Cooperation, joint venture or captive - what is the right path for manufacturer-linked financial services?

If the private customer has to spend a multiple of their monthly income on a new car, they will be grateful for assistance in choosing the right financial product. The manufacturer should therefore at least address this request by naming a "preferred" finance partner. Further cooperation can range from simple cooperation agreements, private label solutions and strategic alliances to the formation of joint ventures. By establishing a captive bank, the manufacturer ultimately assumes overall responsibility for the sales success of its vehicles and the financial services used. With direct contact to the end customer, the manufacturer now frees itself from dependence on its dealer organization or, in the digital world, on established brokerage platforms.

What criteria need to be considered when deciding on the form of interaction between the vehicle (industrial) business and the financing (banking and leasing) business?

Cost-effective refinancing

The procurement of funding is an important factor in the "make or buy" decision. Car dealers often lack the necessary capital strength and creditworthiness to meet manufacturer specifications for sales and service equipment and, above all, the required stock of new and used vehicles. This is where the manufacturer can help with attractive conditions.

However, the cost of funds is also a decisive factor for competitiveness in the market in retail financing. The better the vehicle manufacturer's original business performs, i.e. the higher the profitability and the lower the level of debt in the core business, the more favorable the cost of funds will be. This is reflected in the rating grade. It stands for the probability of default of the financing instrument or the issuer. And the lower the probability of default, the lower the cost of raising funds. A manufacturer will therefore always look to work with a bank partner with a strong credit rating if it does not have a top rating itself.

Efficient contract processing

When large volumes of loan and leasing contracts need to be processed, it is important to maximize efficiency. The business measure for this is the cost/income ratio. The lower this ratio, the more cost-effective the work. To achieve this, financial products must be standardized and the process chain from the customer to the back office should be automated throughout. This also increases the speed with which contracts are concluded and portfolios are managed. Digitalization helps with the integration of customer contact and networking with data providers such as SCHUFA or DAT. From the manufacturer's point of view, the question of how to process contracts as economically as possible arises anew for each sales market and will have to be answered depending on the market size or the targeted market share. For small and medium contract volumes, it is sufficient to cooperate with a banking partner. They should have the appropriate know-how and sufficient flexibility to adapt processes. Having your own back office is generally not worthwhile here. Increasing numbers of contracts lead to increasing payments to the banking partner. This can provide the impetus to create your own financial services provider.

Regulatory requirements

The constantly increasing regulatory requirements can prove to be a showstopper for a captive. In the last two years alone, national and European regulatory authorities have passed over 600 legal acts, directives and regulations. These range from accounting (IFRS 9) and payment transactions (PSD II) to reporting and disclosure obligations (AnaCredit) and capital market (CSDR, MiFID II) and banking regulation (CRR/CRD).

And this year, climate and environmental risks will become a further component of banking supervision; the EU Commission has compiled corresponding requirements in the Sustainable Finance Disclosure Regulation (SFDR). The existing risk management systems must therefore be expanded. This primarily concerns risk assessment and reporting. In order to avoid the expense of compliant monitoring and reporting in-house, it makes sense to outsource the banking business to partners.

Risk management

The customer's creditworthiness is decisive for the approval of a loan or leasing application. The rating should determine the extent to which the borrower is in a position to meet their future obligations in full and on time. The automotive banks can make the most of their advantages when assessing creditworthiness. Their simply structured product range and access to many years of default and loss experience enable a quick and accurate assessment of the default risk. If collateral requirements become necessary, they should not slow down sales success, but rather safeguard it. This also applies to the management of residual value risk. Leasing assets account for around a third of manufacturers' total sales financing volume and the result from the leasing business depends largely on the correct assessment of the market price risk. The knowledge required for this is the classic core competence of automotive banks. Most non-captive banks shy away from taking on such risks; their core competence lies more in the management of (credit) default risks. In addition, cooperation with the associated brand dealers is proving to be another advantage for captives. This is because the prices in finely controlled sales to end customers generally beat the achievable prices to resellers. It therefore makes sense for manufacturers to take residual value risks and remarketing into their own hands. As a rule, this only works with their own captive. Otherwise, the banking partner will tend to rely on its strengths in the credit business and only offer car leasing if the customer or the dealer guarantees the residual value risks.

Strategic goal: Customer loyalty

The intense competition in the vehicle manufacturers' core business requires comprehensive customer loyalty to the brand worlds within the Group. This can only be achieved in the long term with a dedicated captive. In the long term, customer and dealer financing will therefore become an important strategic cornerstone of any Group strategy. However, the associated high funding requirements, the costs of meeting banking regulation requirements and the costs of the necessary organizational apparatus require a profitable and stable industrial vehicle business in order to lead to a sustainable symbiosis under one roof. Especially in times of technological change from combustion engines to electric drives and digital transformation, a manufacturer's industrial and financing business are competing for scarce financial resources. The involvement of financing partners creates additional scope for the Group treasurer. However, the question that always hovers over such partnership-based business models is: who owns the customer?