Millions of drivers caught up in the car loans scandal face losing around £500 each under a compensation scheme being drawn up by the City watchdog, a law firm has warned.

The row centres on compensation due to motorists who took out car finance agreements between April 2007 and November 2024 without being fully informed about the commission paid by lenders to brokers, usually car dealers.

Law firm Slater & Gordon has launched a blistering attack on the Financial Conduct Authority (FCA), which it claims is protecting the banks and finance firms behind the scandal by limiting the compensation to consumers.

It claims that the FCA’s proposed redress formula will short-change as many as 14.2 million car buyers by a combined £8.1 billion.

The firm accused the regulator of doing “a big favour to the very banks that caused the problem and that are reporting huge profits”.

Under the FCA’s current plans, the average payout to affected drivers would be about £700. Slater & Gordon insists a fair figure should be closer to £1,200 – leaving motorists roughly £500 worse off than they should be.

The FCA estimates lenders will pay out around £11 billion in total, made up of £8.2 billion in compensation and £2.8 billion to run the scheme. Payouts on up to 14 million unfair agreements could start next year.

Major banks are already bracing for the hit. Lloyds, the biggest player in car finance through its Black Horse brand, has set aside £1.95 billion, while Barclays, Santander and Close Brothers also face significant bills.

Slater & Gordon, which says it has signed up “hundreds of thousands” of affected motorists, is particularly critical of the FCA’s proposed “hybrid” compensation formula and the interest rate to be applied.

Under the plan, compensation would be calculated as an average of the total commission paid and the FCA’s estimate of consumer loss. Interest would be added at base rate plus 1%, rather than the 8% often used in personal finance redress cases.

Research commissioned by the firm from WPI Economics suggests the hybrid formula alone would cut payouts by £3.5 billion, with the lower interest rate shaving off a further £4.6 billion.

Slater & Gordon said: “The scheme systematically undervalues the harm suffered, despite clear legal precedent indicating that full commission repayment with appropriate compensatory interest is the correct remedy.”

Industry bodies disagree. The Finance and Leasing Association has argued the scheme should be tightened in the opposite direction, excluding millions of car buyers who it claims suffered no loss and had no unfair relationship.

The FCA closed its consultation on December 12 and is expected to finalise the compensation terms by the end of February.

Lenders are reportedly considering judicial review if the scheme is seen as too generous, while Slater & Gordon has signalled it may take legal action if it is not generous enough.

An FCA spokesperson said: “We’re considering feedback to the consultation which will help us refine our proposals to ensure any scheme is fair and robust. Our scheme aims to be simple for people to use. That means on such a complex issue not everyone will get everything they would like.

“We said when we launched the consultation that consumers can choose not to use the compensation scheme and instead go to court, where they may get more or less compensation. However, the outcome of a court claim is uncertain and, accounting for legal fees they may pay, many consumers could end up with less. The FCA’s scheme is also likely to be faster and simpler than going to court.”