Is the Banking industry driving through another consumer finance mis-selling scandal? 

The consumer finance landscape (rather, labyrinth) has been fraught with numerous systemic failings, causing further trust erosion, not to mention immense frustration, among unwitting customers. 

Memories aren’t short about the last big mis-selling scandal about Payment Protection Insurance (PPI), where this TLA (three-letter-acronym) had become a four-letter-word for many of the retail banking players, costing them billions of pounds, not only in redress compensation but also due to the massive operational overheads. 

This article explores the issue facing banks/lending firms, the potential detriment faced by customers, the regulatory intervention, the overall scale of the financial impact and key considerations for impacted firms to handle this issue effectively. 

Issues:

• Discretionary Commission Arrangements (DCAs) were a commission structure where car dealers or brokers could influence the interest rate on a car loan taken out by a customer. 
• The higher the interest rate, the more commission the broker earned. 
• This could have disadvantaged consumers as they might be placed on a higher interest rate than they qualified for. 
• Potential widespread misconduct in historical DCA practices from 2007 to 2020. 
• DCAs were banned by the Financial Conduct Authority (FCA) in January 2021. 

Potential Customer Detriment: 

DCAs (Discretionary Commission Arrangements) in the motor finance sector had several significant impacts on consumers: 

1. Higher rates of interest: DCAs allowed dealers/brokers to set interest rates for customer loans within a range, with their commission linked to the rate charged. This incentivised dealers to offer higher interest rates to customers, potentially leading to consumers paying more for their car finance. 

2. Lack of transparency: Very few brokers disclosed the actual commission they received for arranging finance for their customers. This lack of transparency meant consumers were often unaware of the financial incentives influencing the deals they were offered. 

3. Conflict of interest: DCAs created an inherent conflict of interest between dealers/brokers and customers. Dealers/brokers were incentivised to maximise their commission by charging higher interest rates, which was not in the best interest of consumers. 

4. Potential widespread harm: The FCA’s ongoing investigation suggests that there may have been widespread misconduct in the industry, potentially affecting many consumers who purchased cars on finance between 2007 and 2021. 

5. Unfair treatment: The Financial Ombudsman Service (FOS) ruled in favour of consumers in two DCA-related cases, concluding that these arrangements failed to treat customers fairly.  

6. Inadequate complaint handling: 99% of DCA-related complaints received between January 2019 and June 2023 were rejected by firms, potentially leaving many affected consumers without proper recourse. These may, no doubt, be candidates for a Past Business Review exercise. 

Regulatory Intervention:

The FCA has been investigating Discretionary Commission Arrangements (DCAs) in motor finance for several years, banning the practice from 28^th Jan 2021 to mitigate customer harm and conflicts of interest between dealers and customers. The FCA has yet to deliver a definitive judgment concerning widespread misconduct or consumer detriment stemming from historical Discretionary Commission Arrangements. Nevertheless, the financial market has witnessed noteworthy developments.  

The FCA remains actively engaged with firms, pursuing its investigatory work through formal information requests and emphasising the critical importance of maintaining sufficient financial reserves to address potential remediation obligations. The Prudential Regulation Authority (PRA) has echoed this sentiment, issuing information requests that underscore the need for firms to rigorously challenge their assumptions and comprehensively evaluate stress scenarios related to motor finance commission structures. 

In a recent update on its diagnostic efforts, the FCA acknowledged delays in obtaining necessary data from firms and the pending outcomes of key legal proceedings, preventing the regulator from reaching a conclusive assessment or announcing subsequent actions. The FCA’s findings and subsequent steps are now projected for release in May 2025. The pause on DCA complaint handling and resolution has been extended until December 4, 2025, to afford the regulator ample time to deliberate on potential redress mechanisms. 

In October 2024, the Court of Appeal made a landmark ruling in the cases of Hopcraft v Close Brothers Ltd, Johnson v Firstrand Bank Ltd, and Wrench v Firstrand Bank Ltd, declaring undisclosed commissions on car loans unlawful. The court deemed it unlawful for lenders to pay ‘secret commissions’ to car dealers (acting as brokers) without the customer’s knowledge and informed consent. The ruling emphasised that brokers had breached their fiduciary duties by failing to obtain informed consent from customers regarding commission payments. 

