Lloyds Banking Group has announced a provision of £1.2 billion to cover potential compensation costs linked to motor finance commission arrangements, as its annual profit experienced a decline of 20%.

In the financial results for the year, the bank reported a pre-tax profit of £6 billion for 2024, a drop from the £7.5 billion posted the previous year, and below analysts' forecasts.

The £1.2 billion provision comprises an additional £700 million set aside in the final quarter of the year, building on a previous provision of £450 million confirmed in the prior year.

Lloyds' exposure to this issue is partly through its Black Horse brand, a major player in the UK car finance market.

The issue has arisen due to ongoing scrutiny from the UK's financial watchdog regarding undisclosed commission arrangements between car dealers and borrowers, which are currently the subject of significant regulatory review and legal challenges.

In its financial report, Lloyds cited a decline in income, increased business expenses, and the need for larger provisions as contributing factors to its profit decrease.

Despite these challenges, the bank's share price increased by 6% following the announcement, attributed to effective cost management and plans for shareholder distributions.

The additional £700 million provision was prompted by a court ruling in October that declared it unlawful for car dealers to receive commissions on motor finance from lenders without obtaining informed consent from customers.

This verdict is expected to lead to a new wave of consumer complaints regarding past motor finance agreements.

Lloyds' Chief Executive, Charlie Nunn, acknowledged investor concerns regarding the implications of this ruling for both the financial services sector and broader market confidence in the UK. He indicated that the ongoing legal landscape remains uncertain, with the upcoming Supreme Court hearings expected to provide more clarity.

Nunn expressed confidence in the adequacy of the provision, describing it as the bank's best estimate of potential financial impacts.

However, uncertainties remain regarding whether the final costs might exceed or fall short of this estimate.

Lloyds' Finance Chief, William Chalmers, reiterated this position, emphasizing the speculative nature of the costs involved.

Compared to Lloyds, other major lenders have also reported provisions related to motor finance.

Close Brothers recently announced a reserve of up to £165 million, while Santander and Barclays reported setting aside £295 million and £80 million, respectively.

In conjunction with addressing these financial provisioning issues, Lloyds reported achieving £1.2 billion in cost savings over the past year.

This reduction was largely facilitated through the automation of services, closure of branches and some head office locations.

The group plans to shut an additional 136 high street branches in the coming year.

The bank has also initiated a share buyback scheme valued at up to £1.7 billion, which contributed to its recent share price increase.

Lloyds acknowledged the volatility in the mortgage market impacting its customers, attributing some difficulties to geopolitical instability and fluctuations in the US market that affect mortgage pricing.

Looking ahead, Lloyds anticipates a modest increase in house prices of 2.1% through 2025, adjusting its previous estimates, alongside expectations for two further interest rate cuts within the year.