Are we really aware of the downside?

Director & Head of Retail Banking, 
American Express Bank Limited

Feb 14 - 20, 2005



Consumer Auto Financing/Leasing is normally the first product on the menu of the any bank venturing into consumer banking. For the financial institutions, it seems for now that Consumer Auto Financing is a win-win situation primarily on the pretext that the vehicle can be repossessed and sold, and always end up making money, it is insured and if stolen or damaged the financial institution gets the claim, no money lost, and therefore the financial spreads at least at the planning stage are attractive.

In Pakistan, historically, financial institutions have done well in Consumer Auto Financing, at least as a perception.

Now with new Prudential Regulations of SBP on Consumer Banking is in place and following structured reporting of the consumer portfolio mandatory for the banks, we will have a clearer state of affairs of the consumer finance portfolios of the financial institutions in the coming years. The purpose of my article is not to discourage the financial institutions from financing of autos, but it is to refresh that there is lot more to this product than just the upsides, I have stated above.

At present, the Unique Selling Preposition (USP) for the majority of the financial institutions are the rate/price they offer to the client. Is the rate/price war needed or justified? This war might have started due to the fear of loosing the market share, low credit demand/volumes and comparative spreads from the conventional corporate sector in the recent past. In auto consumer lending where average net financing per customer is approximately Rs500,000 an upward variation in the pricing by 3% over a 3 years payback period will increase the monthly installment/rental by approximately Rs715 a 5% variation will have an impact of Rs1,200. A compromise or casual approach towards the overall portfolio spreads in this kind of business can have negative consequences on the revenue streams especially when consumer auto lending portfolio is prone to the following risks.

EARLY TERMINATIONS: There can be reasons such as damage to the vehicle, a better deal from a competitor (Balance Transfer etc), a change in model or shifting of the client to a new location can generate a termination request. If the termination charges are compromised, depending on the timing of the termination, the financial institutions might not even cover the acquisition costs etc. As a rule, in any event, the financial institutions across the board, should not compromise on the termination charges and should refrain from using a Zero Termination charge as a selling tool.



SALES STRATEGY: At present, financial institutions are soliciting deals through a network of Contractual Sales Force and/or with sales staff at the car dealerships. This trend is going way out of control and the sales staff are being paid commissions which at times are over 1% of the net financed amount. The contract sales staff hired by a financial institution can unofficially work for more than one institutions by grouping up with the sales staff to maximize the reward in the shape of commissions, which vary based on the volume slabs. Dealerships on the other hand are also being paid commissions by the financial institutions to pass on the deals. As financial institutions we need to discipline this trend, defined boundaries and benchmarks, impart proper training etc before we are left with very limited real spread for our books.

INSURANCE: It is very critical element in this business and a requirement both for the bank and the customer. Let the insurance experts/companies based on their individual strength manage the insurance risk, it's pricing and also own the total premium amount. A lowest insurance rate/deal etc used as an acquisition tool by the financial institutions is not advisable. Claims are settled based on the insured amount or market value which ever is less. With no organized, scientific mechanism to match the insurance and secondary market values, it leaves us very little in control to recover outstanding/due amounts in full in case of a insurance claim. Prudent spread strategy and customer equity levels can mitigate this risk to a large extent. If we do not set correct equity and spread levels at some stages, it does not make economic sense the insurance companies shying away from auto portfolio or will be very selective or increase the premium rates (this trend has started to creep in already).

RESIDUAL VALUES: With no or very limited organized auto historical value tracking data available and our equity levels not aligned to the auto historical resale value etc, an adverse movement in the values of the secondary market can leave us with fleet of repossessed cars not fetching our required values. Thus forcing the financial institutions to do distress sales and book losses. This situation can arise in case the imports become cheaper, overall prices come down due to cheaper inputs, or new manufacturers come up. As a start, banks should develop in-house value tracking MIS of their auto portfolio for reference and give this data due importance while reviewing the product programs, particularly for setting equity levels for various classes of customer risks and auto models. Segregate the existing data related to new car prices, value received from forced sales, value tracking of second hand cars (if involved in financing of used cars).

In addition, for financial institutions a few don't also include loading the market premium amounts due to late delivery schedules in the car values before financing, and also not getting involved in bulk bookings of new cars to provide priority deliveries to the customers.

A factor in the above elements in the product program and continuos awareness of these downsides will leverage the revenue stream and prevent spread erosion for the financial institutions involved in Consumer Auto Financing.