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Wednesday, 28 June 2017

Bank of England on risks of car finance crash

The Bank of England publishes its Financial Stability Report every six months. The June 2017 edition has just come out, and in it there is a very interesting and somewhat worrying analysis of the car finance market (starting on the page numbered 18 in the linked document, which is the relevant chapter of a prohibitively extensive publication).

What sounds worrying is that there is so much PCP finance around these days. Back in the days when dealership car finance was all about standard hire-purchase agreements, things would have looked better, but Personal Credit Purchase schemes - although they are a form of hire purchase - are different. The cost to the consumer is kept down by fixing a value for the car at the end of the loan period (the car being the subject of the loan, not money). When the term finishes, of course, the consumer can choose to make a balloon payment and take ownership of the car, or hand it back: and if the used car market is weak at that point, then first of all the consumer will prefer not to make the payment because it will be on the high side compared with what the car is worth, and secondly the dealer won't be delighted to get the car back in satisfaction of the credit agreement because it won't be worth enough to wash its face.

Although dealership finance has gone up by some 20 per cent a year since 2012, increasing by £30 billion over that period, it still accounts for a relatively small part of banks' lending. So although 85 per cent of car sales use dealership finance, mostly PCP, the Bank estimates that even a 30 per cent shortfall in residual values would have relatively little impact on banks' capital ratios. In addition, car finance being secured on the car is inherently less risky than other types of consumer finance, so the sector should be pretty stable - and the Bank acknowledges that arrears are less of a problem in motor finance than other areas. Of course they are - the finance company takes the car back if the arrears get too high.

But it strikes me that the same might have been said of mortgage lending before 2008. And we live in times which are, to say the least, uncertain.

Postscript: today (30 June) Bloomberg highlights the growth in vehicle finance in Europe, remarking that the continent is heading down the road already taken by the US. Explaining how securitisation deals - finance companies selling off their consumer debt - are to a large extent based on residual values, the Bloomberg piece makes me wonder about the BoE's assessment that even a substantial fall in the used car market would have little effect on banks' capital ratios. Perhaps the point is that it's not the impact on capital ratios that we should be worried about.

Also, a day earlier, the Telegraph reported that the FCA had been consulting with US authorities to gain a better understanding of the emerging problems, given the fact that the Americans have more experience of the impact of this type of secured lending in the automotive sector.

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