Banks are bracing themselves for demands from City watchdogs to pay billions of pounds to customers who were illegally hit with hidden commission charges on loans taken out to buy a new car.
Just this week, it emerged that Lloyds alone, which arranged £15 billion of loans through its Black Horse brand, is potentially facing a bill of £2 billion.
At the same time, other high street banks and finance companies are setting aside billions of pounds in anticipation of being ordered to track down and pay compensation to millions of customers.
The scale of the issue has triggered echoes of the Payment Protection Insurance saga, which saw millions of people misled into taking out expensive insurance policies alongside loans and other finance deals.
Lloyds Banking Group has said it is assessing the potential impact of a landmark court ruling over car finance mis-selling.
Last Friday the Court of Appeal ruled in favour of three car buyers, saying it was unlawful for lenders to have paid a commission to car dealers without the borrowers’ knowledge.
The test case involved borrowers of two other car loan providers – FirstRand Bank and Close Brothers – and concluded that consumers needed to know all the material facts that could affect their borrowing decision including the total commission to dealers, and how it was calculated, in order to be able to consent to the loan.
Close Brothers and FirstRand have indicated that they intend to appeal against the ruling in the UK supreme court.
Separately, City watchdogs at the Financial Conduct Authority (FCA) have been looking at the establishment of a formal regime that would require the firms to identify and compensate the drivers involved.
Lloyds said the court’s decision “sets a higher bar for the disclosure of and consent to the existence, nature, and quantum of any commission paid than had been understood to be required or applied across the motor finance industry prior to the decision.”
It added: “The group is assessing the potential impact of the decisions, as well as any broader implications, pending the outcome of the appeal applications.”
The prospect of having to find billions of pounds to refund customers has triggered a fall in shares of the finance giants involved.
Lloyds had already put aside £450m in February after the UK regulator opened an investigation into the matter, amid concerns that consumers had been charged inflated prices for car loans. But some analysts believe the bank may have to find another £1.5bn to cover potential compensation.
Matt Britzman, Senior Equity Analyst, Hargreaves Lansdown, said cheers around bumper profits at Lloyds have turned to tears “as it looks like the motor finance debacle could cost more than initially thought”.
He added: “Lloyds has set aside £450m already, and analysts had pencilled in another c.£500mn for next year. But with some rumours suggesting the number could be closer to £2bn, that leaves a £1bn hole to be filled in current consensus and shares have dipped 5 percent as a result.
“It’s hard to put an exact number on these things, and Lloyds isn’t the only name with skin in the game. But it does have more exposure than most of its peers, and while the broader Lloyds investment case looks solid, this remains one of the biggest risks.”
Danni Hewson, the head of financial analysis at AJ Bell, said Lloyds was clearly in “damage control mode” and that “any glow from Lloyds’ better-than-expected quarterly numbers last week has well and truly disappeared”.
He added: “This will increase nervousness ahead of the FCA’s own probe into the issue and potentially prolong the agony for Lloyds and the other names affected.”
Analysts at Shore Capital said that the Court of Appeal judgment had “cast a longer shadow of uncertainty over the motor finance industry, which could have significant financial implications for lenders … in terms of potential redress/remediation costs.
“One outstanding question for us is whether the ruling can be extrapolated more broadly to include other lending agreements where commission is payable to a third party as an incentive to distribute a loan.
“For example, the ramifications of this could be huge if it was to include mortgage distribution, which is a largely intermediated industry, albeit there is no suggestion at this stage that this could be the case.”
Analysts at Jefferies said: “The rulings are not specific to motor finance. In theory, this might also apply to commissions paid to credit brokers in the intermediation of other financial products.”
