Motor finance – The first major regulatory review in the credit sector
People buy, generally, on emotion! Never can this be truer than when it comes to choosing a car, new or used, we know what we want and usually if we think we can afford it, we go out and get it.
Motor finance has for years been perceived as being at the lower end of the risk spectrum within the financial services market. Two things have changed this outlook. Firstly, the growth, as reported by the Bank of England’s financial stability report, in the number of motor finance agreements, from 1.2m in 2008 to 2.3m in 2017 – accounting for 88% of new car registrations in that year, and secondly the implementation of FCA regulation of the Credit Broking industry.
Credit Rating Agency (CRA) data, sampled by the FCA, showed that motor finance accounted for 16% of total unsecured debt for consumers in 2013 and had increased to 24% in 2016. It is these statistics that have put motor finance on the Regulator’s radar, the result of which has been a two year ‘deep dive’ into the industry itself, and the practices within it, from product providers to intermediaries and the motor dealerships themselves.
It is fair to observe that much of the initial work in the sector was driven by the Regulator’s desire to understand the influences that underpin the market, such as product design, the variety, and mechanics, of the way products were sold and distributed to consumers.
The initial findings of the review confirmed the growth of the sector and in particular personal contract purchase (PCP) arrangements. The FCA believed that the industry was adequately managing key institutional risks, such as a dramatic fall in used car valuations. It was also noted that even though arrears levels and default rates were low there had been an increase in arrears for higher credit risk borrowers.
When looking at the way in which consumers were sold motor finance, the review found inconsistencies in the relationship between interest rates charged and commission rate paid, and the way in which practices are monitored and managed by product providers. The FCA state they ‘are concerned that the way commission arrangements are operating in motor finance may be leading to consumer harm on a potentially significant scale.’
Two further issues highlighted in the review concern firstly, whether consumers are given the right kind of information about the finance product they are buying and is the information being given at the most appropriate time. Secondly, is affordability being properly assessed, particularly when the customer might be ‘higher risk’?
This type of commentary is familiar when considered in the context of other historical regulatory reviews of retail financial services, asking the rhetorical questions for customers ‘do I know what I have bought?’ and ‘is it the right product and am I paying the right price for it?’ In other words, ‘was I given suitable advice?’
In its findings the FCA has given an indication as to potential impacts the market practices it has looked at, in regard to commission models, might have on consumers by stating that a credit broker’s discretion over the interest rate could be costing customers £300m more annually when compared against a baseline of Flat Fee models.
The Regulator further estimates that on a typical motor finance agreement of £10,000, higher broker commissions under certain models can result in the customer paying around £1,100 more in interest charges over a four-year term.
It is early days in terms of gauging market reaction to the Motor Finance Review, and so far, precedents for setting outcomes from complaints are yet to emerge. Never the less lenders have been given clear direction from the Regulator as to the need to increase controls around the distribution of motor finance products to ensure commission models meet the Treating Customers Fairly principles and that adequate checks on credit worthiness are in place.
Credit brokers recommending motor finance agreements going forward will need to ensure they are being consistent in their advice and that they are fully disclosing the product particulars, and the way they are remunerated, to their clients.
What about consumers with their car loan finance? Opinion suggests that due to the ‘importance’ of the car in family life, borrowers will do all they can in distressed situations to keep their car finance up to date – which may to some extent be keeping a lid on situations where there has been a ‘mis-sale’ or a poor product recommendation. Will this situation continue as press commentary and claims management companies look to what might follow the PPI scandal?
Quantifying the scale and size of issues within the sector is difficult to estimate, but figures quoted by the Finance and Leasing Association who stated that in 2017 their members were responsible for 35% of UK Consumer Credit, and of that, £44 billion went to help households and businesses purchase cars.