The credit crunch threatening to bring Britain’s £100bn car market to a juddering halt

A shock ruling over ‘unfair’ loans risks repercussions that go well beyond the auto sector

Late last Friday afternoon, as people started to trudge home for the weekend, a sudden and unexpected shock wave tore through the stock market.
Shares in UK banks began to plunge. Lloyds saw £3bn wiped off its market value and Close Brothers, a smaller specialist lender, crashed by 25pc.
The reason? A shock judgement from the Court of Appeal on car finance. The ruling, which stemmed from a slow-rumbling row over how car loans are arranged, upended years of convention and sparked panic in the City.
At issue were the commissions offered to dealers and how much customers were told about them.
The Court’s far-reaching ruling suggested that any payments between banks and brokers that weren’t clearly flagged could be unlawful. The decision has destabilised the entire market, amid confusion about how broadly it might apply and what exactly lenders can do to avoid falling foul of the rules.
Nearly a week later, Britain’s largest banks and car dealerships are still scrambling to contain the fallout, which threatens to drive up costs for motorists and – in a worst-case scenario – bring the UK’s £100bn motor sector to a shuddering halt.
“There’s a lot of disruption,” says Adrian Dally, from the Finance and Leasing Association (FLA), which represents motor finance lenders.
“We’re all immediately having to restructure to comply with this in order to keep cars being bought and finance flowing,” he adds.
Commissions have been paid to car salesmen working on Britain’s forecourts ever since motor finance was invented. Dealers are typically paid a fee based on the value of the loans they sell.
While it is long-standing, the practice means dealers effectively get paid more money for selling more expensive loans. This is not good for customers.
Regulators ruled last year that the practice was a conflict of interest, opening up a deluge of claims against lenders over “unfair” loans. Experts have compared the scale of the crisis to the PPI scandal, with some saying banks face a bill of up to £16bn for mis-sold loans.
Last year’s decision centred on outcomes for customers, with claims hinging on whether car buyers ended up paying more than they should have for loans.
But last week’s court decision goes much further, implying that any fees paid to brokers are unlawful – regardless of the outcomes for customers. It covers not just commission but things like loan arrangement fees.
“The bottom line is that last Thursday every motor finance agreement was lawful but by Friday afternoon every motor finance agreement was unlawful,” says Dally.
“That’s a really extraordinary place to be. Usually when you have a significant change in regulatory requirements it is considered by the regulator, there is a public consultation, the final rules are refined and then businesses are given six months to comply. All that has been condensed into a nanosecond.”
The Court’s ruling effectively said that keeping secret the amount of cash the kickback is worth is unlawful. Car salesmen now owe a “fiduciary duty” to their customers, meaning they must look after their best financial interests.
The ruling has implications well beyond just the car finance industry, with the potential to affect everything purchased on credit, from washing machines to mobile phones.
Lenders have been scrambling to figure out how to comply. Several have already paused car finance activity altogether.
Dealerships, meanwhile, are urgently revising their sales practices to avoid a paralysis in the market. Car salesmen have been left scrambling to draw up new paperwork to cover themselves and limit legal liability.
Drivers showing up to buy a new car today are likely to be asked to sign consent documents confirming they are happy the salesman gets paid their hundred pound or so bonus.
“If consumers don’t consent to the payment of commission, that might change the economics for a dealership,” Dally explains.
The issue matters for Britain’s economy because most workers need loans to buy their cars. The vast majority of new cars are bought on finance, with around 2m vehicles purchased using debt every year, according to the Financial Conduct Authority (FCA), which regulates the car loans market.
There could be broader repercussions over the next few months as lenders reassess whether they want to be in the market at all.
“If this court ruling holds, what you will get is banks pulling out of the motor finance sector,” says Benjamin Toms, an analyst at Royal Bank of Canada.
Close Brothers temporarily stopped writing new motor loans after the judgement, saying it needed to check whether its contracts were compliant with the new laws.
MotoNovo, which is owned by South African banking giant FirstRand, has also stopped lending for now.
The group said it had spoken to UK and South African regulators and remained “concerned” by the judgement because of its “far-reaching negative consequences”.
Secure Trust Bank, another large lender, has also “temporarily paused” new lending while it “assesses the action required”. Honda Finance Europe, the lending arm of Honda, has signalled a change to its lending practices.
The Court of Appeal’s ruling was meant to get the best financial outcomes for customers. Perversely, a credit crunch means customers could end up having to fork out more to finance their vehicles.
“Ultimately you will have less providers, that’s less supply, which means that prices will go up,” says Toms.
“If it’s less profitable to do business, for some banks it might not meet the threshold of something that they want to do, particularly if there’s an elevated risk.”
Lloyds, one of the UK’s largest motor financiers through its Black Horse arm, on Tuesday abolished bonuses paid to car dealers to avoid falling foul of the latest ruling.
The bank has introduced a “no commission” contract but will keep lending because it wants to stand by customers and the UK economy. William Chalmers, Lloyds’s chief of finance, held an urgent call with investors on Tuesday night.
While gallant, the decision still leaves serious questions for dealerships; not least, how exactly they will make money.
“Theoretically if there’s no commission why would a dealer be incentivised to sell your contract?” says Toms. “There might be an implication for volumes. The [business] model needs to be rebuilt on how motor dealers are essentially paid.”
The matter has reached the highest levels of government, with the FLA holding an urgent meeting with Treasury officials and regulators from the FCA on Tuesday to press the seriousness of the matter.
Nikhil Rathi, the FCA’s chief executive, later addressed the issue in a speech to investors at Mansion House, saying he was working “at pace” to find a solution.
Options include the FCA stepping in to pause any possible legal claims against lenders to stop a PPI-style avalanche of payments.
The Court of Appeal case involved Close Brothers and FirstRand, both of which have appealed the decision at the Supreme Court, which could reverse or uphold the judgement.
Adding to the cloud of legal uncertainty is the fact that Barclays is also appealing the original ruling against bonus kickbacks by the Financial Ombudsman Service made last year, which first triggered uncertainty for the banks.
The FCA said it was urgently seeking to understand the judgement and could step in to offer further guidance soon.
For now, chaos reigns on Britain’s forecourts.