The UK’s motor finance industry is facing a potential scandal that analysts predict could cost lenders tens of billions of pounds in compensation, rivaling the infamous Payment Protection Insurance (PPI) scandal. This follows a Supreme Court case and ongoing investigations by the Financial Conduct Authority (FCA) into car loan sales practices.
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Shares in major motor finance providers like Lloyds (LLOY.L) and Close Brothers (CBG.L) dipped after the Supreme Court rejected an intervention application from the UK chancellor, Rachel Reeves. Lloyds recently announced a £700 million provision for potential motor finance commission remediation costs in its full-year results, adding to existing concerns.
The Genesis of the Motor Finance Scandal
The FCA’s investigation into motor finance commissions began in 2017, culminating in a 2019 consultation on Discretionary Commission Arrangements (DCAs). DCAs allowed car retailers and brokers to set interest rates, incentivizing them to sell more expensive loans, potentially harming consumers.
The FCA banned DCAs in 2021, projecting annual consumer savings of £165 million. However, the issue resurfaced in January 2024 when the FCA launched a review of historical motor finance DCAs to assess potential misconduct and consumer harm before the ban. A subsequent Court of Appeal ruling broadened the scope to encompass all car finance commissions, potentially leading to a multi-billion-pound redress scheme. This ruling deemed it illegal for dealerships to receive commissions without “fully informed consent” from buyers.
Expanding the Scope and Implications
The October ruling significantly expanded the potential liability for lenders. While the FCA initially estimated the DCA issue alone wouldn’t reach the scale of PPI, the broader scope now raises serious concerns. FCA general counsel Stephen Braviner-Roman acknowledged this uncertainty in a December Treasury committee hearing.
Close Brothers and FirstRand (FSR.JO) appealed the October ruling, and the Supreme Court granted permission for an appeal hearing in April. The Treasury’s unsuccessful attempt to intervene in the case, citing potential economic harm and impact on motor finance availability, further underscores the gravity of the situation.
Lenders Brace for Potential Payouts
Anticipating potential compensation claims, lenders are setting aside funds. Close Brothers provisioned up to £165 million in the first half of its financial year, acknowledging the significant uncertainty surrounding the final cost. Lloyds’ £700 million provision adds to the £450 million allocated last year, bringing their total to over £1 billion. Lloyds CEO Charlie Nunn has voiced concerns about the “investability problem” facing the UK consumer finance sector due to the ruling.
The Path Forward
The FCA plans to outline the next steps in its review in May, potentially offering an update on non-DCA complaints. The Supreme Court’s upcoming hearing in April will be crucial in determining the ultimate scope of the scandal and the potential financial implications for lenders. This developing situation warrants close monitoring by investors and consumers alike.
