A growing scandal over mis-sold motor finance could leave lenders facing compensation bills of up to £30 billion, according to a warning from leading credit rating agency Moody’s.
The estimate is the highest so far and raises concerns that the issue could mirror the payment protection insurance (PPI) debacle, which ultimately cost firms around £50 billion in redress.
While major banks like Lloyds Banking Group, Barclays, and Santander UK may be able to absorb the impact, smaller and more specialised lenders—including Close Brothers, Aldermore, Investec, and the financing arms of Ford and Volkswagen—could suffer a “more significant hit to earnings and capitalisation,” Moody’s cautioned.
The motor finance industry has been under increased pressure since the Financial Conduct Authority (FCA) banned discretionary commissions in car loan deals in early 2021. The regulator was concerned that such commissions—paid by lenders to car dealers or credit brokers for arranging finance—were unfair because they incentivised higher interest rates for borrowers.
Consumer complaints about these payments have escalated, prompting the FCA to announce a wide-ranging review in January, examining discretionary commissions dating back to April 2007. This ongoing inquiry has unsettled the industry, fuelling speculation that the watchdog may compel car loan providers to compensate affected borrowers.
In July, the FCA indicated that the likelihood of requiring compensation was “more likely than when we started our review.” Moody’s estimates that potential redress costs for the industry could range between £8 billion and £21 billion.
The situation could worsen if a recent Court of Appeal ruling is upheld. Last month, judges determined that any commission not properly disclosed to a borrower was unlawful, making lenders liable to repay the money to consumers. This ruling applies to all types of commission, not just the discretionary arrangements under the FCA’s focus, potentially adding a further £9 billion to the compensation bill, according to Moody’s.
By setting a higher standard for commission disclosure, the court has opened the door to a new wave of consumer complaints. Close Brothers and FirstRand (owner of Aldermore), the lenders central to the ruling, plan to appeal to the Supreme Court. Meanwhile, the judgment has thrown the industry into turmoil, with some lenders temporarily halting their car loan operations to ensure compliance.
Santander UK delayed its third-quarter results to assess the impact of the judgment and is expected to release its figures on Wednesday.
There is uncertainty regarding the scope of the judgment, with speculation that it could extend to commissions paid in other types of consumer finance. Moody’s warned that if this is the case, it would “result in a significantly broader and more negative impact” on many lenders.
Most banks and the finance arms of car manufacturers have yet to set aside funds to cover potential motor finance compensation. Lloyds Banking Group is one of the few that have made provisions, earmarking £450 million.
As the industry grapples with the potential financial fallout, comparisons to the PPI scandal have intensified. The scale of the possible compensation payments raises serious concerns about the stability of smaller lenders and the broader impact on the UK’s financial sector.
