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Since the debts are discharged through the bankruptcy, the bankrupt individuals will have improved balance sheets and increased disposable incomes. As a result of their improved balance sheet and increased disposable income, bankruptcy filers may reduce their credit demand in the short run, but as they are able to access credit at a lower cost, they can increase their credit demand in the long run. This immediate effect, ceteris paribus, is likely to be larger for ‘fresh starters’ than ‘income gleaners’ because the unsecured debts of fresh starters are discharged, while ‘income gleaners’ continue to repay some of their debts for a longer payment schedule.

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On the other hand, an improved balance sheet makes borrowers are more creditworthy to lenders. However, a bankruptcy flag on the credit report also signals to lenders that the borrowers may be the risky type and thus more likely to default again compared with non-bankrupts with similar balance sheets. Therefore, lenders may reduce their lending to these borrowers or lend at an increased cost.

It is reasonable to expect a decreased post-bankruptcy credit demand and credit supply in the short run, but both credit demand and credit supply recover in the long run. Moreover, it is reasonable to expect that this process is slower for income gleaners than fresh starters since income gleaners continue to pay their debts for a longer time.

3.3

Literature Review

Access to credit is generally considered as a financial necessity, but the ability of individuals to access the credit varies dramatically (Demirguc-Kunt and Klapper, 2012). The inability to obtain financial products and services is termed as financial exclusion (Simpson and Buckland, 2009). Financially excluded individuals face difficulties in participating fully in everyday transactions and this can play an important role as a drag on economic and social progress (Demirguc-Kunt and Klapper, 2013).

Demirguc-Kunt and Klapper (2012) provide the first analysis of the Global Financial Inclusion (Global Findex) Database, a new set on the financial behaviour of individuals from 148 countries. They find that 50% of adults worldwide have an account at a formal financial institution, though account penetration varies widely across regions, income groups and individual characteristics. Half of adults around the world remain unbanked and the most

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commonly reported barriers are high cost, physical distance, and lack of proper documentation. They also state that these barriers to account use can be addressed by public policy.

Empirical studies find that financial exclusion can be on economic grounds such as income, wealth and employment status and non-economic grounds such as ethnicity and race (Hogarth, Anguelov and Lee, 2005; Devlin, 2005; Carbo, Gardener and Molyneux, 2007; Simpson and Buckland, 2009).

Hogarth, Anguelov and Lee (2005) explore the factors affecting bank account ownership in the US, focusing on bringing low-to-moderate income families into the financial mainstream. They use data from Survey of Consumer Finances and find that socioeconomic characteristics play an important role in access to financial institutions. Their results indicate that account ownership increased from 1995 to 1998.

Devlin (2005) analyse the financial exclusion in the UK. He uses a common model to test and compare influences on the financial exclusion for a wide range of financial services, not just bank accounts. His findings show that the most important factors affecting the financial exclusion are employment status, household income and housing tenure, closely followed by marital status, age and education level.

Similar to studies focusing on the UK and the US, Carbo, Gardener and Molyneux (2007) analyse the financial exclusion in Europe. They find that after intense deregulation and globalisation pressures within the process of completing the internal market and the development of European monetary union, the financial exclusion emerged as a major issue. They suggest that this issue should be addressed by taking the institutional context of different countries in consideration.

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In their analysis, Simpson and Buckland (2009) develop a model that identifies observable measures of credit constraint and financial exclusion and relate them to consumer characteristics. They find that the financial exclusion increases as income and wealth fall. They also find potential important links between financial literacy, formal education, asset building and financial constraint and exclusion.

The consumer bankruptcy can be considered as a determinant of financial exclusion as an economic phenomenon. The literature on the post-bankruptcy access to consumer credit can be divided into two parts as theoretical and empirical literature. Theoretical literature mostly relies on quantitative macroeconomic models, while empirical literature generally uses aggregate level or individual level data on the consumer bankruptcy to analyse the post- bankruptcy credit access.

Theoretical studies on the consumer bankruptcy mostly discuss optimal consumer bankruptcy policies. They generally have partial or general equilibrium approach in which they usually assume the existence of market exclusion after the consumer bankruptcy. Examples include Athreya (2002), Livshits, MacGee, and Tertilt (2007) and Narajabad (2012).

Athreya (2002) develops a dynamic, stochastic, general equilibrium model of personal bankruptcy to investigate the trade-off between the consumption smoothing role of bankruptcy and the interest rate and finds that the elimination of bankruptcy altogether has substantial benefits. Livshits, MacGee, and Tertilt (2007) state the consumer bankruptcy provides partial insurance against adverse event, but it also makes lifecycle smoothing more difficult by driving up the interest rates. They develop a quantitative model of consumer bankruptcy to assess this trade-off and find that persistent adverse

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events make the bankruptcy option more desirable. Narajabad (2012) analyses the relationship between the technological improvements and the consumer bankruptcy. He finds that these improvements provide lenders more accurate signals as to a borrower’s type affect bankruptcies, and also finds that this is an important channel. These studies incorporate the existence of market exclusion after the consumer bankruptcy filing in their model.

