New insolvency rules are having a salutary effect on many lenders

Published on Friday 22 August 2008 23:11

LENDERS' balance sheets are likely to take a further hammering in the months ahead as low-income debtors take advantage of the ability to petition for their own bankruptcy and crystallise their financial position.

Prior to 1 April 2008, insolvency law in Scotland revolved around the need to involve creditors. Third parties seeking to collect outstanding debt were the catalyst for insolvency proceedings taken against individuals, who until this year had been able to petition for bankruptcy on their own behalf only in limited circumstances.

The logic behind the legislation was that individuals should not be able to seek their own bankruptcy as an easy way of writing off their debts. However, the unintended consequence was that many individuals found themselves in a financial hinterland where servicing their debt ate up every penny of their income, without the debts ever being large enough for creditors to instigate insolvency proceedings.

In effect, this meant that those low-income debtors remained shackled to never-ending payments, while creditors never saw the return of the capital they had originally lent.

Now that individuals who meet the low-income, low-asset (LILA) criteria can petition for their own bankruptcy, many of the debts they hold with commercial lenders will be seen for the bad debts they are.

According to figures recently published by Accountant in Bankruptcy – which administers the process of personal bankruptcy in Scotland – the total number of Scottish insolvencies during the first quarter of 2008 was up by over 78 per cent on the corresponding quarter in 2007.

This huge jump was down to the 1,709 awards that were made in relation to LILA petitions and, with another 725 acknowledged to be in the pipeline for the next quarter, it is fair to assume that LILA insolvencies are going to have a significant effect in the months ahead.

Insolvency is never the desired outcome for any individual's financial plight, but at least the new legislation will introduce a degree of transparency.

By crystallising the position of low-income debtors, those that have been successful in petitioning for bankruptcy can begin rebuilding their financial position. This will also shake out the loans from lenders' figures that would never have been repaid and mean their default numbers are a truer representation of how their business is performing.

Unfortunately this jump in bankruptcies comes at a time when the slowdown in the economy, rising inflation and the restricted access to borrowing is beginning to bite deep into consumers' pockets. While many people across Scotland have balked at the prices they are now paying at petrol pumps and supermarket tills, it will take time for this to push them into the financial mire.

Headlines have raged over the increases being fed through by energy companies and again this is something that does not have an immediate impact. Only when the next quarterly bill comes through the door will problems come home to roost.

Mortgage borrowers also continue to struggle to find rates that are comparable to the deals they took out over the last two years and which are now coming to an end. For many, meeting bigger monthly payments is going to be incredibly difficult if not impossible.

While the LILA changes to insolvency law may have crystallised the position for those trapped by their debt, the issues in the wider economy are going to create problems for people across the social and financial spectrum.

The insolvency figures for Scotland may have surged last quarter on the back of the legislative changes, but in the quarters to come it is going to be these more widespread issues pushing up the insolvency numbers.

While most people will be acutely aware of the worsening financial environment, it often takes time for people to readjust and make significant changes to their daily spending habits. In turn this means they exacerbate the potential problems they are facing.

It is never easy to sit down and take stock of exactly what comes in and what goes out each month, and looking at where savings could be made is often a depressing and upsetting task. However, such an appraisal will definitely help people keep their finances afloat and avoid many of the problems that lie ahead.

Seeking professional, independent advice on how to manage debt will also help steady the ship.

• Eileen Blackburn is a partner in French Duncan Chartered Accountants