The operating environment for European consumer finance banks has changed significantly in the past few years. In S&P Global Ratings' opinion, rising inflation and the monetary policy shift in the euro area following Russia's invasion of Ukraine has impinged more on the consumer finance markets than on other banking industry subsegments. We don't expect consumer finance banks to benefit from higher interest rates as much as their universal banking peers.

The difficult economic environment has brought European consumers' post-pandemic spending spree to an end, and with it, new business generation for European consumer finance banks. Consumer finance lending accounts for roughly 10% of total lending to European households, but over the past two years, outstanding consumer credit has grown by about 2.5% per year, roughly half the rate before the COVID-19 pandemic (see chart 1). While we expect consumer finance banks' asset quality to be more vulnerable to low economic growth and above-target inflation than that of other banks, the increase in credit costs should remain manageable for most.

Chart 1

At the same time, consumer finance banks need to adjust their business models continuously as online channels are increasingly replacing traditional channels for new business generation. Competition from new business models such as buy now pay later (BNPL) is also ramping up. In our view, the challenging economic environment and additional pressure from higher funding costs may test the viability of many consumer finance banks' business models, particularly those that were already struggling in an era of cheap money and those that have relied on continued growth and the expectation of future profitability.

The economic environment is also detrimental to previous years' spirit of innovation, which saw new business models coming to the market, and in the case of BNPL, strong growth, albeit from low levels. We expect established banks to increasingly buy in to such fintech service offerings and thereby add to the pressure to consolidate in the fintech space.

Consumer Finance Banks' Profitability Does Not Benefit From Higher Rates

Unlike other banks, many consumer finance banks have not benefited from the monetary policy shift in the euro area and other European jurisdictions. While consumer finance activities generally yield comparatively high net interest margins (NIMs), these have not risen further despite increasing policy rates. In many cases, NIMs even fell year on year in 2022 versus the prior year, and we don't expect this trend to have reversed in 2023 (see chart 2).

In our view, the main reasons for this situation are consumer finance banks' often weaker funding profiles, with greater reliance on wholesale funding and more price-sensitive deposit franchises. Increases in interest expenses relative to the funding base have often outstripped increases in interest income relative to earning assets (see chart 3). Furthermore, the regulation on usury rates in some countries--including France, Finland, Switzerland, and Poland--limits consumer finance lenders' ability to adjust their pricing to absorb the higher funding costs and increased cost of risk and thereby defend their risk-adjusted profitability in volatile markets.

Chart 2

Chart 3

That said, we have seen some upward adjustments of interest rate caps on consumer loans in a few countries to take account of the higher interest rates and pressure on lenders' funding costs. For example, in Switzerland, the interest rate cap has increased by one percentage point to 11% since May 2023, and in France, it has increased by 88 basis points to 21.92% since January 2023, showing large differences in regulatory caps. Nevertheless, we expect pressure on NIMs to continue because interest rates will remain high over the coming months, and competition for retail deposits from other subsegments of the banking industry will likely gain further traction.

Consumer finance entities that are part of larger banking groups are, to some extent, able to access cheaper funding from within the group, or leverage the groups' often better access to wholesale funding markets. However, we do not expect these channels to fully compensate for increased funding costs for retail customer deposits.

Consumer Loan Growth Rates Should Remain Soft

European consumers have been hit by the economic shockwaves following the outbreak of the Russia-Ukraine war in early 2022. Rising energy and food costs, among others, have affected consumer finance customers disproportionately. While the impact of external factors on the economy and consumption varies significantly between countries, the post-pandemic spending spree that we observed in many markets in 2021 in particular has come to an end.

While consumption expenditure recovered quickly during this spree, outstanding consumer credit remained flat. This indicates that households financed the increase in consumption largely with savings that they had accumulated at the height of the pandemic, and less with additional debt. While more recently, outstanding consumer credit has grown more than overall consumption expenditure, consumer loan demand remains depressed (see chart 4).

Aggregate consumer confidence, a forward-looking indicator, has been significantly below its long-term average since the beginning of 2022 (see chart 5). We therefore expect relatively muted growth rates for consumer loans, as negative macroeconomic effects should also reduce consumers' borrowing capacity and loan demand, weighing on loan growth and thus earnings.

