The credit crisis threatens to bring the British car market to a standstill

Almost a week later, Britain’s biggest banks and car dealers are still trying to contain the fallout, which threatens to drive up costs for motorists and – in the worst case – destroy Britain’s £100 billion car sector. brings to a standstill.

“There is a lot of disruption,” said Adrian Dally of the Finance and Leasing Association (FLA), which represents car finance lenders.

“We all need to restructure immediately to comply so that cars can be purchased and financing can continue to flow,” he adds.

Since the invention of car finance, commissions have been paid to car salesmen working at British petrol stations. Dealers typically receive compensation based on the value of the loans they sell.

While this practice has been around for a long time, it means dealers actually get more money for selling higher-priced loans. This is not good for customers.

Regulators ruled last year that the practice was a conflict of interest, sparking a flood of claims against lenders for “unfair” lending. Experts have compared the scale of the crisis to the PPI scandal, with some saying banks are facing a bill of up to £16 billion due to mis-sold loans.

An overnight disaster

Last year’s decision focused on customer outcomes, with claims hinging on whether car buyers ended up paying more than they should have for loans.

But last week’s court ruling goes much further, implying that any fees paid to brokers are unlawful – regardless of the outcomes for customers. It not only includes the commission, but also things like loan arranging costs.

“The bottom line is that last Thursday every car finance deal was legal, but by Friday afternoon every car finance deal was illegal,” says Dally.

“That really is a special place to be. If there is a significant change in regulatory requirements, it is usually considered by the regulator, a public consultation takes place, the final rules are refined and companies are then given six months to comply. All that is summarized in a nanosecond.”

The Court’s ruling essentially stated that it is illegal to conceal the amount of cash worth the bribe. Car salespeople now owe a “fiduciary duty” to their customers, which means they must look after their best financial interests.

The ruling has implications far beyond the car finance sector, and could affect everything bought on credit, from washing machines to mobile phones.

Most people cannot afford a car

Lenders have been scrambling to figure out how to comply. Several companies have already stopped car financing activities altogether.

Dealers, meanwhile, are urgently reviewing their sales practices to avoid market paralysis. Car sellers are having difficulty preparing new paperwork to cover themselves and limit legal liability.

Drivers who turn up to buy a new car today are likely to be asked to sign consent papers confirming that they are happy for the seller to be paid the bonus of around a hundred pounds.

“If consumers don’t agree to pay commissions, it can change the economics of a dealership,” Dally explains.

The issue is important for the British economy because most workers need loans to buy their cars. According to the Financial Conduct Authority (FCA), which regulates the car lending market, the vast majority of new cars are purchased with finance, with around 2 million vehicles purchased each year with debt.

Banks could vote with their feet

There could be wider implications in the coming months as lenders reassess whether they want to be active in the market at all.

“If this court ruling stands, you will expect banks to withdraw from the auto finance industry,” said Benjamin Toms, an analyst at Royal Bank of Canada.

Close Brothers temporarily stopped issuing new car loans after the ruling, as it needed to check whether its contracts complied with the new laws.

MotoNovo, owned by South African banking giant FirstRand, has also stopped providing loans for the time being.

The group said it had spoken to British and South African regulators and remained “concerned” by the verdict due to its “far-reaching negative consequences”.

Secure Trust Bank, another major lender, has also “temporarily suspended” new lending while it “assesses the required action.” Honda Finance Europe, Honda’s lender, has announced a change in lending practices.

The Court of Appeal ruling was intended to achieve the best financial outcomes for customers. Perversely, a credit crisis means that customers ultimately have to spend more money to finance their car.

“Ultimately you have fewer providers, which means less supply and that means prices go up,” says Toms.

“If it’s less profitable to do business, it may not meet the threshold for some banks of something they want to do, especially if there’s an increased risk.”

Lloyds, one of Britain’s biggest motor financiers through its Black Horse arm, on Tuesday scrapped bonuses to car dealers to avoid falling foul of the latest ruling.

The bank has introduced a ‘no commission’ contract but will continue to lend as it wants to support customers and the UK economy. William Chalmers, chief financial officer of Lloyds, held an urgent telephone call with investors on Tuesday evening.

An appeal to the common sense of the Court of Appeal

Although brave, the decision still leaves serious questions for dealers; not least, how exactly they will make money.

“Why would a dealer theoretically have an incentive to sell your contract if there is no commission?” says Toms. “There could be an implication for volumes. The (business) model needs to be rebuilt based on the way car dealers are essentially paid.”

The case has reached the highest levels of government, with the FLA holding an urgent meeting with Treasury officials and FCA regulators on Tuesday to highlight the seriousness of the matter.

Nikhil Rathi, the FCA’s chief executive, later discussed the issue in a speech to investors at Mansion House and said he was working “at pace” to find a solution.

Options include the FCA stepping in to pause any legal claims against lenders to stop a PPI-like avalanche of payments.

The Court of Appeal case involved Close Brothers and FirstRand, both of which have appealed the decision to the Supreme Court, which could overturn or uphold the judgment.

Adding to the legal uncertainty is the fact that Barclays has also appealed last year’s original Financial Ombudsman Service ruling against bonus kickbacks, which led to uncertainty for the banks for the first time.

The FCA said it was urgently trying to understand the judgment and could intervene quickly to provide further guidance.

For the time being, chaos reigns in the British courts.