Car prices are rising, regulatory forces are closing in on auto lenders, and the fintech solutions of the 21st century are here to replace legacy systems. Amidst this tumult, the specter of COVID-19 has created unprecedented uncertainty in auto markets worldwide, with lenders deploying innovative digital strategies to keep volumes up. With the global economy rapidly evolving, both lenders and borrowers will be taking new approaches to auto finance. How do banks find the best path in a time of uncertainty and change?
With cars becoming more expensive, customers are seeking ways to afford the increasing cost. This has become even more imperative as the economic upheaval of COVID-19 ripples through the market. One option is extending the length of their auto loan, thus lowering their total monthly payment. As many buyers focus more on monthly payment than interest rate, average loan length has been steadily climbing. Likewise, many lenders today are offering payment deferral plans, allowing borrowers to defer several months’ of payments until the COVID-19 clouds have passed.
According to research conducted by Experian, between Q1 2018 and Q1 2019, used cars saw a decline of volumes in 37-60 month loans, with increases in the volume of 61-84mo terms. For new vehicles, we are even seeing the introduction of 85-96mo loans, where volume increased by 38% during the same period. While this is not a new trend, the longer terms and payment deferral plans also bring a new set of challenges.
Longer loans mean a very different risk profile along with a few point-blank questions: will the buyer pay according to plan, trade in the car after two years, and need an even bigger loan, or will they default during the lengthy loan period? Likewise, how quickly will the economy stabilize, and how do banks incorporate payment deferrals and rising default risks into their profitability calculations? Lenders today know they must account for these variables – as well as many others.
And if the human factor was not enough – the regulatory environment is changing rapidly, too.
While lenders have understood for many years that their interest rates must remain fair across factors like age, gender, and ethnicity, the new regulatory environment around the globe seeks to address the role of car dealers in the final price a customer receives. Regulatory bodies have indicated that dealers will have less leeway in marking up the loan prices quoted to them by the lender, to ensure that all customers are treated fairly.
Even before COVID-19, a new set of regulations from the UK’s Financial Conduct Authority (FCA) was on the way- further refining the existing regulatory framework. The FCA was acting based on results from a study of dealer and lender behavior in the UK auto market, which found that commission-based compensation often encouraged dealers to over-charge borrowers. The new rules aim to eliminate this conflict of interest, creating a more competitive market that treats consumers more fairly. More recently, the FCA has also unveiled a series of measures aimed to protect borrowers impacted by COVID-19, including three-month freezes on auto loan payments and a temporary halt on vehicle repossessions.
While the spirit of the regulations is in line with long-standing industry policies, the details require indirect lenders to update their pricing models to account for shifting dealer behavior and dealer compensation programs, as well as newly announced government relief plans. Thus as dealers seek to navigate the new regulations [this is also a strong statement], lenders must quickly recalibrate their pricing models to capture the new relationship between the price quoted by the bank to the dealer and the final price that the dealer quotes the customer.
The McDrive experience
Looking beyond the regulatory requirements, we see a new type of customer – a challenge and a blessing, all at the same time. A challenge because these customers expect a seamless buying experience – they want to receive offers without struggling through complicated systems or entering a branch. And a blessing because it’s their requirements that are pushing outdated delivery systems to change.
On the enterprise’s end, this means a daunting but vital transformation: from a product-centric legacy system to an agile, customer-focused network of smartly used data. A system where questions about pricing are answered immediately, in real-time.
Systemization on another level
Everything changes and nothing remains still. Even without Plato – the thought leaders of 21st-century banking are painfully aware of the truth of the above statement. They know that a legacy institution’s only chance for survival is by turning their historical, brick-and-mortar-optimized systems into customer-focused, flexible platforms where they can be proactive about their clients’ needs and wants. Systems, that give way to sophisticated and streamlined pricing operations, algorithm-based rate changing processes.
But auto lending propels lenders towards customization in another way, too. In many cases, auto loans are the first point of contact with a given customer for the bank. While many customers maintain historical bank preferences due to geography and/or familiarity, they rarely look at the logo of the lender when signing a contract at a car dealership. They want the best rates – in exchange, the bank gets a relationship with a customer who might otherwise have been outside of their footprint.
With the data and interactions from this new relationship, the lender is in an ideal position to offer better bundles and other relevant retail products – creating a happy and loyal customer.
What’s to come?
We now understand that artificial intelligence and machine learning are not just buzzwords, but powerful tools banks need to leverage to the fullest. Powered by smart analytics, proactive lenders can use pricing as more than a simple lever (‘down’ for volume, ‘up’ for profit), turning it into a precision tool for meeting the modern banking customer’s expectations, adapting to regulatory changes and staying on top of risk management requirements.
We are at the threshold of banking’s sophistication revolution – bringing a better world to both clients and financial institutions. Instead of waiting for a customer to walk into a dealership, a lender will be able to identify when they are likely to begin shopping and proactively present a digital, packaged offer including exactly the products that customer needs at exactly the price they want to see.