His Majesty’s Treasury (HMT) and the Financial Conduct Authority (FCA) sought permission to intervene in a legal dispute at the Supreme Court scheduled for April 2025 focusing on allegations of commissions being paid to salespeople without consumers’ knowledge. Other organisations that applied to intervene in the case were the Finance Leasing Association, National Franchise Dealers Association (NFDA) and Consumer Voice. However, the Supreme Court rejected Chancellor Rachel Reeves’ bid for the treasury to intervene, only granting the NFDA and the FCA permission to do so.

Financial Impact: 

The car finance industry is preparing for significant potential payouts, with analyst estimates ranging from £16 billion to £44 billion in total to cover customer compensation, operational costs and legal expenses.  

Some lenders have already set aside cash to cover potential costs arising from claims, e.g., Lloyd’s made a £450 million provision for this in 2024 and an additional provision of £700 million in 2025. Close Brothers has earmarked £165 million while Santander had set aside £295 million. 

While the exact number of banks expected to set aside funds is not explicitly stated, the search results suggest that more lenders are likely to follow suit. 

Banks / Lender Considerations:

While impacted banks and finance companies play the waiting game, firms should leverage this additional time to proactively address their historic exposure. Priority actions for firms include: 

1. Data Diligence: Firms should prioritise the enhancement of data availability and quality pertaining to historical DCAs. They should try to proactively identify all car finance agreements made before January 28, 2021, as DCAs were only applicable before this date and then examine the terms of these agreements to determine if brokers had the discretion to set or adjust interest rates. Firms should analyse commission models used in your firm during the relevant period and focus on whether commissions were tied to interest rate adjustments by brokers. They should gather documentation such as commission contracts, invoices, and system records showing variations in commissions and interest rates. Addressing prevalent data gaps concerning APRs, rate cards, risk-based pricing, commission structure disclosures, and overall deal structures is crucial. Firms must demonstrate exhaustive efforts to obtain and extract data, validate unavoidable gaps, and devise strategies to address these gaps. 

2. Scenario Sensitivities: Upon maximising data extraction, firms should analyse this data to construct potential remediation scenarios. This exercise is critical for Boards to comprehend potential financial exposures relevant to shareholders and auditors. In conducting scenario analyses, firms should consider regulatory requirements, expectations, and Financial Ombudsman Service (FOS) decisions to ensure plausible scenarios that highlight possible eventualities arising from the FCA’s conclusions.  

3. Fiscal Fortitude: The PRA and FCA consistently emphasise the importance of maintaining robust financial resources. Historical data and adjusted financial statements can provide a clearer picture of potential liabilities. Sufficient provisioning should be carried out not only for the cost of redress payouts but also the operational overheads incurred in managing the remediation and getting the funds across to the customer. Also to be considered are the costs of FOS referrals and potential fines levied by the FCA. Firms should, therefore, integrate potential remediation costs into stress testing and reverse stress testing exercises. Evaluating the impact on capital and liquidity under severe yet plausible scenarios is paramount, alongside assessing the firm’s capacity to uphold regulatory minimums while achieving lending targets. 

4. Remediation Readiness: Firms must ensure the availability of skilled personnel, case management systems, efficient processes, and sound decision-making frameworks to execute potential remediation programmes and manage DCA complaint backlogs. Proactive planning and consideration of necessary activities, resources, and skill sets are essential to ensure fair and customer-centric processes. Strong governance, skilled complaint handling resources, system-driven activities, legal expertise, a “right first-time” approach, and a focus on customer needs and support are vital components. 

5. Engaging Experts: Having the right level of expertise on hand to cover aspects like customer identification and cohort analysis, data gathering and processing, redress calculation, customer correspondence, programme governance and so on, hopefully all suitably underpinned by automation & AI, will ensure firms can handle this remediation programme in a cost-effective, compliant and customer-centric manner. 

Concluding Thoughts: 

The extended FCA timeline provides financial institutions with a valuable opportunity to assess the impact on their portfolios and proactively prepare for potential remediation activity. Evidently, this will be a bumpy road for car finance firms, but with the right regulatory and operational support, they can certainly look to avoid a major car crash!

About TORI Global 

TORI Global offers a comprehensive solution to help firms navigate complex regulatory requirements. Our multi-disciplinary service combines expertise in governance, risk, and compliance with operational excellence and digital transformation capabilities. 

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