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Higher U.K. Car-Finance Defaults Add to Consumer-Credit Risk

Updated on
  • FCA says increase is driven by buyers with lower credit scores
  • Personal contract purchase deals have helped fuel growth

Default rates in the U.K. car-finance market are creeping up, adding to regulators’ concerns over the risks posed by consumer credit.

The Financial Conduct Authority said on Thursday that the increase is driven by buyers with elevated credit risk, despite low interest rates and economic growth. These consumers account for about 3 percent of lending, the FCA said in a report. Overall, arrears and default rates remain low.

British regulators are grappling with a surge in consumer credit, led by motor finance, which can pose risks to banks and the economy. The Bank of England estimated last year that dealership car finance had grown at an average rate of about 20 percent a year since 2012, an increase of more than 30 billion pounds ($42 billion).

The surge in car finance has been driven by the popularity of personal contract purchase, or PCP, deals, whereby consumers pay a deposit and make monthly payments over an agreed period. At the end of the contract, the consumer returns the car or buys it at a price fixed at the start of the deal. Lenders stand to lose if the car is returned at the end of the contract and its second-hand value is lower than that initially agreed with the customer.

Read more: Car Loan Boom Led by Lloyds Stokes Loss Fears as Sales Dip

“A small shock can be absorbed very well by everybody, but there is the potential for it to be worse or massively worse” said Philip Rush, chief economist at Heteronomics in London. “There is risk of complacency.”

The FCA said the firms it supervises are adequately managing these risks, and the “financial impact of such a fall wouldn’t materially affect their overall financial soundness.”

That’s in line with an assessment by the BOE’s Prudential Regulation Authority, which found lenders are taking a “prudent” approach, though they may be under-estimating the potential for “structural changes” related to the diesel market, which could cause prices to change.

The impairment charge at the U.K. motor-finance division at Lloyds Banking Group Plc, the lender with one of the biggest exposures to the British car market, rose 48 percent last year to 111 million pounds, driven by loan growth and provisions for residual value risks, the lender said in its annual report. Signs of stress in the market were also seen at MotoNovo, the U.K. vehicle funding arm of the South African bank FirstRand Ltd., where nonperforming loan provisions increased by 29 percent.

The FCA said that some commission arrangements “could incentivize dealers to arrange more expensive finance for customers,” and that in some cases consumers aren’t getting “key information in an accessible manner.”

(Updates with detail from FCA report in last paragraph.)
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