Car finance scandal and other misconduct will cost lenders £25bn

Misbehavior, including the growing scandal in the car finance industry, could cost lenders at least £25bn, the Bank of England has warned.

Sam Woods, deputy governor of the Bank, said it was not considered a risk to the UK’s financial stability.

But he warned yesterday that in the past, this type of misconduct “has often been a pretty significant obstacle.”

He added: “We have spent a lot of time on that issue.”

Lenders continue to count the cost of a recent Court of Appeal ruling into the way car dealers sold loans to customers to finance vehicle purchases.

In a ruling that surprised the industry, the court said it was illegal for distributors to receive a commission from those banks without receiving the customer’s informed consent.

The Financial Conduct Authority (FCA) has said this means many customers who took out a loan through a dealer may be owed compensation.

Credit rating agency Moody’s has estimated that the total cost of the industry could reach £30bn.

Woods set out the Bank of England’s response as it published its semi-annual Financial Stability Report, which assesses the health of the British financial system and its ability to cope with significant stresses both in the UK and globally.

The report said: “Some lenders face uncertainty about the potential for compensation payments associated with certain historical commission payments.”

Woods told reporters: “We didn’t try to make a point estimate on that particular issue; what we did was take a crude but cautious approach.”

Instead, the Bank extrapolated the assumptions it had made in previous ‘stress tests’ giving average annual costs of £5 billion for ‘conduct’ issues and multiplied them over five years.

“That’s a £25bn hit. Even if it takes a hit of that magnitude, the system still has a lot of room to maneuver,” Woods said.

‘We do not consider this issue to be a risk to financial stability. But misconduct has often been a pretty significant obstacle and our job is to make sure we capture it adequately in the stress tests we conduct.’

Lloyds Banking Group is among lenders facing a potentially large compensation bill and has set aside £450m to cover the cost.

Meanwhile, Santander UK has set aside £295m.

Two smaller lenders, Close Brothers and Investec, have also revealed that they continue to face uncertainty over the impact of the scandal. The lenders involved in the court case plan to appeal.

The Bank’s broader assessment in yesterday’s report concluded that “UK household and corporate borrowers are likely to remain resilient.”

This is despite growing complaints from businesses that they are facing Labor budget measures, including a £25bn raid on employers’ National Insurance and a sharp rise in the minimum wage, as well as the introduction of a series of new workers’ rights.

The report did point to broader risks faced by smaller companies, as well as companies saddled with large debts, including those owned by private equity firms.

Asked about the budget’s negative impact on businesses, Bank of England Governor Andrew Bailey said: “At the moment we are not seeing any signs of an increase in corporate distress.

“But, as expected, we will be watching very closely how the effects of all this trickle down to both the business and household sectors.”