The FCA is probing whether borrowers who took out loans before January 2021 were charged higher interest rates, resulting in increased commissions for car dealers.

The FCA revealed that the model, known as discretionary commission, allowed dealers to set borrowers’ interest rates, affecting nearly 40% of car finance lending between 2013 and 2016. Numis analysts estimated Lloyds could face a £1.5bn compensation bill, while Royal Bank of Canada suggested a range between £2bn and £8bn for the industry.

According to the Finance & Leasing Association (FLA), 93% of new cars are purchased through finance, making it the second most popular form of household borrowing, with approximately £40bn borrowed annually. The FCA’s ban on discretionary commission is expected to save consumers £165 million yearly in cheaper repayments, The Times reports.

Recent decisions by the Financial Ombudsman Service ordered Barclays and Lloyds to refund borrowers over £1,000 each in excess interest payments. The complainants argued that the commission was concealed, and they were unaware of paying higher interest rates, leading to additional payments to the dealer.

The FCA’s investigation, anticipated to last 37 weeks, was initiated following over 16,000 complaints made to the Financial Ombudsman Service since September 2022. Claims companies believe undisclosed commission could become a mis-selling scandal comparable to the payment protection insurance, costing banks £38.4bn.

Despite Lloyds’ history of paying over £20bn in compensation for mis-sold payment protection insurance policies, Numis anticipates a lower bill for car finance mis-selling. The FOS ruled that compensation should only cover the extra interest paid, not the entire finance cost. Lloyds’ car finance division, Black Horse, stated they are reviewing the FOS decision and will collaborate with the FCA on the upcoming review. The FLA expressed their commitment to working with the FCA to resolve the issue in the coming months.