Mark Carney is right‎ and the car loan market is heading for a crash

Aside from admiring his Don Draper style and good looks, I’ve been no fan of Mark Carney.  The Bank of England’s Governor comes across as a little big for his boots, a little too charming and far too political, as his high-profile role during the Project Fear campaign ahead of the Brexit vote showed so vividly.

Yet Mad Men can grow up.  And Carney appears to have done just that, in both tone and substance. He was still super smooth when he addressed the Bank’s Financial Stability Report press conference this week, and super diplomatic, saying that the “risks to financial stability were neither particularly elevated nor subdued.” Then came his grenade: “As is often the case in a standard environment, there are pockets of risks that warrant vigilance.”

What Carney meant is that the banks are behaving recklessly. And to stop them, the Financial Policy Committee is ordering the banks to put aside more capital for a rainy day, to stop lending money to households for mortgages on such high salary to loan ratios and lending so much unsecured credit for auto finance and other loans.

Carney has put the banks on the naughty step. He wants them brought under control. And his message is clear – consumer debt is soaring dangerously high and it’s the complacent behaviour of the banks in their lending policies – and not low interest rates – that is to blame.

Carney is right, just as he is right that putting up interest rates now would be catastrophic for the economy. Sorry savers, but it’s true. There would be people out on the street within weeks. Which is why he’s spot on in pinpointing the amount of lax bank lending there is to consumers.

The UK consumer credit market is worth about £200bn – a seventh of the size of the £1.4trn mortgage market but it’s highly sensitive to a reverse because the write-offs in unsecured loans are several times larger than those of mortgages. (People pay off mortgages but default on credit cards and cars).

Of total consumer credit, the fastest- growing element is car finance, which has been rising at 20% a year for each of the last five years.  You only have to drive for five minutes to see the extraordinary number of brand new Range Rovers, Tiguanes, Touaregs, Cayennes and other flashy named cars on the roads to see why car credit is on speed.  And to understand why, at a time of so-called austerity and stagnant wages, this sign of ostentatious spending is scaring the pants off the policy-makers not just at the Bank of England but also the regulators at the Financial Conduct Authority.  More of that later.

No wonder then that Carney has ordered the UK’s banks to put aside an extra £11.4bn over the next 18 months to take their capital buffers back up to 1%.   This will take the banks back to where they were a year ago before Carney let them loosen up the financial buffer they had in their countercyclical capital buffer ( the CCyB) to help soften any potential Brexit blow.

Although the Governor was criticised by many at the time, he was on balance right when he moved last August to loosen capital buffers, cut interest rates and extend QE.  Being ready to move swiftly is more important. As he says : “We want to move the levels of capital back up to the level they should be – any time you move into more benign credit conditions there have been fewer defaults….Lenders may be placing undue weight on the recent performance of loans in benign conditions.”

It isn’t just the screws on the buffers being tightened now. The banks must prepare tighter rules on credit card lending to stop the binge in debt putting their financial stability at risk; they must check on mortgage borrowers because they fear too many lenders have been lax about allowing a far higher salary to loan ratio, in some case up to nearly 100% again, and mortgage lenders will also be forced to insist that  their customers go through affordability tests to check they can afford a 3% increase in their loans which is a rise to about 7%.

At the same time, the FPC is going to look at whether a rule limiting loans at a high loan-to-income ratio to 15pc of total mortgage lending should now become a permanent fixture – it should – and not just a temporary one.

In another tightening, the FPC is to bring forward its annual stress tests on the banks which estimate a bank’s potential losses in a hypothetical recession. It must be worried if that’s too long to wait, and is pulling the tests forward from November to September because of worries over defaults on credit cards or car loans, or both.

Once bitten, twice shy as they say. Having been burnt over PPI mis-selling, the authorities are scared witless by the prospect of another PPI type scandal.  The initials they fear this time are PCP  – or Personal Contract Purchases – the name given to the car credit agreements being taken out nationally for new cars with next to nothing deposit.

PCPS are working like a drug. The Finance and Leasing Association reckons that 86.5 per cent of all new cars were bought last year using credit – a cool £18.6bn of new borrowing.  Another £14bn of borrowing was spent on buying used cars.

How worried should we be by all these shiny new Cayennees? On the surface, ballooning car finance might seem trivial in the scheme of things. In total, customers have been lent £58bn by car dealership finance companies – mainly by the big German manufacturers – and another £24bn by the banks. This sounds small.

But regulators are concerned that these new PCPs whereby customers pay a small deposit and monthly payments for a fixed period, usually three years, will turn sour. When the contract its over, customers buy the car from the manufacturer for an agreed price, usually about 85% of what the car is expected be worth.

Here’s the rub: newer used car prices are falling more sharply than ever as customers get hooked on buying new, snazzier cars and this could be a big risk for the manufacturers who will be landed with the losses.

Since many of these car loans are securitised, just as mortgages were in the run-up to the 2008 financial crisis, regulators are terrified that any slowdown in car sales – and much lower second hand prices – could put the skids under the financial markets. Carney was right to switch on the hazard lights.