The models alleviate moral hazard problems by imposing the non- negotiable financial exclusion after bankruptcy, but debt negotiations occur and there are no legally binding restrictions on providing credit to a bankrupt. Even though the existence of an automatic exclusion in a model serves as a reasonable assumption, Athreya and Janicki (2006) state that this is a ‘commonly used but rarely justified assumption’. They argue that such exclusion is not easily supported and deserves more justification and they identify that choosing to punish the bankrupts ex-post by exclusion is a key problem, because this assumption ignores that lenders and borrowers forgo opportunities for mutually beneficial trade that exist after bankruptcy. They conclude that such an assumption is hard to justify from a theoretical perspective and should be supported by related empirical studies. Our study contributes to the literature to fill this gap in the area.

The empirical studies regarding post-bankruptcy credit access has been small due to the lack of individual level data. Earlier studies include Staten (1993), Stavins (2000) among others. Staten (1993) analyses credit reports of a random sample of 2,000 individuals and finds that consumers are able to obtain new credits one year after bankruptcy filing. He reports that 73 per cent of bankruptcy filers in the sample could access at least one line of credit within one year. On the contrary, Stavins (2000) investigates data from Survey of Consumer Finances and finds that 8.5 per cent of households in the US have

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filed for bankruptcy at some point and the bankrupt individuals are less likely to have credit cards than non-bankrupt individuals.

Furthermore, Fisher, Filer and Lyons (2000) and Musto (2004) provide evidences in support of the market exclusion. Fisher, Filer, and Lyons (2000) use a panel study of households and find that the consumptions of households have higher income sensitivity in the post-bankruptcy period than the pre- bankruptcy period, and they state that this is consistent with binding borrowing constraints in the post-bankruptcy period.

Musto (2004) uses credit bureau files to analyse the impact of the removal of the bankruptcy record from an individual’s credit record. He finds that individuals get more credit cards and credit limits are increased immediately after the removal of the bankruptcy flag, suggesting that lenders reduce the credit supply to the borrowers who have a bankruptcy flag on their credit report. He concludes that we observe boost in apparent creditworthiness, especially for the more creditworthy bankrupts, delivering a substantial increase in both credit scores and the access to credit in the short term. However, we also observe lower scores and higher delinquency than initial full- information scores predict in the long term.

Recently, Cohen-Cole, Duygan-Bump and Montoriol-Garriga (2013) use a large sample of credit reports from 2003 and 2004, and they find that the bankrupt individuals are indeed excluded from the credit markets, but this exclusion is very short lived. They report that more than 90% of bankrupt individuals receive credit shortly after filing. Individuals with good credit score before filing have reduced credit availability after bankruptcy while those with low credit score before filing receive more credit. They also find that the default

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probability on new debts increases after bankruptcy, especially for individuals with good credit score before filing.

On the contrary, Jagtiani and Li (2015) use a dataset on consumer credit find that bankrupt individuals have much reduced credit limits even though they recover their credit scores after bankruptcy, and the impact is longer than the discharge period. The data used in their study allow to distinguish between Chapter 7 and Chapter 13 bankruptcy types. They report four main findings. First, despite speedy recovery in their risk scores after bankruptcy filing, most bankrupts have much reduced and long-lasting access to credit. Second, the reduction in access to credit stems mainly from the supply side. Even though the consumer demand for credit recover significantly after bankruptcy, credit limits remain low. Third, creditors do not treat Chapter 13 (income gleaning) bankruptcy more favourably than Chapter 7 (fresh start) bankruptcy. Fourth, on average, income gleaning bankrupts end up with a slightly larger credit access than fresh start bankrupts because they are able to maintain more of their old credit before the bankruptcy filing.

Due to the lack of suitable individual level data, the literature on the consumer bankruptcy specifically devoted to the UK is limited. There is a growing literature on the credit market exclusion in the UK, but the existing studies mostly focus on the exclusions based on the non-economic grounds. For example, in a recent article, Deku, Kara and Molyneux (2015) use data from the Living Cost and Food Survey and investigate household access to consumer credit in the UK between 2001 and 2009. They find that non-white households are less likely to access to consumer credit than white households. They also find that even if non-white households have access to credit, the intensity of credit access is lower than that of white households.

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It seems that there is no empirical study on the credit access after consumer bankruptcy in the UK, a gap this study hopes to fill. This study investigates the access to consumer credit after bankruptcy using individual level longitudinal data from representative households in Great Britain in order to fill this gap in this research area.