Chart 4

Chart 5

New Business Generation Continues To Move Online

Consumer finance banks' business models have arguably felt the impact of digital disruption more than other subsegments of the banking industry. This has required them to continuously adapt their strategies and operations in line with market developments and evolving customer preferences. Digital disruptors have rapidly captured niches of the consumer finance market by providing consumers with user-friendly and convenient applications and thereby challenging traditional players. We expect to see a continued need for investments in digital capabilities to keep up with customer demand. However, at the same time, we expect the pressure on incumbents to abate due to the higher interest rates and more difficult funding conditions for new competitors, particularly those operating on a stand-alone basis.

Retail trade--one of consumer banks' prime channels for new business generation--has changed dramatically over the course of the pandemic, with a decisive move away from the high street and shopping centers toward online platforms, after years of a more gradual shift. Although its share has since plateaued, e-commerce is surely here to stay (see chart 6).

While the degree of disruption varies between different retail subsectors, the rise of e-commerce has in many instances cannibalized high street offerings. It has therefore not only affected retailers, but also prompted consumer finance banks to generate new business in the highly competitive--and more transparent--online arena, where they are competing against other consumer finance banks as well as fintech and big tech firms.

Chart 6

The rise of online retail trade suits a consumer demographic that is increasingly unattached to traditional banking service providers, branches, or products, particularly the younger generations. This is even more true for consumer finance products, which are essentially commoditized, with demand depending on the relative pricing and availability across distribution channels.

At the same time, many incumbent banks have been either unwilling or unable to provide simple online or mobile consumer finance products, because of such products' higher credit risks, the stigma of consumer credit, or because incumbents have often needed to undertake large-scale IT modernization projects first. This has opened the door to new, more agile competitors with innovative business models. Sometimes these challengers have benefitted from their products being beyond regulatory scrutiny, supporting more agile operations and a faster time to market than fully regulated financial institutions can achieve.

We consider changing customer preferences as a more pressing disruption risk factor than technology, regulation, and industry (see "Tech Disruption in Retail Banking: Country-By-Country Analysis 2023. Leaders and Laggards Emerge," published Sept. 27, 2023). That said, client expectations with regard to digital solutions vary considerably from country to country. While this gives some banks more time to adapt and launch digital products, we believe that client preferences can change quickly along with the pace of innovation, endangering banks' existing proposals.

Banks' credit offerings have become significantly more comparable with the point of sale moving online, making consumers' lives easier. Even in less digitalized societies, consumers are increasingly adapting to more convenient service channels for consumer loans. For example, even in the German market, which we consider has rather conservative customer preferences, the share of borrowers that consulted a physical bank branch prior to entering a consumer credit agreement decreased to only 40% in 2022, down 11 percentage points from 51% in 2014. In contrast, the share of borrowers using web-based comparison tools increased to 24% from 15% (see chart 7). These numbers reflect the broad definition of consumer credit that the German Association of Consumer Credit Banks uses and include car financing.

Using a narrower definition of consumer credit that excludes car financing, we would expect the online channel continues to play a significantly more important role than physical bank branches. Theoretically, the general move toward online platforms should enable consumers to make more informed decisions, while increasing competitive pressure on suppliers of credit.

Chart 7

In our view, banks in digitally advanced markets that have not yet adjusted to the new reality will find it increasingly difficult to catch up with established online incumbents, such as Klarna Bank AB. This adaptation has proved particularly challenging for captive consumer banks with strong strategic and operational links to high street retail groups, for example France-based Carrefour Banque or Oney Bank S.A. In some cases, these banks' parents have struggled with the digital transformation of their business models.

At the same time, as the point of sale has moved online, this has opened up business opportunities for early movers and enabled entirely new business models, such as BNPL.

Chart 8

We Expect Significant Pressure On BNPL Players To Consolidate

There are three main reasons for this pressure.

Both consumers and retailers incur costs for connecting to new payment providers.   Consumers have the nonmonetary cost of setting up accounts with new providers. This makes them reluctant to switch, which they will only do if the benefits of the new services exceed the cost of switching. Retailers have the cost of connecting their IT systems to new platforms and managing cash flows across multiple platforms.

