Car finance scandal could cost lenders £30bn, warns Moody’s

A mounting scandal over mis-sold motor finance could leave lenders footing a compensation bill of as much as £30 billion, a leading credit rating agency has warned.
Moody’s estimate is the highest so far and will fuel speculation that the scandal facing banks and other car loan providers will mirror the payment protection insurance debacle, which ultimately resulted in firms absorbing about £50 billion in redress costs.
While larger lenders such as Lloyds Banking Group, Barclays and Santander UK are likely be able to soak up the impact, smaller and more concentrated firms, including Close Brothers, Aldermore, Investec and the financing arms of Ford and Volkswagen are threatened with “a more significant hit to earnings and capitalisation”, Moody’s cautioned.
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It also warned that the problem confronting banks could become more serious if a Court of Appeal ruling last month has a bearing on other areas beyond car loans.
The motor finance industry has been under pressure ever since the Financial Conduct Authority banned discretionary commissions in car loan deals in early 2021. The regulator was concerned that this type of commission, paid by lenders to car dealers or credit brokers for arranging finance, was unfair because it provided an incentive for borrowers to be charged higher interest rates.
Consumer complaints about these payments have mounted in recent years, prompting the authority to announce in January a wide-ranging review of discretionary commissions as far back as April 2007.
This inquiry, which is in progress, has rattled the industry and stoked speculation the watchdog will decide to force car loan providers to compensate borrowers. The regulator said in July that this outcome was “more likely than when we started our review”. Moody’s, which assesses the creditworthiness of companies, reckons this could amount to between £8 billion and £21 billion in redress costs for the industry.
The bill could rise by a further £9 billion if last month’s court judgment is upheld, it added. The ruling widens the problem facing lenders because it applies to all types of commission, not just the discretionary arrangements that are the focus of the FCA.
The judges found that any commission which was not properly disclosed to a borrower was unlawful and that lenders were liable to repay the money to consumers. In doing so, the court has set a much higher bar for the disclosure of commissions that goes beyond existing regulation and has paved the way for a fresh wave of consumer complaints.
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Close Brothers and the Aldermore owner FirstRand, the lenders that are the focus of the ruling, intend to appeal to the Supreme Court, which will have the final say. In the meantime the industry has been thrown into turmoil by the judgment, with some lenders temporarily pausing their car loan operations while they ensured their processes complied with the ruling.
Santander UK delayed its third-quarter results to consider the judgment and will release its figures on Wednesday.
There is also uncertainty about the judgment’s scope, and speculation that it could apply to commissions paid in other types of consumer finance. Moody’s said it would “result in a significantly broader and more negative impact” on many lenders if this was the case.
Most banks and finance arms of car manufacturers have yet to set aside money to cover any motor finance compensation they might owe. Those that have made provisions include Lloyds, which has earmarked £450 million.