British banks will sell £9 billion of bad consumer debt to debt collectors this year in an effort to free up capital on their balance sheets.

Meanwhile, investment banks are expected to join the market for impaired credit with renewed enthusiasm as they seek to replace the income lost from the collapse of sub-prime mortgages in the United States.

TDX Group, which acts as a bad debt broker on the banks' behalf, calculated that banks sold about £7.4 billion of underperforming debt, such as unpaid credit card bills and personal loans, last year. The market has ballooned in the past three years - in 2004, only £2 billion of loans passed into debt collectors' hands.

Mark Onyett, the chief executive of TDX, expects the market to grow by a further 25 per cent this year as banks continue to feel a squeeze on capital. Under accounting rules, banks must make provisions for bad debts, which eats up cash that could be used on profitable lines of business. In a credit-constrained world, it is better to move the debt off your balance sheet and free up the capital, Mr Onyett said.

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Debt collectors are also expecting a boom year. Ken Maynard, chief executive of Cabot Financial, which buys multimillion-pound packages of debt from banks, said that $2.5 billion (£1.28 billion) of debt came up for sale in the first quarter. “It was the busiest first quarter we've ever seen,” he said.

Most banks reported increased bad debt provisions in their full-year 2007 results. Mr Maynard expected to see these impaired loans come up for sale in about six months. “There's a lot of bad debt rolling through,” he said.

The debt packages are typically about £500,000 to £2.5 million in size. TDX cuts the unsecured loans into different tranches, including “gone-away debts”, where the borrower has no forwarding address, and “international”, where the borrower has moved overseas after running up debts. Debt collectors, such as Cabot Financial, pay anything from 3 per cent to 20 per cent of the face value of the debt to secure their preferred tranches.

The amount of discount offered on the face value depends on the age of the debt and perceived difficulty of recovery. Mr Onyett said that most banks sold their debts after trying for at least a year to recover the cash. Mr Maynard said that banks increasingly were selling “fresh” debt of six months' impairment, or less.

“Capital adequacy rules under Basle II have made some banks think harder and longer about holding this debt on their balance sheets,” he said. Debt collectors will usually wait up to five years to collect on their investment. Investments banks are taking an increasing interest in the purchase of unsecured consumer debt, according to TDX's research, either through direct acquisitions of debt packages, or by backing debt collectors.

Mr Onyett said: “Instead of investing in a collateralised debt obligation connected by several layers to a debt in the US, they can see exactly what they're buying in the unsecured market.” Deutsche Bank, Lehman Brothers and Goldman Sachs are known to have played in the unsecured consumer loan market in the past.

Mr Maynard said that banks were concerned about their brand being damaged by overzealous collectors. However, he said that only a small proportion of debts required a visit from a bailiff. “If you approach it in a certain way, you can get money from people where they haven't been willing to pay up in the past,” he said. “You just have to be patient.”

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