We expect that new entrants will find it increasingly difficult to compete against incumbent fintech and financial institutions. We therefore view a more concentrated market structure, similar to that for credit cards and other payment services, as likely over the medium term. The BNPL market may also amalgamate with other payment services markets at some point.

Higher interest rates make BNPL more suited to being a product within a portfolio rather than a stand-alone business.  Running a BNPL business requires funding. In contrast to stand-alone BNPL providers, which usually fund themselves through the private or wholesale markets, regulated financial institutions usually have access to cheaper retail deposit funding. This has become increasingly relevant since the monetary policy shift in 2022, as many stand-alone BNPL players and fintech firms that are not yet profitable have found it increasingly difficult to obtain new funding at feasible rates.

We expect existing banking institutions in particular to play an active role in the consolidation of BNPL markets, as such products could be an attractive addition to retail banks' product portfolios and complement their existing credit cards. BNPL certainly meets customer demand, as evident from the rapid growth of the segment over recent years, a trend that we expect to continue. We believe that high inflation over the past two years has contributed to BNPL volumes as households' money management has become more important and payment deferral an offering much in demand.

Increasing regulation should favor regulated lenders that provide BNPL products.  To date, nonbank BNPL product offerings and providers often operate with significantly lower regulatory requirements than incumbent banks' traditional consumer finance products are subject to. These range from know-your-customer and anti-money-laundering rules to those aimed at protecting customers. Lawmakers in multiple jurisdictions are working to change this and align the rules for BNPL with those for other consumer finance products. We believe that incumbent regulated lenders will be better prepared for this because they can leverage their existing compliance structures.

Widespread Use Of BNPL Has Spurred Legislators Into Action

The surge in the take-up of BNPL has been particularly pronounced among younger consumers. This is likely due to a high share of online shoppers in this age group, combined with an attractive, easy-to-use, digital, or even fully mobile, financial product, and such consumers' typically weaker economic position and lack of financial literacy or experience. For example, German credit bureau Schufa observed a significant rise in low amounts of consumer credit over 2020-2022, which it attributes to BNPL becoming more widespread in the country over that period (see chart 9).

Similarly, in the U.K., the Financial Conduct Authority's (FCA's) most recent Financial Lives study found that the use of BNPL surged by 10 percentage points to 27% of U.K. adults between May 2022 and January 2023, and in a more pronounced way among younger and lower-income parts of the population. Frequent users of BNPL services were also significantly more likely to be in financial difficulty compared to segments of the population that do not use BNPL.

To date, in many jurisdictions, nonbank BNPL providers are subject to less supervisory scrutiny and regulatory requirements than providers of comparable traditional consumer finance products. In many cases, BNPL financing is provided without prior consultation of, or reporting to, nationally centralized credit bureaus. While this makes BNPL an attractive option for those without a formal or sufficient track record of income, inadequate affordability checks may ultimately result in both consumers' inability to service debt and a higher cost of risk for lenders, particularly if consumers build up credit balances across multiple BNPL platforms. In our view, the latest regulatory and consumer protection initiatives in various jurisdictions, including the consolidation of debt information in public credit registries, aim to close this gap between BNPL and other consumer credit products.

Chart 9

We believe that the increasing popularity of BNPL products, particularly among the arguably more vulnerable parts of society, have sparked heightened supervisory and legislative attention. In the EU, the European Council and the European Parliament agreed a revision to the Consumer Credit Directive (CCD) in October 2023. CCD2 will repeal the older CCD1 from 2008, and EU member states need to translate it into national law within 24 months. Among the significant changes are the explicit inclusion of BNPL products in the scope of the directive (unless the seller of a good or service offers the BNPL service directly without a financial intermediary) and the expansion of the scope to include general credit agreements with a value of less than €200.

With this directive, BNPL will fall under the same rules and regulations as other forms of consumer credit. CCD2 also sets a higher bar for the minimum requirements for the precontractual information that lenders need to provide to consumers; compulsory creditworthiness checks, which also ensure that consumers do not enter into credit agreements that will cause them to become over-indebted; and advertising requirements for consumer credit in scope of the directive.

