The Payment Protection Insurance (PPI) mis-selling scandal has rumbled on for years. But how did PPI impact loan margins pre-crisis?
This post argues that income from cross-selling PPI substantially offset lenders’ margins on personal loans between 2004 and 2009, and compares the pre-crisis PPI-adjusted margin to loan spreads today.
PPI is insurance attached to loans to protect consumers if they are unable to earn income to make repayments. But PPI was commonly mis-sold. It was used by lenders to reduce risk of non-repayment, but also as an additional source of loan-related income.
Both effects meant banks could charge lower interest rates on loans with PPI. So personal loan spreads (the headline rate charged to the customer less the rate at which the lender accesses funds) appear artificially low until lenders effectively stopped cross-selling PPI in 2010.
Estimates from a Competition Commission report and FCA data suggest that half of personal loans had PPI in 2004. The report suggests that the addition of PPI was roughly equivalent to doubling the interest rate on these loans. Most of this additional premium was profit to the lender (after costs of providing the policy). So if lenders had not offered PPI, personal loan spreads would have had to be significantly higher to make the same margin.
If we adjust loan spreads to incorporate this additional PPI income, then it suggests an uplift of about 60% pre-crisis. Abstracting from potential differences in risk, personal loan spreads today are similar to pre-crisis PPI-adjusted levels.
Chart: Personal loan spreads – difference between effective personal loan rate and two-year swap rate (also seen here)
David Seaward works in the Bank’s Macro-financial risk Division.
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