The motor finance industry in Britain is facing a crisis, as banks prepare for massive payouts.

• The motor finance industry in Britain is facing a crisis, with experts predicting potential outcomes as severe as the country's most expensive banking scandal.
• The issue originated with a ruling from the U.K.'s Court of Appeal in October, which declared that car dealers could not receive bonuses from banks offering motor finance without obtaining the customer's prior consent.
• The UK's payment protection insurance (PPI) scandal, which cost banks over £50 billion ($63.8 billion), has led to comparisons with the PPI scandal in Britain.

The motor finance industry in Britain is facing a crisis, with experts predicting potential outcomes as severe as the country's most expensive banking scandal.

The current crisis has its roots in a significant court decision from the U.K.'s Court of Appeal in October, which declared that car dealers cannot receive bonuses from banks offering motor finance without obtaining the customer's informed consent.

The sudden decision has led to a potential billion-pound redress scheme for consumers in the motor finance industry.

The mis-selling scandal involving payment protection insurance (PPI) in the UK has been compared to the PPI scandal in Britain, which cost banks over £50 billion and is considered the biggest financial services mis-selling scandal in the country's history.

The Financial Conduct Authority of Britain announced on Wednesday that it will request the Supreme Court to make a quick decision regarding lenders' right to appeal a ruling.

Banks left 'in limbo'

The FCA may intervene to share its expertise if permission to appeal is granted, as it noted that car financing groups are likely to have received a surge in complaints in recent weeks.

Motor finance groups were encouraged to establish financial provisions to address the high volume of complaints.

Since the Oct. 25 court ruling, Britain's banks have been left in a state of uncertainty, with Black Horse being considered the most at risk through its business, according to equity analyst Niklas Kammer at Morningstar. However, he added that Barclays also has some exposure, but it is not as significant as Black Horse's.

The Court of Appeal's ruling caught both the banks and the FCA off guard, as the banks claim they followed the FCA's rules and guidelines, which do not align with the new ruling, according to Kammer's email to CNBC.

Banks face significant uncertainty regarding the rules they must follow, as the FCA awaits a potential Supreme Court ruling before making a decision, according to Kammer.

"If the ruling is upheld, the FCA will need to modify its guidelines on disclosures. Initially, the FCA emphasized that the situation should not resemble the PPI mis-selling scandal, but if the new ruling is enforced, the worst-case scenarios could have a similar magnitude of impact."

Lenders 'likely to pull out of the market'

The motor finance sector, comprising both banks and non-banks, could face a potential downside impact of £28 billion if the Supreme Court upholds the lower courts' verdict, as stated by Benjamin Toms, U.K. banks analyst at RBC Capital Markets.

Lenders may withdraw from the market, resulting in fewer options and higher prices for car buyers, according to Toms.

Other types of lending, such as premium finance, may also be subject to legal scrutiny, he noted.

The FCA conducted a review of the motor finance industry in January to investigate if there was widespread misconduct related to discretionary commission arrangements, which were banned in 2021.

The Court of Appeal's judgement is currently being considered by the organization on Wednesday in regards to its review.

Earlier this month, Close Brothers Group's ratings were placed on "Rating Watch Negative" by Fitch, a significant rating agency, due to the lender's substantial exposure to the motor finance industry.

Significantly involved in motor finance lending are Barclays, Investec, Lloyds, Santander UK, and other lenders, according to Fitch.

Britain's largest car finance company, Lloyds, has allocated £450 million for financial provisions.