LONDON (Reuters) -The Bank of England wrote to lenders on Friday to urge them not to underestimate the risk of loan defaults as higher inflation and increased interest rates hit more vulnerable borrowers.
In a letter to chief financial officers at financial institutions supervised by the BoE, which it published online, the central bank also warned them not to overestimate how much money they would recover when borrowers defaulted on loans.
"We encourage further efforts by firms to challenge whether models capture risks associated with affordability, including the impact of higher inflation and interest rates on vulnerable borrowers or sectors," Victoria Saporta, the BoE's executive director for prudential policy, wrote.
England and Wales saw the highest number of company insolvencies since 2009 during the second quarter of this year, and earlier this month administrators of failed homeware retailer Wilko said all its remaining stores would close by next month, with the loss of thousands of jobs.
Personal bankruptcies and related debt-relief measures largely remain below pre-pandemic levels, and the BoE has previously stressed that overall indebtedness remains below the rates seen before the 2008 financial crisis.
However, in its letter to lenders, the BoE said they needed to look beyond aggregate risks and should identify whether particular types of borrower had specific vulnerabilities.
Banks, for example, could look at spending patterns in their customers' current accounts and whether they had fixed-rate mortgages which would soon need to be refinanced at higher rates, the BoE suggested.
It said for business lending, banks should not rely on a broad sector-based approach to risk and instead should in some cases consider specific companies' liquidity risks.