2007 highlighted the potential risks households can pose to the financial system and the economy,” and as such, “the level of the debt warrants close attention given the shocks that can adversely affect household incomes.” This is particularly true in light of the economic fallout Barbados and Barbadian households are experiencing from the COVID-19 pandemic.

One effect has been the major increase in unemployment, which could result in more people being unable to make payments on the debt they owe, leading to an increase in what financial institutions call non-performing loans (NPLs).

The NPL ratio for household debt peaked in 2014 and then declined, but it began to increase once more during 2019, and at the end of March 2020, reached 8.3 percent, higher than the ratio for total borrowers. Mortgages make up almost two thirds of household NPLs.

Should a significant number of households struggle or be unable to repay their loans, for example due to a sustained increase in unemployment, it could have implications for the soundness of the financial institutions that they owe. It could also increase the length of a recession, as being able to have the economy performing well depends on Barbadians having money to investment and spend on goods and services.

At the moment, Barbados’ financial institutions are sound, but the article stresses the need to be vigilant:

“From a policy perspective, the growth rate of credit to the personal sector does not fall within the range considered to be problematic, but a sharp decline in household income might pose immense challenges for both DTIs and households.”

Copyright 2020 by Central Bank of Barbados