How does the car finance decision affect UK banks?

The UK banking industry is on high alert for a possible wave of compensation claims after top UK judges ruled in favor of consumers who believed they had paid too much for car finance products.

In cases against Firstrand Bank and Close Brothers, the Court of Appeal agreed with customers who said they were being overcharged because of “hidden” commissions earned by brokers through discretionary commission arrangements.

The case centered on whether brokers owe a fiduciary duty to their clients, meaning they have a legal obligation to act in the best interests of another person or entity.

The bank most exposed to the problem was Close Brothers, which lost a quarter of its shares within a day after the decision. As a result, the group stopped selling new vehicle loans.

The Financial Conduct Authority, which is conducting its own review of the practice, has paused the eight-week period during which firms must respond to complaints, but the wider impact on the industry remains unclear.

What are discretionary commission agreements?

Until the practice was banned in 2021, car dealers in the UK received a percentage of the total interest paid by customers as a commission. They could also adjust the interest rates on these loans, known as discretionary commission arrangements.

When the FCA banned them, it asked companies to review their practices and address any harms identified as a result. The regulator stressed the importance of doing this, given that motor vehicle finance is not protected by the Financial Services Compensation Scheme like many other types of consumer credit. The FCA said it was concerned that the use of discretionary commission agreements may have given brokers and dealers an incentive to charge customers higher interest rates.

Earlier this year the FCA launched a review into discretionary commission agreements following two new decisions in favor of claimants by the Financial Ombudsman Service and others in the district courts, after their initial complaints were dismissed by the companies concerned. .

The FCA has also temporarily suspended the eight-week deadline for automotive finance companies to respond to relevant customer complaints for a period of nine months. Effects on Companies”.

What is the significance of the case?

Early last month, Court of Appeals judges ruled that certain commissions paid by lenders to auto dealers were unlawful, prompting lawyers and analysts to warn that a precedent could be set that would lead to serious liabilities for auto finance lenders.

Hüseyin Sevinç, senior director of financial institutions at Fitch Ratings, said the decision “materially increases” the possibility of a compensation plan to compensate customers.

But analysts at Jefferies said the decision may not be as concerning as initially thought. This is primarily because it has already been assumed that the FCA review will find something wrong with the motor market. But the case also found that the “privacy” finding depends on the facts of each case, making it difficult to apply marketwide.

Jefferies said the real issue now was whether the FCA should take a tougher approach to motor compensation calculations. The better scenario would be the same template used in payment protection insurance reimbursement, where lenders are told to pay only a portion of the commission.

But analysts warned that if the compensation plan is based on the Court of Appeal’s finding that the lender has a fiduciary duty to its customers, it may be difficult to avoid a compensation plan that fully compensates for the entire commission paid. The added difficulty is the result of one of the situations where the client is compensated for the entire commission amount.

Who is most at risk?

Close Brothers, Lloyds Banking Group, Bank of Ireland, Investec Bank, Paragon, Santander UK and Firstrand Bank were affected by this issue. Close Brothers has the greatest relative exposure with these loans accounting for around 20 per cent of its loan book, followed by Bank of Ireland at around 13 per cent. According to Fitch Ratings, the risks of Lloyds, Santander UK and Paragon are around 2-3 percent.

Close Brothers’ shares have lost half their value in the last six months, while Lloyds has lost 7 percent.

Following the case, in which Firstrand and Close Brothers said they would appeal to the Supreme Court, Santander delayed the release of all UK results until the end of October, saying it was trying to determine the potential cost of the court decision.

According to the Financial Times, a group of credit institutions affected by the situation held “urgent talks” with the Undersecretariat of Treasury and warned against possible turmoil in the automotive finance sector. There are warnings that this could lead to a repeat of the PPI crisis, which cost the UK’s banking sector around £50bn.

Close Brothers has suspended all vehicle finance loans, while Lloyds Banking Group, owner of Black Horse, the UK’s largest vehicle finance provider, has suspended commission payments on new vehicle finance loans. Finance departments of automakers BMW and Honda briefly stopped issuing new car loans last week, the Financial Times reported.

Meanwhile, the FCA said it was focused on ensuring customers were “fairly treated” in accordance with the law.

Analysts are divided on whether the impact of the case can yet be measured and, if so, how much banks will have to pay. Previous estimates of the full cost of compensation have ranged from £6bn to £18bn.

However, analysts at Citi said it was “almost impossible” to calculate the estimated amount that could be paid out since the outcome of the case, but warned it also increased the risk of this spreading to other products sold and distributed through third channels. parties.

Others are less pessimistic. Analysts at Jefferies argue the market may be “overdone.” “He is in danger of missing out on all the good things going on in this industry.”

What are discretionary commission agreements?

What is the significance of the case?

Who is most at risk?

Related Posts