A growing scandal over mis-sold motor finance could result in compensation bills of up to £30 billion for lenders, according to a warning from credit rating agency Moody’s. This latest estimate raises concerns that the issue could rival the scale of the payment protection insurance (PPI) scandal, which ultimately cost UK firms around £50 billion in redress.
The impact of the scandal may be more severe for smaller, specialist lenders, such as Close Brothers, Aldermore, Investec, and the financing arms of Ford and Volkswagen. While larger banks like Lloyds Banking Group, Barclays, and Santander UK may be better positioned to absorb the costs, Moody’s cautioned that these smaller institutions could face a “more significant hit to earnings and capitalisation.”
The motor finance industry has been under growing scrutiny since the Financial Conduct Authority (FCA) banned discretionary commissions in car loan deals in early 2021. These commissions, paid by lenders to car dealers or credit brokers for arranging finance, were seen as unfair, as they incentivised higher interest rates for borrowers.
The ban followed increasing consumer complaints about the commissions, leading the FCA to launch a comprehensive review in January, examining such payments dating back to April 2007. The ongoing investigation has prompted speculation that the regulator may soon require car loan providers to compensate affected borrowers.
In July, the FCA indicated that compensation for mis-sold finance was now “more likely than when we started our review.” Moody’s estimates the potential compensation costs could range from £8 billion to £21 billion for the industry.
The situation worsened last month following a Court of Appeal ruling, which determined that any undisclosed commission paid to a borrower was unlawful, making lenders liable to repay the money. This ruling applies to all types of commission, not just discretionary payments, and could add up to £9 billion to the compensation bill.
The judgment has caused turmoil in the industry, with some lenders halting car loan operations to ensure compliance. Close Brothers and Aldermore, central to the ruling, are planning to appeal to the Supreme Court. Meanwhile, Santander UK has delayed its third-quarter results to assess the financial impact of the judgment, with figures expected to be released Wednesday.
Uncertainty surrounds the scope of the ruling, with speculation that it could extend to other forms of consumer finance, which would amplify the potential fallout for lenders. Moody’s warned that a broader application of the judgment could have a “significantly more negative impact.”
So far, most banks and car finance arms have not set aside funds to cover potential compensation, with Lloyds Banking Group being one of the few to make provisions, earmarking £450 million. The scale of potential compensation payments has raised concerns about the stability of smaller lenders and the wider impact on the UK’s financial sector.
