The failure of Tricolor, a car lender little known outside of its low-income customer base in a few US states, is a good moment to reflect on how modern banking works. Tricolor filed for bankruptcy on Wednesday, and is being probed by the US Justice Department over allegations of fraud. Thanks to the rise in so-called shadow banking, this mini-drama has maxi-implications for banks everywhere.
Tricolor offered high-interest loans to low-income consumers, notably in Hispanic communities in states such as Texas, California and Nevada. Since it isn’t a bank and therefore does not take deposits, it borrowed from institutions including JPMorgan, Fifth Third and Barclays, lent to car buyers, then bundled its auto loans as securitised bonds to sell to institutional investors. With the proceeds, it then paid back its own lenders, rinsed, and repeated.
The amounts involved at Tricolor were small in the context of the US financial system. Tricolor had about a $1bn credit line with its bank lenders. The $200mn loss that Fifth Third is contemplating compares to its $21bn of shareholder’s equity.