Will the FCA's motor finance probe lead to PPI-style payouts?

A regulatory probe into the historical sale of loans by the UK motor finance industry could mirror the PPI scandal and result in billions of pounds of compensation. 

Some analysts fear the surprise Financial Conduct Authority review, launched last month, represents a ‘powder keg’ that threatens the future of the country’s motor finance sector.

It follows complaints from consumers claiming their compensation for so-called ‘discretionary commission arrangements’ were unjustly rejected by lenders.

The Financial Ombudsman Service recently ruled in favour of two customers whose complaints were turned down by motor finance groups. Other claims have been upheld in county courts. 

Probe: The Financial Conduct Authority (FCA) launched a review last month into the historical sale of loans by the motor finance industry

The FCA has now told lenders to stop handling any complaints they have received about DCAs since 17 November for nine months and extended the period consumers can refer their grievances to the FOS from six to 15 months.

Some commentators believe this saga will lead to another PPI-style scandal, which cost banks, building societies, and credit providers tens of billions in compensation.

Will motor finance companies be on the hook for a similar amount?

What were DCAs and why are they controversial? 

Involved in around three-quarters of all car financing deals between 2007 and 2020, DCAs allowed vehicle dealerships and brokers to decide the interest rate on a car purchaser’s finance agreement.

This incentivised brokers to charge customers higher rates regardless of other factors, such as the loan agreement’s length, a customer’s credit score or the loan’s value. 

An FCA report published in 2019 estimated that customers on a typical four-year £10,000 motor finance deal were paying an extra £1,100 in interest charges.

It questioned why brokers had such significant discretion to set rates and warned that the set-up threatened to ‘break the link’ between interest rates and a person’s credit risk.

Given all these factors, the FCA banned DCAs two years later, estimating this would save consumers about £165million per annum.

Why has the FCA launched a motor finance probe? 

While the regulator has scrutinised the motor finance sector for some years, it has ‘been asleep at the wheel,’ according to Simon Evans, who runs the Consumer Redress Association, a trade body for the claims management businesses.

‘We have long said that there is a systemic problem with financial services firms that is detrimental to consumers, in this instance with salesmen and intermediaries who want to play the system to line their own pockets at the detriment of consumers when taking out car finance,’ he adds.

Over the past year, complaints related to motor commissions have surged, with the Financial Ombudsman hearing from around 10,000 people who believe they paid too much for motor finance.

The FOS has upheld claims from two women – referred to as Mrs Y and Miss L – who respectively made commission deals with Barclays and Black Horse, Lloyds Bank’s motor finance lending arm.

It ruled that both were not treated ‘fairly and reasonably’ because they were unaware their brokers were paid commissions and had the incentive to charge them above what Barclays or Black Horse would have accepted.

‘I’ve worked with dealerships in the past and seen where they’ve had hidden tools for the dealer to manipulate the interest rate without the customer knowing about it,’ says Stuart Masson, editorial director at The Car Expert website.

Following the FOS rulings, regulators expected to receive a deluge of complaints from people demanding compensation.

As a result, the FCA has asked motor finance lenders to pause their response to relevant customer complaints to prevent any ‘disorderly, inconsistent and inefficient outcomes for consumers and knock-on effects on firms and the market’.

Compensation: As discretionary commission arrangements were so commonly used to fund car purchases, millions of Britons could receive payouts if the FCA proves wrongdoing

Will the FCA investigation be positive for consumers? 

As DCAs were so commonly used to fund car purchases, millions of Britons could potentially receive payouts if the FCA proves wrongdoing.

For that to happen, it has to prove the misconduct was a ‘widespread issue across the industry, not just one or two finance companies and a few dealerships,’ says Masson.

If it is successful, motorists could expect to receive a modest amount of damages.  Bott & Co Solicitors estimates the clients it has represented in motor finance cases win over £1,600 on average.

But the launch of a fresh FCA probe almost immediately sparked comments about the potential for ambulance-chasing behaviour among claims firms.  

Indeed, some claims firms stand to benefit handsomely if the FCA comes out with a favourable ruling.

Many lawyers have been itching for another legal goldmine ever since the payment protection insurance scandal died down, according to some observers.

Graham Hill, a motor finance expert on the BBC show Rip-Off Britain, claims he knows at least one class-action law group ‘keen to get stuck into the claims and earn millions from the process’. 

How much will banks end up paying in compensation? 

Deputy governor of the Bank of England and boss of the Prudential Regulation Authority Sam Woods told MPs this week he had been very ‘closely engaged engaged’ with the FCA probe.

He said: ‘I’m not concerned at this point that this is a financial stability issue, but it clearly does have the potential to become a quite significant conduct issue with potentially quite significant financial ramifications,’

Analysts have been throwing around massive figures. Broker Jefferies predicts the motor finance industry could end up paying a whopping £13billion related to the scandal.

RBC Capital Markets suggests anywhere between £6billion and £16billion, having recently upgraded its estimates following a recent FCA webinar on historical motor commission arrangements.

The investment bank thinks Lloyds Banking Group, Black Horse’s parent company and the UK’s biggest motor finance lender, could pay out around £2billion alone in compensation.

Large sums: RBC Capital Markets suggests motor finance lenders could end up paying Britons anywhere between £6billion and £16billion

It also anticipates Santander UK will have to cough up £850million, while Barclays and Close Brothers will pay up to £120million and £150million, respectively.

While such compensation levels may be of keen interest to consumers, Graham Hill warns the FCA is ‘sitting on a powder keg’ and could destroy the motor finance sector if it forces them to disburse huge sums.

He said: ‘When some of the smaller brokers signed their broker agreements with the large lenders, they signed up to an ‘indemnity clause’ indemnifying the lender against claims made against them resulting from agreements with their introduced customers.

‘This could easily bankrupt the smaller brokers and some of the larger ones as well.’

How might lenders try to pay less compensation? 

Motor finance firms will be keenly aware that they may end up owing an inordinate number of drivers, so they will inevitably be looking to keep their bills as low as possible.

Stuart Masson believes they might attempt to blame the dealers for overcharging customers, though he admits this might be a long shot.

‘What the finance companies will presumably do is say, “We know nothing about this.

‘These are tools that are provided. They’re provided to every dealer around the country, and if they manipulate that without our knowledge, that’s not really our fault.”

‘I don’t know [if] that argument’s going to work very well because they will know exactly what they would have approved for customers and then what the dealer ultimately told the customer the finance rate was.’

Motoring expert Hill also says customers ‘had every right to negotiate down’ their interest rate when negotiating a deal, or shop around for a better offer. 

He adds: ‘Given that customers have 14 days to cancel their finance agreement and replace it with another, even after signing, they could have still rectified the situation by finding a cheaper rate elsewhere.’

Whatever they may argue, motor finance businesses have an uphill battle to prove their lack of fault and avoid suffering from a fallout similar to the one that rocked the financial services sector over the PPI scandal.