Car finance disaster menace to dwelling and motor insurance coverage: Banks on hook for billions in new PPI scandal

The crisis engulfing the car finance market could spread to other parts of the insurance sector, experts warned.

The Court of Appeal ruled last month that commissions paid between banks and brokers on car deals may be unlawful because they were not clearly flagged to the customer.

The decision plunged the car finance sector into turmoil.

Shares in major lenders, including Lloyds, nosedived because it was feared they could face a similar bill to the £50billion in costs and compensation they paid over the mis-selling of payment protection insurance (PPI), one of the biggest scandals to ever hit the banking industry.

Ruling: The Court of Appeal ruled last month that commissions paid between banks and brokers on car deals may be unlawful because they were not clearly flagged to the customer

The latest court case involves so-called ‘discretionary commission arrangements’ used by the motor finance industry before they were banned in 2021.

Close Brothers, one of Britain’s oldest merchant banks, has stopped making car loans while it considers an appeal to the Supreme Court. 

But analysts at investment bank RBC warn that if the Appeal Court’s verdict is upheld ‘motor finance litigation could spread to other products like premium finance’, where commissions also are paid to intermediaries by banks but may not be disclosed either.

Warning of the impact of the court ruling, the RBC report said: ‘One possible interpretation is that the decision is broad enough to encompass any broker commission in any finance arrangement in which the borrower did not provide informed consent to the commission being paid.’

Close Brothers was already on the hook for up to £390million in customer payouts if it lost the car loan court case, RBC calculated. 

But the company has pencilled in an extra £250million compensation bill for the bank in the event of a ‘bad outcome’.

Car loans make up about a fifth of lending at Close Brothers – or almost £2billion. But premium finance accounts for another tenth of its loans, or £1billion.

James Daley of consumer campaign group Fairer Finance said the court ruling could have ‘massive consequences for the whole lending sector and possibly beyond’. 

Banks were ‘pretty angry’, he added, and were ‘lobbying hard’ for government intervention.

Premium finance involves customers borrowing money at high rates of interest to spread the cost of their car or home insurance by monthly instalments, rather than paying a one-off lump sum. 

Over 20m customers are estimated to pay for their car and home insurance this way and more than three-quarters of adults in financial difficulty have used the product, according the City watchdog, the Financial Conduct Authority.

While much smaller than the £39billion car finance market, premium finance loans topped £5billion in 2022, generating up to £1.2billion revenues to providers, according to the FCA.

Motor insurance policyholders saw their premiums rise by an average of 25 per cent last year, driven by inflation and rising insurance claims.

The regulator is reviewing both premium and motor finance amid concerns customers are not getting fair or competitive deals.

Close Brothers was contacted for comment.

The business recently sold its asset management arm for £200million and scrapped dividend payouts to shareholders in a bid to preserve capital.

The bank said the court ruling could result in ‘significant liabilities’ but described its financial position as ‘strong’.

Close Brothers shares fell 2.5 per cent to 220.2p yesterday – a 30-year low.