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A regulatory investigation into historic loan selling by the UK car finance industry could mirror the PPI scandal and lead to billions of pounds in compensation.
Some analysts fear the Financial Conduct Authority’s surprise review, launched last month, represents a “powder keg” threatening the future of the country’s auto finance sector.
This is because lenders unfairly rejected consumer complaints seeking compensation for so-called “discretionary fee arrangements.”
The Financial Ombudsman recently ruled in favor of two customers whose claims were rejected by car finance groups. Other claims have been upheld in the county courts.
Investigation: The Financial Conduct Authority (FCA) launched a review last month into the historic selling of loans by the car finance industry.
The FCA has now told lenders to stop handling any complaints they have received about DCAs since November 17 for nine months and extended the period in which consumers can refer complaints 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 auto finance companies be forced to pay a similar amount?
What were DCAs and why are they controversial?
DCAs, which were involved in around three-quarters of all car finance deals between 2007 and 2020, allowed car dealers and brokers to decide the interest rate on a car buyer’s finance deal.
This incentivized brokers to charge customers higher rates regardless of other factors, such as the length of the loan agreement, the customer’s credit score, or the value of the loan.
An FCA report published in 2019 estimated that customers with a typical four-year £10,000 car finance deal were paying an extra £1,100 in interest.
He questioned why brokers had so much discretion in setting rates and warned that the setting threatened to “break the link” between interest rates and a person’s credit risk.
Taking all these factors into account, the FCA banned DCAs two years later, estimating that this would save consumers around £165 million per year.
Why has the FCA launched an investigation into car finance?
While the regulator has scrutinized the car finance sector for some years, it has “been asleep at the wheel”, according to Simon Evans, who heads the Consumer Redress Association, a trade body for claims handling companies.
“We have said for a long time that there is a systemic problem with financial services companies that is to the detriment of consumers, in this case with sellers and intermediaries who want to game the system to line their pockets to the detriment of consumers when they contract auto financing,’ he adds.
Complaints relating to car commissions have increased over the past year, with the Financial Ombudsman hearing from around 10,000 people who believe they paid too much for car finance.
The FOS has accepted the claims of two women – known as Mrs. Y. and miss l – which respectively entered into commission deals with Barclays and Black Horse, the car finance lending arm of Lloyds Bank.
It ruled that both were not treated “fairly and reasonably” because they did not know that their brokers were paid commissions and had the incentive to charge them more than Barclays or Black Horse would have accepted.
“I’ve worked with dealers in the past and seen them have hidden tools for the dealer to manipulate the interest rate without the customer knowing,” says Stuart Masson, editorial director of The Car Expert website.
Following the FOS rulings, regulators expected to receive a flood of complaints from people demanding compensation.
As a result, the FCA has asked car finance lenders to pause their response to relevant customer complaints to avoid “messy, inconsistent and inefficient outcomes for consumers and knock-on effects on businesses and the market”.
Compensation: Since discretionary commission deals were so frequently used to finance car purchases, millions of Britons could be paid out if the FCA proves wrongdoing.
Will the FCA investigation be positive for consumers?
As DCAs were so frequently used to finance car purchases, millions of Britons could receive payments if the FCA is proven to have acted wrongly.
For that to happen, you have to show that the misconduct was a “widespread problem across the industry, not just one or two finance companies and a few dealerships,” Masson says.
If successful, motorists could expect to receive a modest amount of damages. Bott & Co Solicitors estimates the Clients he has represented in car finance cases earn over £1,600 on average..
But the launch of a new FCA investigation almost immediately sparked comments about the potential for ambulance-chasing behavior among claims firms.
In fact, some claims firms will benefit greatly if the FCA makes a favorable ruling.
According to some observers, many lawyers have been eager to find another legal gold mine since the payment protection insurance scandal died down.
Graham Hill, a car finance expert on the BBC show Rip-Off Britain, says he knows of at least one group of class action lawyers “keen to get involved in the claims and make millions from the process”.
How much will the banks end up paying in compensation?
Bank of England deputy governor and head of the Prudential Regulation Authority, Sam Woods, told MPs this week he had been “very engaged” with the FCA investigation.
He said: “At this stage I’m not concerned that this is a financial stability issue, but it clearly has the potential to become a fairly significant behavioral issue with potentially significant financial ramifications.”
Analysts have been throwing out huge numbers. Broker Jefferies predicts the car finance industry could end up paying a whopping £13bn in connection with the scandal.
RBC Capital Markets suggests between £6bn and £16bn, having recently upgraded its estimates following a recent FCA webinar on landmark motor commission deals.
The investment bank believes Lloyds Banking Group, Black Horse’s parent company and the UK’s largest car finance lender, could pay around £2bn in compensation alone.
Huge sums: RBC Capital Markets suggests car finance lenders could end up paying Britons between £6bn and £16bn
It also expects Santander UK will have to shell out £850m, while Barclays and Close Brothers will pay up to £120m and £150m respectively.
While these levels of compensation may be of great interest to consumers, Graham Hill warns that the FCA is “sitting on a tinderbox” and could destroy the car finance sector by forcing them to fork out huge sums.
He said: ‘When some of the smaller brokers signed their brokerage agreements with the large lenders, they signed an ‘indemnification clause’ which indemnified the lender against claims made against them as a result of settlements with their clients lodged.
“This could easily bankrupt the smaller brokers and some of the larger ones as well.”
How could lenders try to pay less compensation?
Car finance companies will be very aware that they may end up owing too many drivers, so they will inevitably look to keep their bills as low as possible.
Stuart Masson believes they could try to blame dealers for overcharging customers, although he admits this could be a long shot.
‘What financial companies will probably do is say, “We don’t know anything about this.”
‘These are tools that are provided. “They are provided to every dealer in the country, and if they tamper with them without our knowledge, it’s really not our fault.”
“I don’t know (if) that argument is going to work very well because they will know exactly what they would have approved for customers and then what the financing rate was that the dealership ultimately told the customer.”
Motoring expert Hill also says customers “had every right to negotiate down” their interest rate when negotiating a deal, or shopping around to find a better deal.
He adds: “Given that customers have 14 days to cancel their finance agreement and replace it with another, even after signing it, they could still have rectified the situation by seeking a cheaper rate elsewhere.”
Whatever their argument, auto finance companies have an uphill battle to prove their lack of blame and avoid suffering consequences similar to those that rocked the financial services sector over the PPI scandal.
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