The Supreme Court of the United Kingdom is set to hear arguments on Tuesday that could lead to a major financial crisis for the UK’s banking sector. At stake is the potential for billions of pounds in legal costs and compensation claims, following a decision by the Court of Appeal in October that ruled it unlawful for lenders to pay commissions to motor dealers without a customer’s informed consent.
The ruling has raised concerns about the scale of possible remedies for affected borrowers. To date, major financial institutions like Lloyds Banking Group, Close Brothers, and Santander UK have set aside over £1.5 billion ($1.9 billion) in anticipation of potential compensation claims. Some analysts believe the fallout could surpass even the massive £40 billion payout banks made for mis-selling payment protection insurance.
What Will the Supreme Court Consider?
The Supreme Court will review three key claims—two against South African lender FirstRand and one against British firm Close Brothers—focused on whether car dealers, also acting as credit brokers, are legally obligated to fully inform consumers about commissions they receive. If a duty of care is confirmed, the court will examine whether commissions paid by lenders to car dealers were sufficiently disclosed, and whether lenders could be held liable for facilitating the breach of duty by credit brokers.
The court’s ruling could also determine whether the financial relationship between lenders and consumers is deemed “unfair” under the Consumer Credit Act of 1974, potentially triggering remedies for affected borrowers. The court is expected to deliver its judgment by summer.
Who Could Be Affected?
In 2021, the Financial Conduct Authority (FCA) banned discretionary motor finance commissions, removing incentives for brokers to inflate the interest rates on car loans. However, many consumers argue they were subjected to unfair practices before the ban was implemented. This has prompted the FCA to launch an investigation into possible historic misconduct in January 2024.
If the Supreme Court rules that lenders and brokers should have been more transparent about commissions, the FCA has indicated it will introduce a compensation scheme within six weeks. The motor finance market serves more than 2 million people annually, according to FCA data, making the ruling potentially impactful for a large number of consumers.
How Much Could Banks Be Required to Pay?
Only a few UK lenders have significant motor finance operations that would be heavily impacted by the ruling, such as Lloyds, Close Brothers, and Santander UK. These institutions have already set aside £1.15 billion, £295 million, and £165 million respectively for potential claims. However, analysts warn that other types of commissions paid by banks to credit brokers could come under scrutiny if the court determines that customer consent is necessary for such payments. Moody’s ratings agency estimated that the total worst-case costs to the industry could reach £30 billion, while RBC Capital has projected a base-case impact of £18 billion on both banks and non-bank lenders.
What Might Influence the Supreme Court’s Decision?
The outcome of another recent legal case, Expert Tooling vs. Engie Power, could influence the ruling in the motor finance case. In this case, the Court of Appeal found that commissions paid by Engie to an energy broker should have been disclosed, though it did not hold Engie responsible for the broker’s breach of duty due to a lack of evidence of dishonesty. Some legal experts believe lenders could avoid major financial liability unless claimants can prove that commission payments were intentionally concealed or misrepresented. However, others argue that there are key differences between the two cases, particularly because Expert Tooling involved a business rather than a consumer.
What’s Next for the Banking Industry?
The uncertainty surrounding this case has had a chilling effect on mergers and acquisitions (M&A) activity among major UK banks, as concerns about a potential consumer finance scandal loom large. However, clarity over the Supreme Court ruling and any resulting compensation scheme could release the funds set aside for legal expenses, potentially boosting dealmaking activity in the sector, according to analysts and industry insiders.
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