Britain’s car finance fiasco risks crashing the economy

Honda has temporarily stopped sales of new cars on finance after a court found commission fees may be unlawful
Honda has temporarily stopped sales of new cars on finance after a court found commission fees may be unlawful - Matt Cardy/Getty Images Europe

Share prices are falling. Banks are pulling loans. And many of the biggest car companies such as Honda and BMW have been forced to temporarily stop sales of new cars on finance.

The Court of Appeal has thrown both the car and the financial markets into turmoil with a ruling on commission fees added to financing deals. Sure, we can all argue about whether the court has made the right or the wrong decision, and how much customers should be told before they take out a loan.

However, one point is already scarily clear. The car market can’t function without loans, and neither can many other industries. The UK could soon be facing a full-scale credit crunch – if that happens, the Government and the Bank of England would have to step in to stop it from crashing the economy.

Rachel Reeves’s first Budget as Chancellor was so spectacularly misjudged that it has already thrown the gilts market into turmoil. And yet, as serious as that is, very soon it may well be the least of her problems.

What started as a fairly obscure judgement in the Court of Appeal is fast becoming a far bigger issue.

After years of argument, the court ruled that any payments made between banks and brokers when finance deals were arranged on car loans may be unlawful unless they were clearly flagged to the customer.

In the week since then, the share prices of many of the major lenders have plunged as investors worked out that they could be facing liabilities that would run into tens of billions, dwarfing even the vast sums that the PPI scandal ended up costing them.

Some of the auto companies stopped finance sales completely, albeit temporarily, while their lawyers worked out what the consequences of the judgement were. Most have resumed activity, but they admit the solutions they have adopted are sticking plasters. Uncertainty hangs over the market.

True, we will have to see how it all plays out. The banks and finance companies may be able to appeal, or at least wriggle out of some of the financial costs. And of course we can all argue about whether the customers deserve compensation (the simple answer, for what it is worth, is that they probably do).

But the bigger point is surely this: the car market can’t exist without credit. Almost no one can afford to pay for a new vehicle in cash: even a Ford Puma, the UK’s best-selling car, will set you back at least £25,000 new, and not many of us have that kind of money sitting around in our bank accounts.

Without finance, the UK’s £100bn-a-year auto industry, covering the manufacturers themselves, the suppliers and the network of dealers, will grind to a complete halt.

It might well not stop there. Even fewer of us buy a house with cash than a new car, and yet mortgage financing, which is almost as riddled with commissions and deals as car finance, could easily be impacted by the same ruling. Insurance is hardly any more straightforward, and yet without cover many trades will find it impossible to continue, since the potential liabilities will be too terrifying. The list goes on and on.

It would be easy to blame the lawyers who are warning their clients to pull financing deals from the market. Perhaps they are overreacting, but they are just doing their job. If a deal could end up costing you a couple of billion in compensation payments, you would, to put it mildly, expect your legal team to advise treading carefully.

In reality, the Financial Conduct Authority, the ultimate regulator for the sector, the Bank of England, and indeed the Government have created a complete mess. Vagueness in the rules allowed the Court of Appeal to step in, upending years of established practice in nanoseconds.

The risk now is that the UK economy could face a genuine credit crunch, with finance completely drying up. Very soon, whole swathes of the economy may come to a juddering halt, plunging the UK into a deep recession.

Neither the Government nor the Bank of England can stand by and simply let that happen. If the crisis escalates any further, as it threatens to do over the course of the coming week, they will have to step in and act, and act decisively. How? It is not going to be easy.

The decision of the court can’t simply be overturned, and if customers have been misled then they deserve some form of compensation. If the banks and finance houses have profited from misleading customers – and let’s be honest here, it would hardly be the first time – then they deserve to be punished by regulators.

If the banks don’t face some form of penalty, they will keep on doing the same thing over and over again, and the market will never improve. Customers, who ultimately have to pay for all the hidden commissions, will never get a better deal.

The Bank of England will need to make it clear that it stands behind the banks and finance houses. If necessary, it will have to set up a fund to take over loans that have turned bad, winding them down in an orderly way. It needs to offer finance to the auto companies, possibly directly, to make sure that cars can still be bought on credit.

The Government may well need to pass emergency legislation over the next few days, limiting compensation claims. They cannot leave it entirely to the judges to decide what should be paid, and may need to cap the eventual payouts so that there is some certainty in the market again.

Reeves and Andrew Bailey, the Bank of England Governor, have already been hopelessly slow. They should have acted to calm the market down during the last week. Anything they do now may well prove too little too late.