The banks may suffer a serious setback if car finance missells

According to James Mackreides, big finance avoided the worst possible outcome in the car-finance mis-selling case, but it could still have disastrous consequences

On Monday, shares of Close Brothers increased by 20%. Lloyds saw a gain of nearly 8%. As shareholders rejoiced over the Supreme Court's ruling to reject some of the more outrageous claims regarding the misrepresentation of motor finance, the rest of the banking industry was also experiencing growth.

It was an uncommon display of common sense from a body that has rarely demonstrated any desire to side with business in its brief existence. The market rejected the majority of the allegations that millions of auto finance packages had been missold due to improper disclosure of commissions paid to dealers and other middlemen after it closed last Friday.

A poor choice in auto finance.

The judges made the logical decision that anyone taking out a loan to purchase a car should have read the fine print before signing on the .ted line because the auto industry has, to put it mildly, always been known for its sharp practices. It's easy to understand why the City was happy, considering that the entire compensation bill might have reached 40 billion or more if previous decisions supporting the High Court's claims had been maintained.

There is only one catch. In order to make up for commissions that were too high, the Financial Conduct Authority is now putting forward a more constrained plan. At a total cost to the banking system of between 9 billion and 18 billion, it will pay out an average of 950 to each driver. The banks and finance companies involved will still have to pay a hefty bill.

There are two more serious issues. First, the banks' reputation will suffer yet another setback. In numerous smaller cases, the major banks have been compelled to provide compensation for both personal and small-business products where terms and conditions were improperly disclosed, and there have already been over £50 billion in payouts from the misselling of personal protection plans on mortgages.

The scandal involving the car finance comes after over 15 years in which almost every product offered by a major high street bank that was more complicated than a current account ended up being dubious in some way. The emergence of new, app-based competitors that are better equipped technologically, do not have to pay for hundreds of branches, and generally have better reputations is already posing a serious threat to the banks. Offering payouts for auto-finance claims to millions of drivers will only serve to confirm the perception that everything the banks sell is a scam. Any company that loses the trust of its clients is unlikely to succeed in the long run.

Mass consumer lawsuits in the US.

It will then only serve to promote more widespread claims. One might have hoped that the Supreme Court's decision would halt the class action trend that has become established in the British legal system. However, if the regulator disburses 10 billion or more in payments, the claims-management sectorwhich, if we are being honest, most likely has even more dubious standards than auto financewill receive yet another significant boost.

Without US levels of productivity and innovation to offset it, the UK is headed toward a concerning trend where we see the emergence of mass consumer litigation in the US style, complete with all the associated costs and uncertainties for businesses. It's the worst world imaginable.

Any international investor examining a British bank at this time would conclude that, given the stagnant economy, profit growth will be minimal and that the bank could be hit with compensation payments of a few billion dollars at any time. The combination is unappealing and will make it more difficult to turn the city around. In actuality, practically every type of financial service includes some small print and commissions at some point. Law firms can always claim that the commissions were excessively high, that the terms were not fully disclosed, and that clients were unaware of what they were signing.

If the banks are required to make payments beyond this, they will have to do so repeatedly until the industry as a whole is no longer sustainable. Since the Supreme Court rejected most of the claims, it would have been much better to end the lawsuit and give the City a chance to heal.