Billions in Claims Loom Over Lenders Amid Motor Finance Mis-selling Fears

Lenders in the UK are preparing for a potential financial fallout, with billions in claims looming, as concerns over the mis-selling of car finance products intensifies. An ongoing investigation by the Financial Conduct Authority (FCA) into the historical practices of banks and car dealerships has triggered fears of a scandal similar to the Payment Protection Insurance (PPI) crisis in a scale that could leave major lenders to face significant compensation charges.

The Mis-Selling Allegations: What’s at Stake?

The mis-selling of motor finance products happens when brokers and dealers employ selling practices where customers are not well-informed of the true costs of their car loans. This typically involves inflated interest rates and undisclosed commissions.

The adverse effects of being stuck in mis-sold deals cannot be ignored, as consumers can end up with significant financial burdens, emotional stress, low credit scores, loss of trust towards financial institutions, and many others.

A notable case escalated to the Financial Ombudsman Service is the Black Horse finance claims of a certain Mrs. Young, who spent at least £7,600 in 2016 for a used car. She wasn’t made aware that her loan included a secret commission that the salesman can earn from her loan’s inflated interest rate. She was vulnerable to accepting the deal, considering that she has already been turned down for four other finance products.

Mrs. Young’s experience did not just highlight the significant personal financial burden she faced while she’s forced to pay hundreds more than necessary. It has also made her case an important example for the major regulatory investigation of the larger problem of mis-selling in the car finance industry.

FCA Investigation and its Potential Consequences

The consumer watchdog FCA has recently announced that it will launch a review into the motor finance sector to determine, among other things, whether banks knowingly engaged in deceptive practices that potentially affects thousands of people like Mrs. Young.

A report on the matter is expected in September.

The financial impact of these mis-selling allegations could be substantial, based on varying estimates by industry analysts.

For one, HSBC predicts that the industry could face as much as £16 billion of potential charges for the banks. Meanwhile, analysts at Citi estimate it to be as much as £9 billion.

Moreover, analysts at Jefferies forecast that the industry could be hit with around £13 billion.

Lender Exposure and Market Impact

Lloyds is expected to take the greatest financial hit, according to HSBC, considering that it owns Black Horse, which holds a 20% share of the car finance market. Stock analysts estimate the bank’s costs to range between £1.3 billion and £2.4 billion.

Investors are anticipating Lloyd’s response to the FCA’s activities or are likely to raise the matter with Lloyds’ chief executive Charlie Nunn when the bank presents its annual report later this week.

Barclays may only have a market share of 2.5% in the UK car finance market, but it’s still not spared from the scandal. The bank serves the market through its subsidiary, Clydesdale Financial Services, trading as Barclays Partner Finance.

Last month, the ombudsman ordered Barclays to pay compensation after the dealership failed to inform a certain “Miss L” about commissions during her purchase of a car in 2018. 

Barclays isn’t as vulnerable as Lloyds though. Its “tiny exposure” in the market makes the impact of these challenges likely just a “rounding error,” according to analyst Gary Greenwood at Shore Capital.

Analysts at RBC have also estimated that Close Brothers finance claim compensation can reach as high as £200 million.

The car finance market has grown rapidly, further intensifying the possible impact of FCA’s investigation. Between 2011 and 2018, the amount of money lent to people purchasing cars at dealerships almost tripled from £14 billion to £47 billion, HSBC disclosed.

The huge growth during this period means that many more people might have been given loans they didn’t fully understand. What the FCA finds out in its investigation could have a big effect, not just on the banks involved, but also on the entire financial market.

Kate Robinson at Avyse Partners, a firm that advises lenders on regulatory matters, notes that while the brokers were involved in the process, it’s the banks that are being held responsible, with lenders being “held to the fire somewhat” by the brokers. 

Industry Reaction and Concerns

Last week, Close Brothers cancelled dividend payout, amounting to around £100 million, to brace itself for the potential compensation costs related to the financial watchdog’s investigation. The company said that it is yet to assess whether they will once again pay out dividends beginning 2025.

Robinson explains that the banks are in this “holding pattern” because it has not yet been determined whether discretionary commission models, which are the main focus of the FCA review, cause systematic harm.

On the other hand, Lloyds’ CEO was expected to announce a large buyback of shares, which UK’s finance experts estimated to be a £2.2 billion payout. However, due to the recent developments regarding the motor finance issue, analysts are speculating that Lloyds will recognise some form of remediation charge.

A Potential PPI-Style Scandal?

The current issue of mis-selling in the motor finance industry has triggered fears that it could blow up into a scandal similar to the Payment Protection Insurance (PPI) crisis, in duration and scale.

Just as the PPI scandal unfolded over several years and resulted in significant financial losses for banks, the ongoing regulatory investigation into motor finance practices could lead to prolonged legal battles and substantial compensation costs for lenders.

The Landmark Case on Mis-sold Car Finance

The recent landmark ruling of the Financial Ombudsman over the pivotal test case of “Mrs Young vs Black Horse” has paved the way for more than a million people to file a complaint on their car finance agreements. 

Mrs. Young, whose first name was withheld in documents, bought a car in 2016 with a Black Horse loan arranged by the salesman at her car dealership who is also a regulated loan broker. She spent more than £7,600 on the car, without knowing about the salesman’s secret commission that caused her to pay higher interest rates.

Represented by law firm Bott and Co, Mrs. Young challenged the terms of the loan.

In the end, the Financial Ombudsman upheld the compensation case and Mrs. Young was awarded £630. Her compensation may be modest, but the size of the car finance industry suggests that the problem might become very expensive if mis-selling is found to be widespread.