A turning point for the US automotive financing sector

Lenders in the car financing market face emerging risks, disruptions — and opportunities.

In brief

• Compared to other forms of consumer debt, the data available to market participants, investors and regulators on auto lending is sparse and highly aggregated.
• Without visibility into the auto financing sector, market participants and regulators are unable to identify emerging risks and opportunities as they occur.
• Auto lenders need to protect consumers and manage regulatory risk by examining their practices, updating disclosures and strengthening compliance programs.

According to the Consumer Financial Protection Bureau (CFPB), over 100 million Americans have an auto loan, with the CFPB estimating that there is currently US$1.5 trillion in outstanding auto loan debt, making it the third-largest consumer credit category after mortgages and student loans.¹

Visual 1: Average Car Payment and Auto Loan Statistics 2023

Increased federal and state regulatory scrutiny

With the sharp rise in car prices following the COVID-19 pandemic leading to the nation’s highest levels of auto loan debt in years,³ the CFPB is closely monitoring auto lending practices that may hinder a fair, transparent and competitive marketplace and have an impact on consumer and household financial stability.⁴ In February 2023, the CFPB announced that it had issued orders to nine large auto lenders to supply data to provide insights into lending channels, loan performance and potential future data collection efforts.⁵ In addition, the CFPB has indicated that it will be closely monitoring unfair or deceptive acts or practices,⁶ with the Federal Trade Commission (FTC) following suit.⁷

State attorneys general (AGs) have also increased their focus on numerous auto financing issues, including refunds for add-on products (e.g., guaranteed asset protection (GAP)), inadequate disclosures resulting in debt collection violations and repossessions, and the assessment of “junk” fees at the expense of the customer. In January 2023, an AG entered assurance of discontinuance with two credit unions that will result in US$4 million being returned to borrowers entitled to GAP refunds, with the state securing over US$23.5 million in GAP refunds since 2021.⁸ Additionally, financial institutions charging unfair auto financing rates to minority groups are at the center of a New York State Department of Financial Services settlement with a New York state-licensed bank.⁹

Vendor risk

Addressing vendor risk has also become an increasingly important issue for the auto financing sector, as vendor outsourcing may include a host of risks that can affect the overall business, including operational, strategic, financial, regulatory and reputational risks. To further emphasize the importance of vendor oversight, the CFPB has issued guidance that nonbanks that pose a significant threat to consumers may be subject “to the same standards and examination as banks.”¹⁰

The presence of fraud

Fraud is an ever-growing problem for the auto financing sector, with most deceivers perpetrating fraudulent online applications, with identity theft exceeding US$8 billion in 2022.¹¹ Synthetic identity fraud, which occurs when someone uses a combination of real and fake personal information to create an identity and commit fraud, is on the rise, with auto lenders losing an estimated US$2.2 billion to this type of fraud.¹² According to the Point Predictive 2023 Auto Lending Fraud Survey, the sector’s key focus to prevent fraud centers on using internal analytics, technology and data acquisition.¹³

Visual 2: 2023 Auto Lending Fraud Survey

Actions to take

Compliance

As federal and state regulations tighten and enforcement actions become more prevalent, auto lenders need to continue to protect consumers and manage regulatory risk. They can do this by reassessing their practices; enhancing verbal and written communication, such as how a customer is treated on a call; expanding written disclosures; and implementing robust compliance programs:

• Ensure that the compliance team reflects a high level of talent and expertise to monitor and manage auto financing risk (e.g., does the compliance team contain in-depth knowledge of auto products and their applicable regulatory requirements both at the state and federal level?). This dedicated team or task force should be responsible for identifying and tracking regulatory changes, assessing change impact, and implementing necessary updates to the company’s processes.
• Review the compliance function’s interaction models with first and third lines of defense (LODs) to determine if they meet regulatory expectations (e.g., LODs should have effective monitoring and testing mechanisms, compliance-related issues have appropriate escalation paths should issues arise across LODs).
• Analyze the company’s policies and procedures regularly to verify that they align with the latest state requirements and confirm that there are no unintentional discriminatory outcomes (e.g., protocols around dealer markups, add-on products refunds, repossessions processes).
• Improve processes related to the handling of customer complaints through the modernization of complaint taxonomies, the ability to capture key controls and advanced analytics models used for trending analyses.

Vendor management:

• Update technology and data platforms to confirm that customer data is properly housed and protected when transmitted between vendors.
• Review vendor testing and oversight processes and procedures to maintain appropriate oversight of vendor activities and customer interactions.

Mitigate fraud:

• Invest in core modernization initiatives (e.g., replacing servicing platforms, contract management systems) to help improve efficiency via reduction of business processes/IT complexity while simultaneously combating fraud.
• Digitize the loan origination process and utilize artificial intelligence (AI) capabilities to detect potentially fraudulent activity.
• Use advanced fraud detection technology.
• Invest in employee training to prevent and detect fraudulent transactions.

Conclusion

As increased regulatory scrutiny and pressures have forced auto lenders to experience a rise in regulatory actions and fines, the sector continues to evolve. Auto lenders that are reactive to the evolving regulatory environment and hesitant to update their compliance programs, lending/servicing platforms, data analytics capabilities, and fraud mitigation strategies and processes may experience increased operational and reputational risk as well as escalated regulatory fines. On the other hand, auto lenders that proactively address these challenges will be better able to meet their regulatory obligations and mitigate reputational risk while increasing customer satisfaction and growth.

Raghu Kakumanu, Cal Ballou and Rachael George contributed to the article.