Guideline No. 5.1.1
Motor vehicle financing
I am writing this letter on lending for the purchase of motor vehicles pursuant to section 7(2)(c) of the Banking Ordinance in which I am enjoined to "promote and encourage proper standards of conduct and sound and prudent business practices amongst authorised institutions".
It is a fundamental tenet of prudent lending that a lending institution should make adequate evaluation of the creditworthiness of the borrower. There should be up-to-date and adequate information for that purpose. Additionally, the institution should have adequate arrangements for on-going monitoring of the performance of the borrower.
Following complaints about laxity in credit assessment procedures, the Office recently conducted an examination of institutions involved in financing the purchase of motor vehicles. As a result of that survey, I have come to the view that there is room for lending practices and procedures in this area to be strengthened.
We found that to a large extent institutions involved in motor vehicle financing have little direct contact with their borrowers. Much of the processing of the loan applications is conducted by motor vehicle dealers themselves. The basis of the relationship is a "Master Dealer Agreement", a non-recourse arrangement between the lending institution and the dealer, under which the dealer selling the motor vehicle also carries out the initial preparation and processing of the buyer's loan application. Dealers normally require only minimal information from the buyer - essentially name, identity card number and address. The buyer is seldom pressed to provide evidence as to income and place and nature of employment. Reflecting this, credit files on borrowers are usually brief. Upon the receipt of the loan application from the dealer, the lending institution would normally contact the applicant by phone to confirm the information on the application form. There may be some further negative vetting of the buyer through credit agencies and internal records. However, the lending institution usually does not conduct any face-to-face interview with the applicant, which would enable it to check if the applicant was at the very least the person specified in the loan application.
Our examination revealed that the financing of the purchase of motor vehicles is largely based on formula lending. The amount that an institution would be willing to lend has more to do with the make and model of the car and less to do with the financial position of the buyer. The amount of the loan is normally set at between 80% - 90% of the assessed market value of the motor vehicle.
Institutions should be aware that formula lending carries with it the risk that the creditworthiness of the loan becomes dependent on the market value of the underlying asset, in this case a motor vehicle. As will be appreciated, the market values of used motor vehicles can fall significantly under deteriorating market conditions.
I believe that institutions should take a comprehensive approach to the assessment and supervision of their credit facilities, including the financing of the purchase of motor vehicles. Assessment of creditworthiness should pay close regard to the financial standing and net worth of the borrower, including level and stability of income as well as to the underlying collateral security, in this case the motor vehicle.
I also believe that after a loan has been extended, a credit file should be maintained on the borrower. The file is necessary to enable the lending institution regularly to make an appraisal of the performance and quality of the outstanding loan. Effective monitoring requires that the credit file contains updated and factual information. Such information is also necessary to enable the Office of the Commissioner of Banking to check the quality of the loan book when it conducts on-site examinations.
Against the above background, I would wish authorised institutions to take the following steps towards improving their lending practices and procedures in motor vehicle financing:
- Processing of loan applications for purchase of motor vehicles should include an assessment of the creditworthiness of the borrower, including level and stability of income. In our view, Institutions currently rely too much on the market values of vehicles as a measure of the creditworthiness of motor vehicle loans.
- Our preference is that, as in other areas of lending, institutions should establish arrangements for their own officers to be directly involved in the processing and assessment of loan applications. However, we recognise that institutions may find it impractical to dismantle their long standing arrangements with motor dealers. If motor dealers are employed to carry out the initial preparation and processing of loan applications, the institution should ensure that this is done within clearly defined standards and procedures set by the institution, and it should conduct regular checks to ensure that the motor dealer is complying with that standards and procedures. The quality of borrowers introduced by each dealer should be carefully monitored.
- Institutions should establish and maintain credit files on borrowers. These should contain adequate and timely information on the borrower and the collateral security. The information that we consider basic and indispensable for credit files is outlined in the Attachment.
- In conjunction with the maintenance of credit files, institutions should establish arrangements for the regular and systemic review of loan facilities extended for the purchase of motor vehicles.
I would be most grateful if you would circulate this letter to members of your Association. I look forward to their co-operation in implementing the above measures as early as possible.
Attachment
Information required in credit files
(a) Name of borrower
(b) Current address
(c) Previous address(es) in the last five years (if any)
(d) Occupation
(e) Position
(f) Name of employer
(g) Years of service
(h) Salary
(i) Other income
(j) History of relationship with the borrower
(k) Details of other credit facilities granted
(l) Valuation of the motor vehicle
(m) Name of guarantor, if any, and his financial position
(n) Brief report obtained on the borrower from credit information agencies (if available)
(o) Nature and extent of credit facilities already enjoyed by the borrower at other banks and financial institutions (if available)
(p) Comments and recommendations by interviewing officer or manager
