NEW DELHI, Aug 17: Bajaj Auto Finance's initiative to offer loans for its more illustrious group company's two-wheelers at a flat rate of nine per cent has sparked off a major rate war in the auto finance industry.

Daewoo Motors, for example, has begun offering five-year loans for Cielo cars at a flat rate of eight per cent.

Rahul Khosla, vice-president (retail banking -- India), Bank of America, identifies "intense competition in the auto finance industry" as the main reason for the decline in finance charges.

All big players in the industry have slashed their rates to below 20 per cent calculated on a reducing balance basis. Just three years ago, the rates were as high as 40 per cent.

Since then, there has been a consistent decline in finance rates, which are expected to dip further. However, this does not necessarily imply a drastic fall in the profitability of auto financiers.

Interest rates in the economy have been witnessing a downward trend and it is only logical that auto finance rates also fall in tandem. With falling interest rates, the cost of funds to the financiers is also expected to decline. Hence, a tight squeeze on margins is not expected in the short run.

The cost of funds to the financiers currently ranges from 11 to 15 per cent. With finance rates ranging from 14 per cent to 20 per cent, the spread works out to between three and nine per cent. The world over, the auto finance industry operates at a spread of around one per cent.

Market sources have also revealed that several car manufacturers are compensating finance companies for the loss incurred due to lower finance rates to promote car sales.

Therefore, finance companies have been quoting different finance rates for different car brands.

Daewoo is reportedly compensating financiers to the extent of Rs 60,000 per car financed. A similar scheme was adopted by Maruti Udyog to promote the sales of the Esteem around two months ago. With increasing competition, however, it is only a matter of time before the existing scenario change. The financiers will be forced to operate at lower spreads and improve customer service.

A few players are already preparing themselves to emerge as leaders in the impending competition. "We can work at a negative spread and still provide the best service to our distribution channel and to our customers", said a senior official at Bank of America. With the customer becoming more aware than before, practices like charging upfront processing fees over-and-above the rate of interest are already on their way out.

A senior official at Kotak Mahindra Primus Ltd (KMPL) admitted: "Customers have become more demanding now. They have even started enquiring about the effective rates on our financing schemes". KMPL has restructured its schemes to suit the individual needs of its customers. The company offers over 1,500 schemes tailored to satisfy various customer segments.

With the current state of affairs, while the fate of the players in the auto finance industry seems uncertain, the customer will definitely drive away with superior service at more favourable rates.

Copyright © 1997 Indian Express Newspapers (Bombay) Ltd.