Aprobe unveiled by the City regulator (the Financial Conduct Authority) into motor finance deals after a spike in consumer complaints has put UK banks under pressure as they prepare to make provisions for redresses that analysts estimate could reach as much as £16bn.
“If we find there has been widespread misconduct and that consumers have lost out, we will identify how best to make sure people who are owed compensation receive an appropriate settlement,” the FCA said when it launched its investigation in January.
The recent decision by Close Brothers to scrap dividend payouts for the current financial year, coupled with a sharp decline in shares, underscores the profound challenges the company confronts following the FCA's motor finance review.
Close Brothers, a stalwart in the UK’s financial landscape, has seen its shares plummet by 60% since the FCA’s announcement, making it evident that the spectre of potential compensation costs looms large.
The investigation focuses on historical claims of unfair costs related to discretionary car finance commissions, with the FCA pledging to ensure consumers receive compensation if evidence of widespread misconduct is uncovered.
Shares in Close Brothers have more than halved this year alone, reaching record-low prices. The recent 8.4% drop in shares, triggered by the decision to withhold dividends and the uncertainty surrounding the FCA review, reflects the seriousness of the situation. Analysts estimate the potential impact on the motor finance sector at up to £16 billion, with Close Brothers and Lloyds identified as particularly exposed.
Close Brothers, in particular, could face compensation payouts of around £200 million, according to recent analyses, reported in the finance press. Motor finance constitutes a substantial portion, approximately a fifth, of Close Brothers’ £9.5 billion loan book as of July 2023, according to Bloomberg.
The company, in an unscheduled trading update, acknowledged the “significant uncertainty” regarding the FCA’s review and the potential financial implications. The Board, adopting a prudent approach, opted not to recognise a provision in the group’s half-year results, emphasising the need to plan for a range of possible outcomes.
Close Brothers aims to fortify its capital strength while continuing to support customers and preserve its business franchise. The decision not to pay dividends for the current financial year aligns with this strategy, with a reassessment planned for the 2025 financial year and beyond after the FCA concludes its process.
While these measures indicate a proactive stance by Close Brothers, the situation highlights the broader challenges facing financial institutions grappling with regulatory scrutiny and the uncertainties that follow.
Close Brothers emphasises that its business continues to perform well, with the banking division generating £112 million of adjusted operating profit in the six months to January 31, 2024.
However, the overarching narrative remains shaped by the unfolding FCA review and its potential financial repercussions.
Besides, Close Brothers, shares in Lloyds Banking Group, which owns the UK’s largest motor finance provider Black Horse, have fallen about 10 per cent since the announcement.
Consumer advocate Martin Lewis has drawn parallels with the payment protection insurance (PPI) mis-selling scandal, which cost UK banks over £50bn.
Before the FCA banned discretionary commission (DiC) arrangements in 2021, car dealers could set their own interest rates, leading to potential manipulation by salespeople for higher commissions.
Recent mis-selling cases before the Financial Ombudsmand Service, particularly involving Black Horse Motor Finance and Clydesdale (then owned by Barclays), influenced the FCA's decision to delve deeper.
However, experts caution against generalising these cases to the entire motor finance community. Analysis of Lloyds motor loans data, cited in the Financial Times, indicates most customers paid APRs of 5-7% before the DiC ban.
The Finance and Leasing Association (FLA) notes dealers often used the practice to lower interest rates for competitive plans.
Post-2021, the industry adopted a fixed fee model, with rates ranging from 6% to 12%, varying based on consumer risk profiles.
The extent of the scandal remains uncertain, with questions about the FCA's approach, redress schemes, rate differentials, cost burden sharing, and eligibility for refunds.
Julian Rose, author of Apex Insight’s Used Car Finance: Market Insight Report 2024, writes: "Instead of a blanket redress scheme for all DiC cases, I expect we will see FCA and FOS eventually publish new guidance on how to assess DiC complaints. Some redress may well be required, but it should be limited to a minority of agreements, and possibly only a small minority, where DiC was used and there is actual evidence of unfair pricing."
The FCA's probe covers deals from 2007 to 2021, prompting analysts at RBC Capital Markets to estimate that the motor finance sector's impact on bank pre-tax profits could range between £6 billion and £16 billion.
Lloyds Banking Group PLC is anticipated to bear the most significant cost impact, with RBC forecasting £2bn. Barclays PLC and Santander are expected to face impacts of £250m and £850m, respectively. Close Brothers Group PLC is projected to experience an impact ranging between £150m and £230m.
The extent of the FCA's stance remains uncertain, and considering its intensified emphasis on consumer protection under the July-implemented Consumer Duty regulation, the regulatory response could potentially be stringent.
