Lloyds Banking Group has announced it expects to set aside a significantly larger sum to cover compensation for the UK motor finance scandal. The bank stated that the additional provision required could be "material" following a new redress proposal from the country's financial regulator.
The warning from one of the UK's largest lenders sent its shares down 2.7% and has raised concerns about the wider financial impact on the banking sector. Another lender, Close Brothers, issued a similar warning, causing its shares to fall by 9.2%.
Key Takeaways
- Lloyds Banking Group expects to add a "material" amount to its existing £1.15 billion provision for the car finance issue.
- The Financial Conduct Authority (FCA) estimates the total compensation bill for the industry could reach £11 billion.
- The scandal relates to undisclosed commissions on 14.2 million car loans sold between 2007 and 2024.
- Shares in Lloyds and other lenders, including Close Brothers, declined following the announcements.
Lloyds Signals Increased Financial Provisions
In a statement on Thursday, Lloyds Banking Group acknowledged that its current financial cushion for the motor finance issue is likely insufficient. The bank has already allocated approximately £1.15 billion ($1.54 billion) to address potential claims.
However, after reviewing a consultation paper from the Financial Conduct Authority (FCA), the bank now anticipates a substantial increase. "An additional provision is likely to be required which may be material," Lloyds stated, confirming it is still assessing the full implications of the regulator's plan.
The market reacted swiftly to the news. Lloyds' shares dropped by 2.7% in afternoon trading, underperforming the broader FTSE 100 index, which saw a smaller decline of 0.25%. The announcement has created uncertainty about the bank's future financial performance.
Background of the Scandal
The issue stems from historical practices in the motor finance industry where car dealerships were given discretion to set interest rates on loans. Lenders often paid higher commissions to dealers who charged customers higher rates, a practice that was not always clearly disclosed to the consumer. The FCA banned this practice in 2021, but is now addressing compensation for deals made prior to the ban.
Regulator Outlines £11 Billion Compensation Scheme
The warning from Lloyds follows the FCA's proposal for a widespread redress scheme for consumers who were overcharged on car loans. The regulator estimated that the total cost to the industry could be approximately £11 billion.
This figure, while substantial, was actually lower than some of the market's most pessimistic forecasts, which had led to a brief rally in bank shares earlier in the week. However, the direct confirmation from Lloyds that its provisions will rise has renewed investor concerns.
The proposed compensation scheme is designed to cover an estimated 14.2 million motor loan agreements arranged between 2007 and 2024. The FCA anticipates a high consumer take-up rate of around 85% for the compensation.
The scheme targets deals where lenders failed to adequately disclose the commission structures and contractual arrangements with car dealerships, which may have led to consumers paying higher interest rates than necessary.
Analysts Predict Further Impact on Banking Sector
Financial analysts are now revising their estimates for Lloyds and other lenders. Before the bank's latest statement, analysts at Citi and Jefferies had already projected that Lloyds would need to increase its provisions to around £1.5 billion.
Citi noted on Thursday that in a "worst-case scenario," Lloyds' total provision could climb as high as £1.85 billion. This highlights the significant uncertainty that remains until the final details of the FCA's scheme are implemented.
The issue extends beyond Lloyds. The entire UK banking sector has set aside more than £2 billion so far, with major players like Barclays and Santander's UK arm also making provisions. However, this collective figure is still far short of the FCA's £11 billion industry-wide estimate.
Wider Industry Exposure
Analysts at Shore Capital commented that the warning from Lloyds was "likely to have a ripple effect" across the financial sector. The total liability is expected to be split between traditional banks and "captive lenders," which are the finance subsidiaries of major vehicle manufacturers.
The final cost for each institution will depend on several factors, including:
- The total number of affected customers who file a claim.
- The specific terms of the loan agreements in question.
- The final methodology for calculating compensation as determined by the FCA.
As lenders continue to evaluate the regulator's proposals, investors will be closely watching for further announcements regarding additional provisions, which could impact bank profits and shareholder returns in the coming months.
