A growing scandal over mis-sold car finance could leave lenders facing compensation bills of up to £30 billion, according to a warning from leading credit rating agency Moody’s.
The estimate is the highest yet and raises concerns that the issue could mirror the payment protection insurance (PPI) debacle, which ultimately cost companies around £50 billion in damages.
While big banks such as Lloyds Banking Group, Barclays and Santander UK may be able to absorb the impact, smaller and more specialist lenders – including Close Brothers, Aldermore, Investec and the financing arms of Ford and Volkswagen – could face a ‘more significant negatively impacted earnings and capitalization,” Moody’s warned.
The car finance sector has been under increased pressure since the Financial Conduct Authority (FCA) banned discretionary commissions on car loans in early 2021. The regulator was concerned that such commissions – paid by lenders to car dealers or credit brokers for arranging financing – were unfair because they encouraged higher interest rates for borrowers.
Consumer complaints about these payments have escalated, prompting the FCA to announce a comprehensive review in January, examining discretionary commissions dating back to April 2007. The ongoing investigation has rattled the industry and fueled speculation that the watchdog could force auto loan providers to provide compensation. affected borrowers.
In July, the FCA indicated that the likelihood of claiming compensation was “more likely than when we began our review.” Moody’s estimates that the potential recovery costs for the sector could be between £8 billion and £21 billion.
The situation could worsen if a recent Court of Appeal ruling is upheld. Last month, judges ruled that any commission not properly disclosed to a borrower was illegal, forcing lenders to return the money to consumers. This ruling applies to all types of commissions, not just the discretionary schemes subject to the FCA’s attention, potentially adding a further £9 billion to the compensation bill, according to Moody’s.
By setting a higher standard for commission disclosure, the court has opened the door to a new wave of consumer complaints. Close Brothers and FirstRand (owner of Aldermore), the lenders at the center of the ruling, plan to appeal to the High Court. Meanwhile, the ruling has roiled the industry, with some lenders temporarily suspending their auto loans to ensure compliance.
Santander UK postponed its third-quarter results to assess the impact of the verdict and is expected to announce its figures on Wednesday.
There is uncertainty about the scope of the ruling, with speculation that it could extend to commissions paid in other forms of consumer finance. Moody’s warned that if this were the case, it would have “a significantly broader and more negative impact” on many lenders.
Most banks and car manufacturers’ finance departments have yet to set aside money to cover potential car financing offsets. Lloyds Banking Group is one of the few to have made provisions, worth £450 million.
As the sector grapples with the potential financial fallout, comparisons to the PPI scandal have intensified. The scale of the potential compensation payments raises serious concerns about the stability of smaller lenders and the wider impact on the UK financial sector.