Challenges Facing the Auto Lending Industry in the UK following the Dealer Commissions Issue

Challenges Facing the Auto Lending Industry in the UK following the Dealer Commissions Issue

During the period 2017 to 2021, many UK auto finance companies extended finance to customers through dealerships without necessarily disclosing commissions paid to the dealers for the transaction or seeking the customer’s consent to do so.

Whilst in some cases this was perfectly fairly undertaken, in many instances, dealers were able to charge commissions for arranging finance that were not appropriately disclosed to customers. In many ways this is analogous to the mortgage mis selling issue and resonates with the public at large.

This practice has been deemed by the Financial Conduct Authority (FCA) to be contrary to the regulation and has been through challenge in the courts, which have ruled in favor of consumers in October 2024.

The FCA has subsequently initiated a large enquiry to identify the size and scope of the problem and all UK auto finance lenders have been busy during 2024-25 working with the FCA and several consultancies and accountants to identify their exposure and making provisions for expected redress to customers.

The enquiry and potential redress scheme could lead to significant financial burdens for banks, including compensation pay outs and legal costs. Estimates for the total cost to the industry range from £2 billion to £44 billion. In addition, the effort required to source, analyse and process the data on customer contracts has been a substantial burden on the industry. For example, the UK’s largest motor finance provider Lloyds Banking Group, has set aside £700 million this year to cover potential remediation costs, adding to the £450 million provision made in the previous year. [source]

Whilst major UK auto finance lenders have made balance sheet provisions, the impact on their capital remains limited due to strong pre-impairment profits and capital buffers. However, medium-sized lenders face greater exposures due to lower profit levels and higher concentration in motor finance compared to Banks.

There are high stakes for both consumers and the lending industry. The uncertainty is particularly challenging for small lenders, warning that a broad ruling “could further limit their ability to offer affordable finance.” A significant financial impact following the redress methodologies is due to increased operational costs of underwriting, which has historically been predominantly manual in the UK.

New regulations around Affordability and Consumer Duty have introduced measures to ensure that there is enhanced transparency and fairer treatment of customers. However, this necessitates documentary, data and systems capabilities which are not always easy to deploy given the legacy environment in many lenders and the difficulty of investing in sufficient technology for small and medium lenders.

AI tools are providing a means to alleviate this cost and transparency issue with far greater efficacy than was possible a few years ago.

AI can verify that pre-contractual (customer) information meets the FCA's Consumer Credit requirements and that affordability assessments are appropriately sourced and documented. For example, AI tools can reduce operational costs by 50% for document review; extracting the relevant information from various affordability source documents and classifying this data to automatically be pushed into affordability calculators and present to under writers far more efficiently and with reduced errors than manual methods.

This not only frees up underwriter time to focus on more complex, risky cases but also improves compliance, risk exposure and accuracy.

With increasing volumes and FCA redress schemes demanding banks have more robust processes for regulatory compliance and risk management, there is an excellent opportunity for lenders to invest in the right tools to hit the regulatory requirements whilst driving costs down whilst at the same time improving work quality for employees and maintaining customer satisfaction.