Motor finance: Lloyds, Close Brothers and Santander brace for ‘shockwaves’
Judgement day nears for some of the UK’s biggest lenders as the motor finance scandal heads to the country’s highest court this week.
The Supreme Court will decide whether to uphold the Court of Appeal’s October ruling that it was unlawful for banks to pay a commission to a car dealer without the customer’s informed consent.
The hearings will take place from 1-3 April, as Close Brothers and First Rand look to get October’s judgement overturned.
If an adverse judgement is handed down to the banks, the Financial Conduct Authority (FCA) has said it will confirm an industry-wide redress scheme within six weeks.
Any scheme brought forward by the FCA is predicted to rival PPI on both scale and cost, with analysts predicting major ramifications across the financial industry.
Both a judgment and a redress scheme could come ahead of lenders’ half-year results, with the UK’s top banks set to post a six month update in late July.
In annual results reports, lenders have reserved funds for potential payouts, which have resulted in major losses for the likes of FTSE 100 giant Lloyds.
Total claims could be north of £30bn
Lloyds led the pack for facing the biggest hit in provisions after the bank put aside a near £1.2bn.
Besides Lloyds, major lenders with historical exposure to the matter include Barclays, Bank of Ireland, Close Brothers and Santander.
Analysts at RBC Capital produced an impact assessment that forecasted potential repercussions following the Court’s ruling.
Total compensation could reach £32bn, analysts said, which aligns with ratings agency Moody’s view that claims could top £30bn.
The RBC analysts estimated the base case impact across the banking sector, which included compensation, interest and administration costs, would be £5.9bn.
However, consensus on possible downsides nearly doubled this figure to £10.8bn.
Should the saga steer towards downsides, analysts expect Lloyds to add another £1bn in compensation, bringing its total to £4.6bn when including interest and administrative costs.
Shares across UK lenders sank into the red following to Court of Appeal’s ruling, with Close Brothers losing 6.5 per cent and Lloyds down three per cent.
Following the Treasury’s rejected intervention in the case, Close Brothers shares sunk as much as nine per cent, and Lloyds were down four per cent.
Russ Mould, investment director at AJ Bell, said shareholders would be “watching nervously” with the hearing marking the “next milestone” in the scandal.
Smaller lenders facing ‘existential’ threat
Firms outside of the industry giants who have exposure to car finance have also faced hits, with Secure Trust Bank and Vanquis Banking Group losing between 10 and eight per cent after the Supreme Court brushed off the government’s intervention.
Anna Sherbakova, senior analyst at Moody’s ratings, said: “The continued uncertainty is particularly credit-negative for small banks with high exposure to motor finance, as they need to maintain substantial capital and liquidity buffers for potential consumer compensation costs.”
For the bigger lenders with deeper pockets, Sherbakova anticipated an adverse ruling “would likely be limited given their high levels of capital, strong profitability and ability to adjust financial policies to absorb any potential costs.”
Andrew Foyle, partner at Shoosmiths, said the outcome for smaller lenders could be “existential”.
He added: “The sector has already seen some lenders scale back or pull out of the market completely.
“Ironically, that might be bad for consumers as less choice and less competition in the market tends to result in poorer deals for customers.”
Helen Simm, partner at Browne Jacobson, said: “It seems inevitable that full redress across all disclosure complaints will cause several lenders to exit the market.”
Impact will be ‘far wider’ than car finance
The precedent set by the Supreme Court’s ruling is expected to make waves beyond the banking sector.
Tom Webley, partner at Reed Smith, warned of the “shockwaves” heading towards lenders and wider industries.
Webley said the “huge potential impact” on the economy was the headline reason for the government’s attempted intervention.
The Treasury had amplified lenders’ concerns that resulting fines could trigger a withdrawal of companies from the sector and prevent customers accessing credit to buy cars.
But, Webley highlighted the “impact could be felt by any organisations which provide credit through a commission-earning intermediary.”
“This should be being monitored closely by any entity involved in the provision of finance through intermediaries or whose sales depend on such financing arrangements.”
How did we get here?
The FCA first began investigating the motor finance market in 2016 due to growing concerns over lending practices.
A 2017 report from the regulator titled ‘Motor Finance Market Study’ raised concerns about the lack of transparency in the way car finance dealers were structured.
The regulator introduced stricter rules in 2019 requiring lenders to clearly disclose the total cost of the car finance, including any additional charges or ballooned payments.
The fallout of this led to significant compensation claims as customers believed they were mis-sold or overcharged on their deals.
The use of discretionary commission arrangements (DCA) were forbade in 2021, with the FCA claiming it would save customers £165m a year.
In a landmark ruling in October 2024, the Court of Appeal found it was unlawful for car dealers to receive commissions from lenders without the customer’s informed consent.
Ahead of the Supreme Court battle, the Treasury attempted to intervene in the case sharing fears over the impact on the economy, but was swatted away by the Supreme Court.
The banks have now tapped the country’s leading law firms to help them fight a case that could cost the lenders and the industry billions.