LONDON/FRANKFURT • A plunge in sales of diesel cars in Europe's two biggest markets is helping to drive down the value of used vehicles, posing a risk to the lucrative financing plans used by major automakers to sell millions of cars.

After Volkswagen's emissions test cheating scandal, authorities across Europe are looking to raise taxes on diesel vehicles that are more polluting than originally thought, and ban or restrict their use in some cities.

That is starting to hit demand hard, with new diesel car registrations last month dropping 19 per cent in Germany and 27 per cent in Britain, according to data this week.

This, in turn, is beginning to weigh on used car prices. With regulators also looking to encourage a shift to cleaner vehicles, there seems little prospect of a recovery soon.

The outlook is particularly uncertain in Britain, where car sales hit a record high last year, fuelled by finance packages that now account for nearly 90 per cent of sales, versus around half 10 years ago, according to Exane BNP Paribas analysts.

Under the "personal contract plans", customers pay a small deposit towards a new car and then make monthly payments for two to three years. After that, they can either buy the car outright or return it to be sold secondhand and use the equity to take on a new car, beginning the cycle of monthly payments again.

How much they can borrow depends on what the finance company believes the vehicle will be worth after the 24- or 36-month period.

If residual values fall more than expected, customers will have less money to buy a new car - potentially hitting demand for all new vehicles, petrol as well as diesel.

"It's a big potential problem if that carries on because it reduces the affordability of vehicles (potentially) quite significantly," said Exane BNP Paribas analyst Stuart Pearson.

"The question is how fast those residuals go down. In the US, we've seen them come down almost 20 per cent now, so the UK may have only just begun."

The United States has seen a sharp fall in residual values in recent years as demand - which recovered much more quickly than in Europe in the wake of the financial crisis - has stalled and automakers have slashed prices to try to shore it up.

A similar fall in Europe would hit carmakers that have become increasingly reliant on their financing businesses.

Operating profit at Volkswagen Financial Services leapt 10 per cent to €2.1 billion (S$3.2 billion) last year, compared with group underlying operating profit of €14.6 billion.

Residual values in Britain have fallen around 3 per cent over the past two years, with diesel vehicles particularly affected and the trend has been seen in other European countries too, according to some analysts.

Leasing and finance contracts are both generally priced using an assumption of stable residual values. A sharp fall in used car prices could trigger a spike in leasing prices, which could further dampen demand and increase defaults.

According to Evercore ISI analysts, the cost for eight major European and US carmakers of a 5 per cent cut in residual values in Europe could reach a combined €1.6 billion.

The big three German carmakers would suffer the most, with Volkswagen taking a hit of more than €500 million to earnings, followed by BMW and Daimler.

BMW said on Wednesday it expected a small fall in return on equity in its financial services business this year, although it would remain above its target of 18 per cent.

Concerns about the way finance packages are sold have also prompted Britain's Financial Conduct Authority to conduct a review, warning there may be a "lack of transparency, potential conflicts of interest and irresponsible lending".

British consumer borrowing late last year expanded at its fastest annual rate in 11 years.

But Mr Graham Hill, car finance expert at the National Association of Commercial Finance Brokers, said firms were able to adjust to falling residual values and many would have factored in a potential big fall.

A car with an expected final payment of £10,000from the customer might, for example, be put into the finance provider's books at £9,000, he said.

"They're not naive enough to think that there are things which are going to happen from time to time."

REUTERS