In the U.K., BNPL products are not covered by the legislation that usually applies to consumer loans, such as the Consumer Credit Act. Furthermore, the U.K.'s financial conduct regulator, the FCA, does not have regulatory oversight of these products, unlike the majority of the U.K.'s consumer lending. Draft legislation that the government put forward in 2023 intends to close these gaps, bringing BNPL providers and products more in line with other corners of the consumer finance market by subjecting them to tighter conduct requirements and placing certain types of BNPL under FCA supervision.

However, the current U.K. government has yet to formally make these changes law and BNPL providers can, theoretically, continue to provide short-term installment loans to consumers. Despite this, and despite not having an official mandate to supervise the industry, the FCA has been able to act on behalf of consumers using existing legislation to nudge selected BNPL providers into changing procedures or contracts that it felt were unduly harmful.

We believe that the impact of evolving regulation will vary between BNPL providers and consumer finance providers in general, which have been operating with different underwriting standards and operating processes. However, the new regulations will increase such institutions' administrative processes and related costs and reduce their agility.

We Expect Asset Quality To Hold Up Well

Although we view the consumer finance subsegment as more susceptible to adverse economic developments than other banking subsegments, we do not expect significant asset quality deterioration on a broad basis (see charts 10 and 11). This view rests primarily on our expectation of largely stable labor markets. Deteriorating credit quality would, in our view, most likely go hand in hand with rising unemployment rates.

Our most recent forecast is for euro area unemployment rates to fall moderately to 6.3% by 2026 from 6.5% in 2023, ranging from 3.0% (down from 3.1%) in Germany to 11.8% (down from 12.2%) in Spain (see "Economic Outlook Eurozone Q1 2024: Headed For A Soft Landing," published Nov. 27, 2023). At the same time, we expect high inflation rates to have a disproportionate effect on consumer finance clientele and to weaken the credit quality of this segment more directly than for other forms of retail credit, particularly secured forms.

Within the consumer finance segment, we consider entities focusing on unsecured lending (for example, Oney Bank in France) as more vulnerable than those with more sizable secured consumer lending books, primarily vehicle financing entities such as Santander Consumer Bank in Germany or Socram Banque in France.

Chart 10

Chart 11

Furthermore, large amounts of the credit loss provisions that banks (including consumer finance providers) made for the credit fallout they anticipated from the COVID-19 pandemic were ultimately not needed, as credit quality remained stable (see chart 12). This was partly thanks to strong government support for the economy and a contained increase in unemployment. These reserves are largely still available for banks to employ.

Chart 12

Consumer finance banks are also among the frequent sellers of nonperforming assets to distressed debt purchasers (DDPs) in Europe. However, rated consumer finance entities take different approaches to offloading their distressed assets. We see some consumer finance banks actively selling their nonperforming exposures to DDPs to support their asset quality metrics, while others take a more opportunistic approach.

Table 1

Related Research

• Economic Outlook Eurozone Q1 2024: Headed For A Soft Landing, Nov. 27, 2023
• Tech Disruption in Retail Banking: Country-By-Country Analysis 2023. Leaders and Laggards Emerge, Sept. 27, 2023
• Buy Now, Pay Later Securitizations: What Are The Risks?, March 9, 2022
• European Consumer Finance Buys Now. Will It Have To Pay Later?, March 2, 2022

Last Entity Publications

• Santander Consumer Finance S.A., Dec. 1, 2023
• My Money Bank, Nov. 21, 2023
• Klarna Bank AB, Nov. 2, 2023
• France-Based Oney Bank Downgraded To 'BBB-' On Weaker Profitability And Planned Restructuring; Outlook Stable, Oct. 27, 2023
• Carrefour Banque, Oct. 18, 2023
• Socram Banque, Sept. 22, 2023
• Cembra Money Bank AG, Aug. 16, 2023
• Santander Consumer Bank AG, Aug. 8, 2023
• Oney Bank S.A., Aug. 1, 2023
• Alior Bank S.A., March 28, 2023