China Car Market's Ugly Secret: More Don't Repay Loans

SHANGHAI September 8, 2003; James T. Areddy writing for Dow Jones reported a bad omen for China's fledgling consumer credit business has appeared in the booming car industry: more buyers aren't paying back their auto loans.

That's a charge of the country's insurance industry, as it pulls back from a two-year-old business of providing banks guarantees they will get auto loans repaid.

China's banks, insurers say, are making too many car loans - around US$4 billion worth in the first half of 2003 - to customers they don't know well, leaving insurers holding the bag when buyers can't pay for their vehicle, disappear with it or simply abandon the car to buy something cheaper.

This worrying trend, described by insurers, bankers, carmakers, court officers and in domestic press reports, takes some of the sparkle off car sales numbers that have made China one of the world's largest auto markets.

Yet, more broadly, it also offers a counterpoint to views that high personal savings and cultural aversion to debt make China's consumers low risk borrowers, customers who offer the country's banks their best hope for strengthening bombed-out balance sheets.

The auto loan problem suggests the country's banks simply know very little about the people who borrow, whether to buy cars, homes or for other purposes. This results in risky lending decisions and opens avenues for fraud.

Until 1998, banks didn't really offer consumer loans. And even now, lenders at some of China's biggest banks don't have the computer capability to check if a potential borrower has an account. The most-advanced credit bureau in the nation, the one in Shanghai, remains a virtual island four years after it opened, basically unconnected to its counterparts in other cities, where they exist.

These shortfalls raise questions not only for Chinese banks as they dive into consumer credit, but also for foreign banks and finance companies that see vast opportunities in China for products such as credit cards.

But until insurers started getting burned in their corner of the auto-loan business, any worry was merely theoretical since banks have consistently reported bad consumer loans at less than 1.0% of the total compared with perhaps half for all loans.

"The problem of this business is that it is too costly to get individual credit information, and there is still a lack of a system providing adequate information," says Xu Lei, chief of the vehicle insurance department at China Pacific Property Insurance Co. in Shanghai.

Christian Weidemann, director of the financial services department at General Motors Corp.'s Shanghai operation, which makes Buicks and other cars, says the insurer experience may slow auto lending, if not car sales. "It will hurt, but demand for cars in this country is so huge," he said.

GM's finance arm says when it is permitted to offer loans, its own lending controls will be tighter than what it sees at China's banks, and reflect its experience operating in 41 countries. Still, government control over interest rates will likely leave margins so thin that seeing even 1.0% of loans go bad could put a lender close to losses, Weidemann said.

Auto Dreams

Car ownership dreams are shared by millions of Chinese - and just as enthusiastically by global automakers and other businesses associated with the industry. But even with rocketing auto sales that have defied expectations over the past two years, for many carmakers, such as GM, the really big opportunities won't come until Beijing gives them the green light to offer car purchase finance.

Beijing's foot-dragging on opening this market is one of the few clear cases where it hasn't lived up to commitments made upon joining the World Trade Organization in 2001.

As they idle in neutral, the financing operations of GM and other foreigners have watched domestic lenders gobble up market share. Lenders of all stripes savor at the opportunities suggested by numbers showing only 20% of car purchases are financed in China, compared with rates closer to 80% in the U.S.

For the broader finance industry, car loans represent an early test for the consumer credit business in China, where foreign banks see underserved potential in, for instance, credit cards. Cars are harder to secure than property, so auto loan characteristics are similar to credit card advances.

At this early stage in the market's development and in recognition of how little they know about customers and how tough it can be to attach a lien on a car loan, banks have required perhaps 2% of their borrowers to buy default policies on auto loans. Eager to sell higher-margin collision, theft and fire coverage to car buyers, insurers leaped to get their foot in the door with potential customers by offering loan insurance, some of them before it was made legal in 2001.

But the experience has been bad. Ping An Insurance's Shanghai operation recently stopped writing auto-loan default policies altogether. "Because people don't have a strong respect for the law, it is difficult for us to get recovered," according to Chen Fei, manager of the giant firm's car insurance business.

Defaulters are more numerous than expected and China's patchy legal system makes it tough to chase them down. "We don't have that much energy," said Chen.

No one seems to have numbers on how much the insurance industry has lost or whether car sales have been much impacted, but widespread reporting on the problem in China's otherwise upbeat-focused press suggests a painful sting. Respected Caijing magazine said that in the first half of this year, insurers in one relatively wealthy eastern city, Wuxi, paid claims of around CNY25 million, or 93% of what they earned in premiums, up from 46% in 2002.

Sometimes, buyers abscond with their cars, while other times making payments gets too tough and owners throw up their hands.

But also these days, car owners are responding to the auto industry's own fierce price competition and widening array of model offerings by abandoning their old car - and its loan - to buy a new car. Scofflaws apparently see little risk of being found out and denied loans elsewhere. "Falling car prices" and " fluctuating incomes" are the two main reasons buyers default, says a Shanghai insurer.

Compromises are being worked out in some cities, where banks are agreeing to shoulder more responsibility, such as paying the entire 1-2% premium cost themselves or having only a portion of a loan covered.

But a Shanghai judge who has seen a number of car-default suits expresses frustration that borrowers can be made to pay. "The major problem is, we just can't find the car buyers and the cars."