Saturday, 13 May 2017

The Automobile Finance Bubble: A Relatively Small Problem That Keeps Getting Bigger

Today’s post looks at the recent news that the value of finance deals for the purchasing of cars in the U.K. set a new monthly record in March, concluding at an increased rate of 13% over March 2016, totalling over £3.6 billion in March 2017 alone. We have discussed the issue of the automobile (car) finance bubble growing before here in Financial Regulation Matters, but the nature of the consistent growth means it is worth assessing the situation again because, ultimately, what looked like a relatively small ‘bubble’ is increasingly appearing to resemble much larger bubbles that have burst before, with catastrophic effects. Whilst the bursting of the car finance bubble may not grind the economy to a screeching halt, it will have a detrimental effect upon a global economy that is still recovering from the onslaught of 2007/08. So, in light of this, this post will assess some of the important aspects that are continuing to be prevalent, whilst also assessing the potential for the introduction of a certain variable that could expand this bubble to a size that few had imagined.

The Bank of England (BoE) and the Financial Conduct Authority (FCA) have already raised concerns about the growth of lending within the car finance industry. In April the BoE declared its unease at the rate of growth within the consumer credit market, which reached a growth rate of 10.9% late in 2016 which represented the largest rate of expansion since 2005. Currently, the FCA is investigating a number of car deals and their sponsors, because of a fear regarding a ‘lack of transparency, potential conflicts of interest and irresponsible lending in the motor finance industry’, to which the head of motor finance at the Finance & Leasing Association, Adrian Dally, responded ‘lending is responsible. This is a sustainable model going forwards’. In addition to this, some economists have sought to dampen down fears by affirming that because motorists, under the terms of the oft-used ‘personal contract purchases’ (PCPs) – a system whereby motorists effectively repay an interest-only loan that covers the car’s depreciation and then roll-over onto a new contract at the conclusion, thus developing a cycle of debt if the car is not purchased at the end of the contract -, can return their cars if they cannot afford repayments, there is actually little systemic risk because the risk is carried by the manufacturers and financing vehicles. This claim is somewhat accurate, but there are variants to the viewpoint to consider. Firstly, a customer can return their car because they cannot afford the repayments, but only after they have paid over 50% of the Total Amount Payable (not the total amount borrowed), as determined by the Consumer Credit Act 1974. Also, the fear of negatively affecting one’s credit score is removed because although the ‘voluntary termination’ must be recorded on your credit score, the reason for doing so is not, and there are a multitude of reasons why a Voluntary Termination may be initiated.

Whilst these technical issues may allay fears, the potential of external forces affecting the situation do not. There are fears that an economic downturn could cause the record numbers of people who have purchased cars via finance deals to renege on their financial agreements (even before the 50% threshold is reached). This is based, mostly, on the persistent suspicion that reckless lending lays behind this boom, which is precisely the reason for the regulators’ investigations into such practices. Whilst, technically, the opportunity to remove oneself from the financing deal does exist, the many variants of financing deals, when combined with the understanding that financial education is worryingly lacking in society (as already discussed in Financial Regulation Matters), means that many customers do not know their rights or the acute details of the deals they have entered into; for this reason, some have begun to construct an obvious link between this current bubble and the massive Payment Protection Insurance (PPI) scandal that engulfed the financial sector a number of years ago. Also, to relate the issue back to the one of systemic risk, some onlookers have rightly noted that the leading financial institutions all have connections to this area of finance, with one example put forward being Lloyds Bank that, through its Black Horse brand, is the biggest provider of car loans outside of the manufacturers themselvesthere is a systemic risk.

However, there is a much more worrying factor with regards to systemic risk. While there is a lot of focus on the situation in the U.K. and the U.S., there realisation of the same opportunity in China is, arguably, of the most concern. It was suggested recently that the perception of borrowing amongst the young in China is different from China’s older generations, which Chinese financiers are suggesting ‘offers a great opportunity for e-commerce automotive transaction platforms’ to develop, based on the fact that only 35% of car transactions in China last year involved financing. The numbers that are coming out of China currently – one company recently floated $294 million worth of asset-backed securities on the Chinese market – will not cause much concern now. However, with China recently reporting having 240 million car owners last year – a record -, there is an obvious opportunity for a rapid acceleration in finance deals and that alone should concern us all. Such an expansive marketplace will be music to the ears of international investors, and particular to the ears of international financing vehicles that will compete to provide the financing to meet the massive demand – whether China allows that to happen is another story entirely, but the capacity to fuel the bubble certainly exists.


Ultimately, regulators must seek to root out cases of mis-selling or unscrupulous practices before it is too late. Yes the bubble will not grow to the size of the housing bubble that exploded and wreaked havoc upon society in 2007/08, but that is beside the point. The proximity to the last explosion makes this bubble all the more dangerous, because a massive tremor to this fragile economy could be just as dramatic. The potential entrance of hundreds of millions of Chinese consumers to the bubble means that regulators must do whatever is necessary to uncover poor practices and, potentially, seek to educate people as to the dangers of borrowing in this environment based upon a shaky foundation. However, that will take a lot of time and resources and, regrettably, it is likely that the bubble would have burst before those type of socially positive endeavours are even considered. 

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