Central Bank directs banks to reduce loan ratio on motor vehicles

Sept 15, 2015 (LBO) – Sri Lanka’s Central Bank has issued a directive to commercial banks, speciaized banks and financial institutions to reduce the loan to value (LTV) ratio to 70 percent in respect of loans granted for purchases or utilisation of motor vehicles.

“The Central Bank of Sri Lanka has observed with concern the recent growth of exposure of banks and financial institutions to certain categories of lending, including lending in respect of motor vehicles,” it said in a statement.

“As such, with a view to pre-empt this trend which may develop into a system-wide risk to the financial sector, the Monetary Board of the Central Bank of Sri Lanka decided to impose a maximum Loan to Value (LTV) ratio of 70 per cent in respect of loans and advances granted for the purpose of purchase or utilisation of motor vehicles by banks and financial institutions supervised by the Central Bank in terms of the relevant legal and supervisory provisions.”

The imposition of such LTV ratios is a key regulatory practice adopted globally to address such macro concerns on lending activitiesas and when such concerns are raised, the central bank said.

The directive goes in to effect Tuesday.

“Loans and advances shall include finance leases, hire purchase facilities and other loans and advances granted for the purpose of purchase or utilisation of motor vehicles,” the statement said.

The value of the motor vehicle should be the market value obtained from a professional valuer at the time of granting loans and advances, as per the prevailing practice, the central bank added in the directive.

A lower loan to value ratio, from the 85-90 percent that firms were giving out, could reduce demand for vehicles which has increased several fold in the last year.

Commenting on the directive, Murtaza Jafferjee, the chief executive of JB Securities said: “Loss given default (LGD) is the loss that a financial service company faces in case of default. Normally for leases the figure is around 40 percent based on the current industry LTVs of around 85-90 percent.”

“Now that max LTVs have been mandated at 70 percent LGDs will come down significantly probably to 10 percent. This would significantly derisk vehicle financing, interest rates on leases will come down due to credit spread compression and the NBFIs operating in the subprime market will be pushed out,” he said.

“You might also see a shadow banking market operating that is outside the regulators purview that will offer higher LTVs,” he added.