Shares in Close Brothers were up by 20% on Monday. Lloyds was up by almost 8%. The rest of the banking sector was rising, too, as shareholders celebrated the decision by the Supreme Court that some of the wilder claims over mis-selling of motor finance should be thrown out.
It was a rare example of common sense from a body that, in its short life, has rarely shown any inclination to take the side of business. After the market closed last Friday, it rejected the bulk of the claims that millions of car-finance packages had been mis-sold because commissions paid to dealers and other middlemen had not been properly disclosed.
Car finance mis-selling decision
The judges decided, quite sensibly, that the motor trade has, to put it mildly, always been known for sharp practice, and anyone taking out a loan to buy a car should have checked the small print before signing on the dotted line. Given that the total bill for compensation could have run to £40 billion or more if earlier rulings in favour of the claims by the High Court had been upheld, it’s not hard to see why the City was pleased.
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There’s just one catch. The Financial Conduct Authority is now proposing a more limited scheme that will compensate customers for commissions that were excessively high. It will pay out on average £950 to each driver, at a total cost to the banking system of between £9 billion and £18 billion. There is still going to be a huge bill for the banks and finance houses involved.
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There are two even bigger problems. First, it will be yet another blow to the reputation of the banks. There have already been more than £50 billion in payouts from the mis-selling of personal protection plans on mortgages, and plenty of smaller examples where the main banks have been forced to pay compensation for both personal and small-business products where terms and conditions were not properly disclosed.
The car-finance scandal comes on top of more than 15 years where just about any product more complex than a current account sold by one of the major high street banks has turned out to be dodgy in one way or another. The banks are already facing huge challenges from the rise of new, app-based rivals that have better technology and are not burdened by the cost of hundreds of branches, and typically have far better reputations. If several million motorists are offered payouts for car-finance claims, it will only encourage the belief that everything the banks sell is some form of scam. It is hard to see how any business can thrive in the long term if its customers no longer trust it.
US-style mass consumer litigation
Next, it will only encourage yet more mass claims. It might have been hoped that the Supreme Court ruling would stop the trend towards class actions that has taken root in the British legal system. But if the regulator hands out £10 billion or more in payments, the claims-management industry – which, if we are being honest, probably has even more questionable standards than car finance – will be given yet another huge boost.
The UK is on a worrying path where we develop US-style mass consumer litigation – with all the costs and uncertainties that creates for business – but without US levels of productivity and innovation to make up for it. It is the worst of all possible worlds.
Any global investor looking at a British bank right now will conclude that, with a stagnant economy, there will be very little profit growth, and that it may well be stung for a few billion in compensation payments at any moment. It’s not a very attractive mix, and one that will make it harder to revive the fortunes of the City. In reality, there is almost no form of financial service that doesn’t involve some small print and commissions somewhere along the line. It will always be possible for law firms to argue that the terms were not properly disclosed, that customers didn’t know what they were signing, and that the commissions were too generous.
If the banks have to pay out over this, they will have to pay out again and again, until the whole industry is no longer viable. It would have been far better to stop the litigation when the Supreme Court threw out the bulk of the claims – and give the City a chance to recover instead.
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