Households borrow primarily to pay for large items of expenditure such as houses and cars. The amount they can borrow is normally linked to their income because this is what they are likely to use to pay the interest on any loan and repay the principal. The ratio of household borrowings to household income is therefore often taken as an indicator of household indebtedness. Often, a high ratio is viewed as a ‘bad thing’ – a sign of possible reckless borrowing. [Though if it is, it is also possibly a sign of reckless lending.]
But it need not be. One of the main functions of financial institutions is to act as financial intermediaries – that is, broadly, to borrow funds from one group and lend them to another. Their particular skill is, or should be, to know where the borrowed funds can be safely but profitably lent. Without them, since individuals with funds to lend have only limited knowledge of – or time to find out about – available opportunities, lending and borrowing would be at a much lower level. And this would be to the disadvantage of both the lender and the borrower. Of course it is possible that individuals or firms or governments can borrow too much and, as the financial crisis has shown, financial institutions can lend carelessly and recklessly. But the existence of a high ratio of household debt to income is by no means necessarily an unhealthy sign – it could be the sign of a financial sector that is efficiently channelling funds from lenders to borrowers. And, of course, households as a group also hold financial assets.
In the UK, mortgages make up the bulk of UK household debt; the major financial assets are bank deposits, shares and insurance and pension policies. The graph shows that, whilst the net financial position of UK households and NPISHs deteriorated from 2000 to 2008, holdings of this group’s financial assets as a whole were always at least twice their liabilities. [NPISHs are non-profit institutions serving households which are not mainly financed or controlled by the government and which provide goods or services to households which are free or at economically insignificant prices. Examples are churches and religious societies, sports and other clubs, and trade unions.] However, this is not quite as re-assuring as it might seem: the households who hold the assets are not the same households as those who have the liabilities; the asset holders tend to be disproportionately the older households and, of course, the better off.