In this article, we will explore the potential impacts that rising interest rates can have on asset finance lessors, customers, and balance sheets.
As central banks raise interest rates globally, it can have a ripple effect on the asset finance industry. Higher borrowing costs, more defaults, margin pressure, greater scrutiny, funding challenges, and operational constraints are some of the potential impacts. Consumers may opt for pay-per-use models instead of owning cars, businesses may consider operating leases, and there will be cash management challenges for finance providers. Lessors may need to review their funding and hedging strategies, and firms may need to re-evaluate prices and credit quality.
1. Higher borrowing costs
As interest rates go up, the cost of borrowing money becomes more expensive. This can make traditional lending models, such as car loans, more costly for consumers and businesses. As a result, consumers may opt for pay-per-use models instead of owning cars, and businesses may consider operating leases over finance leases, which can put assets on financiers’ balance sheets.
Example
For example, a consumer may have qualified for a car loan at an interest rate of 4% before the central bank raised rates. After the rate hike, the same consumer may now have to pay an interest rate of 5% on their loan, making it more expensive for them to borrow money.
2. More defaults
When interest rates rise, it can also make floating rate contracts, such as car loans, more expensive. This could lead to an increase in credit defaults, which can cause cash management challenges for finance providers.
Example
For example, a consumer may have had a car loan with a floating interest rate of 4%. After the central bank raised rates, the interest rate on the loan may have increased to 5%. This could make it difficult for the consumer to make their loan payments, leading to a higher risk of default.
3. Margin pressure
Higher interest rates typically mean bigger profits for banks. However, in this case, competitive pressures, a rise in provision levels and non-performing loans and leases can all reduce earnings, affecting budgets and profitability.
Example
For example, a bank may have been able to earn a profit margin of 2% on their car loan portfolio before interest rates rose. After the rate hike, the bank may only be able to earn a profit margin of 1% due to competitive pressures and an increase in non-performing loans and leases.
4. Greater scrutiny
As interest rates rise, credit risk profiles may change significantly. Asset finance firms may need to re-evaluate prices and revalidate scorecard cut-off models in light of the higher cost of risk. They may also need to conduct more regular reviews of credit quality, which can be time-consuming and costly.
Example
For example, an asset finance firm may have previously used a scorecard model that had a cut-off credit score of 650 to determine which consumers to approve for car loans. After interest rates rise, the firm may need to re-evaluate the model and consider raising the cut-off score to 700 to account for the higher cost of risk.
5. Funding challenges
Some lessors may need to review their funding and hedging strategies, as their finance has historically been variable and their balance sheet may be more exposed to rate rises. Less access to cheap funding lines could make it difficult for non-bank lessors to restructure debt facilities, and more expensive to get wholesale market funding.
Example
For example, a lessor may have historically used variable rate debt to finance their car lease portfolio. As interest rates rise, the lessor may need to review their funding and hedging strategies to protect their balance sheet from being exposed to rate rises, which may be difficult and costly.
6. Operational constraints
Rising interest rates and inflation can put pressure on internal resources within asset finance firms. To attract and retain talented employees, firms may need to raise pay, which can increase costs. This may lead to more organizations filling the gap with outsourcing, managed services, and business process as a service solutions.
Example
For example, an asset finance firm may have previously used a scorecard model that had a cut-off credit score of 650 to determine which consumers to approve for car loans. After interest rates rise, the firm may need to re-evaluate the model and consider raising the cut-off score to 700 to account for the higher cost of risk.
Impacts of Rising Interest Rates on Asset Finance:
| Impact | Explanation | Example |
| Higher borrowing costs | Cost of borrowing money becomes more expensive | A consumer’s car loan interest rate increases from 4% to 5% |
| More defaults | Floating rate contracts become more expensive | A consumer’s car loan interest rate increases from 4% to 5% |
| Margin pressure | Earnings reduced due to competitive pressures | A bank’s profit margin on car loans drops from 2% to 1% |
| Greater scrutiny | Re-evaluation of prices and credit quality | A firm raises their credit score cut-off from 650 to 700 |
| Funding challenges | Difficulty in accessing cheap funding and restructuring debt | A lessor’s funding strategy changes to protect against rate rises |
| Operational constraints | Pressure on internal resources and pay | A firm turns to outsourcing to fill talent gaps. |
