Why car finance could be heading for a competition authority market study

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Under the headline ‘Drivers face car loan crackdown to avoid new financial crisis’, the Daily Telegraph reported on Saturday that regulators are looking at the need for tougher affordability tests for car loans in the UK.

The paper said it has seen figures indicating that households with “stressed” incomes are a “major force” behind the record number of car finance deals.

The value of car loans in the UK almost trebled to £31.6 billion between 2009 and 2016, according to the Finance and Leasing Association (FLA), the Telegraph reported, with nine out of 10 new cars being financed through personal contract purchase (PCP) plans.

The paper quoted Steve Baker MP, a member of the Treasury Select Committee, as saying: “It’s a terrifying prospect to think that car loans are being securitised in the way mortgages were in the run-up to the crash. Our economy may well be too dependent on cheap credit and the Bank of England should urgently explore this problem.”

The Bank of England said it could not reveal the extent of the banking system’s exposure to finance subsidiaries of car manufacturers.

This morning, the FCA said in its regulation round-up: “We are concerned that there may be a lack of transparency, potential conflicts of interest and irresponsible lending which may exist in the motor finance industry. We will conduct an exploratory piece of work to identify who uses these products and assess the sales processes, whether the products cause harm and the due diligence that firms undertake before providing motor finance.”

Car finance statistics

In its consumer car finance statistics for 2016, the FLA reported £32 billion of annual new and used consumer car finance. The 2009 equivalent was £10.8 billion. Some of the reasons for the increase include:

  • the recovery of the car market after the 2008 financial crisis
  • the shift from unsecured personal bank loans being used for cars to secured car finance
  • general price inflation (£1 in 2009 was equivalent to £1.23 in 2016 using the retail price index, although the Office of National Statistics inflation data for cars over this period shows a lower price increase of around 10%).

Around 1.2 million cars were financed by consumers in 2009 (500,000 new and 700,000 used) compared to 2.3 million in 2016 (1 million new, 1.3 million used).

The number of cars financed therefore roughly doubled, but the value tripled. General price inflation explains part of this difference, and possibly the figures are not 100% comparable. Even so, it appears the values being financed have increased quite a lot faster than the number of cars.

Possible reasons for that include lower deposits and higher (and more expensive) optional extras.

Role of subsidised PCP

Much of the increase in car PCP plans has been on the back of subsidised, including 0%, finance deals.

The British Veicle Rental and Leasing Association explained this in an interview with the BBC in 2015. It said that two things have driven the increase in PCP.

First, the banking crisis forced manufacturers to find new ways to stimulate car sales.

Second, the availability of very cheap finance, courtesy of the Bank of England’s policy of keeping interest rates very low.

The BVRLA’s Toby Poston was quoted as saying: “It’s all to do with the availability of cheap finance. These deals make cars more affordable for those who don’t have the cash or can’t take a loan… and give access to new, high quality vehicles.”

Does PCP lead to a consumer debt problem? No, the FLA’s Adrian Dally told the Guardian in February this year.

He said consumer car lending in Britain had been highly disciplined, with little evidence of loans to sub-prime borrowers. The UK was “absolutely a world leader in the quality of underwriting and minimising risk” with extremely low levels of default and impairments.

Risk factors

Since the FCA took over consumer credit regulation in 2014, the requirements for assessing affordability, together with the rules on handling arrears, have been tightened significantly.

There’s no public data for car finance, but it’s very likely that acceptance rates have decreased, and loss given default ratios increased, since the FCA took over. The “deep sub-prime” car finance sector now being talked about in the US appears to be (more or less) absent from the UK.

If there are problems with lending policies, as suggested by the Telegraph, they are almost certainly isolated ones. The FCA might be expected to deal with these by taking enforcement actions at a small number of sub-prime lenders. It might also then clarify its existing rules to help other firms.

The Prudential Regulation Authority might also review how banks are providing for expected losses on their car loans, although with new accounting and prudential rules for loan provisions already being implemented, there’s no sign of any problem in this area.

We can then expect some further interventions in the market from the FCA and PRA to address the affordability concerns raised by the Bank of England, but these seem likely to be about monitoring and (if necessary) enforcing existing regulation rather than making affordability checks ‘tougher’.

Moving to securitisation of car loans, PCP does create residual value risks for car manufacturers, but this risk isn’t necessarily transferred to investors. A key difference from mortgage securitisations is that when car loans are sold through asset-backed securities (ABS) by finance arms of manufacturers, the car manufacturers stand behind the performance of the portfolios.

Investors, including banks, aren’t affected by either default or residual value risk unless the car manufacturer goes out of business. This explains why the cost of finance raised using ABS by the captives is so low and why there’s no need to be terrified about car loan securitisation.

How might regulators respond?

Does all this point to less of a problem than the media is suggesting – and therefore a smaller prospect of new regulatory interventions?

Whatever the reasons for the tripling of finance and the safeguards already in place, as considered above, the authorities will consider they can’t just assume growth of this scale in consumer debt can happen without any risks or actual problems.

To fully understand the effects of the tripling of car finance, it’s probably necessary for the regulators to take a wider look at the UK car market. Some questions they are likely to consider include:

  • How do manufacturers cover the costs of subsidised finance?
  • How do PCP plans work in consumers’ interests and are they being sold to consumers who will benefit?
  • How does subsidised finance affect consumers who do not qualify?
  • How does subsidised finance impact competition across the industry?
  • Do consumers have sufficient choice of finance providers?

The FCA has powers to investigate competition issues for financial services markets, but it seems likely that a wider review of car selling would be a job for the Competition and Markets Authority (CMA), the successor body to the Competition Commission.

CMA investigations are anything but fast and Brexit would obviously add extra complexity. However given the Bank of England’s concerns – and the apparent lack of logical options open to the FCA and PRA – a referral by the FCA to the CMA for an initial market study (a first stage review that could be followed by a market investigation) this year is looking increasing likely.

Julian Rose is director of consultancy Asset Finance Policy ( and runs the Asset Finance 500 directory of asset finance brokers ( He prepares the annual AF50, the UK’s most influential annual survey of business and equipment lessors, and is the author of the newly published A to Z of Leasing and Asset Finance.