Car Finance Claims Probe Could Cost UK Banks £16B including Lloyds and Close Brothers

The Financial Conduct Authority (FCA) continues to investigate the car finance claims involving some of the biggest banks in the United Kingdom, with Lloyds Banking Group and Close Brothers getting significantly impacted. The scandal is expected to cost the car finance industry £16 billion driven by consumers who are alleged victims of mis-sold finance deals.

The watchdog seeks to shed light on loan handling by motor dealers, with particular attention to discretionary commission agreements (DCAs), which purportedly resulted in higher rates and fees. The investigation remains underway but has shown potential consequences for lending institutions, prompting them to reserve funds to cover car finance compensation costs.

Lloyds and Close Brothers affected by probe 

Investors, banks, and dealers have been preparing for compensation costs that could come from the investigation, which is predicted to fall between £6 billion and £16 billion. Major banks have been making moves to at least mitigate the impact of the review. 

Lloyds, regarded as one of the biggest motor lenders in the UK, is expected to carry the heaviest burden. RBC Capital Markets experts predicted the cost to be around £2 billion as the bank set a provisionary amount of £450 million as payment for potential redress. 

The bank, which owns Black Horse, is one of the biggest players in motor lending. It is believed to be the most exposed to DCAs, leading to a 14% drop in share price since January. This comes along with an anticipated drop of 110 in financial resilience basis points.

Another key player, Close Brothers, also announced a provision of £400 million in anticipation of payouts, given the £110 million in potential redress estimated by analysts. This calls into question the bank’s financial resilience, which is expected to erode by 270 basis points. 

The probable damages alerted investors as signalled by the almost 50% drop in stock price, pushing the bank to halt dividend distribution. 

Barclays and Santander funnelled funds toward compensation payouts, with an estimated redress of £250 million and £850 million, respectively.

Meanwhile, some institutions such as NatWest did not see much of an impact.

The probe, initiated in January this year, aims to determine whether financial institutions and motor brokers overcharged customers by adjusting interest rates and cost of car loans without sufficiently informing clients. 

EY, FCA join hands in car finance claims review

Consultancy firm Ernst & Young (EY) joined the FCA in assessing the scope of the scandal to the tune of £12 million in contracts. The two organizations will be looking into motor finance agreements dating back to 2007, indicating just how widespread the issue is. 

EY’s role is expected to provide additional measures in maintaining the integrity of the investigation as firms of its calibre are known for their expertise in regulatory reviews. It also serves to ensure thoroughness and fairness, especially in assessing compensation received by DCA victims. 

This partnership is an extension of the two organizations’ cooperation, signalling the scale of the work being done. The review, spanning over 14 years’ worth of agreements, came after the Financial Ombudsman Service (FOS) reported 17,000 car finance claims, many of which were done before the FCA banned DCAs in 2021.

According to the FCA, “If we find widespread misconduct, we will act to make sure people are compensated in an orderly, consistent and efficient way.”

Customers affected by mis-sold car finance overpaid an estimated of £300 million every year collectively, some paying around £1,100 more than the actual expense of holding a four-year car loan. The agency estimates around £160 million a year in savings. 

The Market faces further challenges as the probe progresses

The financial market has been taking cautious steps as the review continues, with investors keeping a close eye on lenders like Lloyds and Close Brothers. 

While some experts foresee substantial costs, the scale is not expected to reach that of the previous market scandal involving payment protection insurance (PPI). Nevertheless, smaller institutions may face considerable impacts.

The motor lending segment will be seeing substantive changes in the industry, especially in light of the Court of Appeal ruling siding with consumers in the consolidated landmark cases involving MotoNovo and Close Brothers. 

More will be revealed in the coming months as the FCA continues the probe and promises an update by May 2025.