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UK personal bankruptcies: a further headache for lenders

14th November 2005

The last few years have witnessed a marked increase in the number of personal insolvencies. Increases in consumer debt, the change in bankruptcy law made effective in April 2004 and a gradual change in attitudes towards debt have played key roles. With lenders already worrying over increased arrears and defaults on unsecured borrowing, the rise in insolvencies will provide little reassurance.

An alarming increase in the number of personal insolvencies has been seen in recent years. In the third quarter of 2005, recent figures from the Department of Trade and Industry showed there were 17,562 individual insolvencies, a 12% increase on the previous quarter and a 46% increase on the same period last year.

Many believe that the growing trend for unsecured lending has brought an increase in personal insolvencies. The higher level of unsecured debt for households has indeed coincided with a rapid increase in personal insolvencies: such unsecured debt has increased households' vulnerability to income shocks, such as a loss of employment, and therefore augmented the probability of individuals pursuing insolvency procedures when such a shock occurs.

Yet individuals' inability to manage their debt is not the only reason for the rise in insolvencies. As part of the 2002 Enterprise Act, the government enacted changes in bankruptcy law that became effective from April last year. While the changes in law were supposed to help failed entrepreneurs get back on their feet quickly if their business collapsed, it has actually meant that it is far easier for individual consumers to declare bankruptcy - as the new rules allow people to have their debts discharged after one year rather than three. Indeed, in the late 1990s, 60% of all bankruptcies concerned a failed business. Now, 60% are caused by consumer debt.

Even more importantly, there is concern that the increase in insolvencies could be symptomatic of a reduced commitment to repay debt, particularly among younger people.

While lenders are already worrying that an economic recession could spark additional arrears and defaults on unsecured borrowing, the rise in insolvencies is one more trend to worry over. Each additional insolvency means one more bad debt on a lender's unsecured portfolio, and one more debt whereby lenders will most likely not recover the full amount.

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