The Interest Rate Swap Scandal Explained
As if the PPI mis-selling scandal wasn’t enough to knock some sense into world’s most powerful banks, it seems the main street banks misselling interest rate swaps is about to make that particular episode look positively trivial.
According to a recent article on the Telegraph website, the cost of compensating businesses that were mis-sold rate swap loans by Britain’s major banks tripled in the last five months of 2013. And far from being the end of the matter, there are some financial analysts who believe the eventual cost of compensating small and medium-sized businesses could dwarf the amount already paid out to victims of the great PPI swindle.
The average size of payout currently stands at around £150,000, but according to the Financial Conduct Authority (FCA) a measly 5 percent of the initial £3 billion set aside by Britain’s biggest banks had been paid out by the end of 2013. However, it seems that the message is finally getting through to SME owners. The cumulative total of £158 million paid out by Barclays, RBS, Lloyds and HSBC by the end of December 2013 was almost double the £81 million that had been paid out at the end of November.
According to Money Marketing, the cumulative figure now stands at over £300 million. But how did we get to this point? Why are the biggest banks in Britain facing another compensation crisis? And who are the worst offenders?
Why Can SMEs Claim Compensation?
Small and medium-sized businesses seeking credit from mainstream lenders – particularly between 2005 and 2008 – were routinely being told that the only way to secure the funds they needed was to enter into loan agreements that bound them to a rate swap arrangement. In most cases, cash-hungry business owners took out these loans without first being told of the risks involved. And in the case of those taking on the fixed-rate end of the deal, the consequences of a sudden and prolonged drop in interest rates were not properly explained. Moreover, these products were hailed as the ultimate protection against interest rate rises – essential for the long-term financial health of small companies.
Of course, the banking crash of 2008 resulted in interest rates being dropped to unprecedented lows. Thousands of small business owners were unaware of the potential for financial loss that these rate swap loans presented, and many have suffered significant losses and gone to the wall as a result. Whether they were sold LIBOR rate swaps, base rate swaps or interest rate caps, nothing and no one prepared them for what was to transpire in the banking and financial markets.
The vast majority of hard-working business owners do not have a thorough understanding of complex financial arrangements such as interest rate swaps. It is incumbent on banks and their representatives to ensure that their customers are made fully aware of all the risks and benefits of the financial products they are buying. It is clear that this was not the case in a huge number of cases. This represents a huge dereliction of care and duty towards consumers.
The Financial Services Authority (FCA) has laid down strict guidelines on the selling of financial products. They include ensuring an interest rate swap is the best option available to the customer, and that all of the associated risks have been fully explained – and understood. The complex nature of these derivative-based arrangements requires detailed explanation – using worst-case scenarios to demonstrate the risks involved. It is now becoming clear that this obligation was rarely met.
Which Banks Are the Worst Offenders?
Unfortunately, it’s probably easier to list the banks that are not involved in this latest mis-selling scandal. State-owned Lloyds Banking Group was systematically misleading its business customers, as its interest rate swaps were sold as part of a fixed-rate loan. And because Lloyds customers are often only made aware of the situation when they try to exit their agreement, the scale of the problem may not be fully understood for some time yet.
Technology tycoon Lord Sugar recently complained to the Lloyds Banking Group, after it emerged that £10 million of hedging products were sold against loans on his properties. This begs the question: if a savvy and experienced entrepreneur can fall foul of hidden derivative schemes, what chance has the humble small business owner got?
Both Lloyds and West Bromwich Commercial Building Society have significant early exit fees attached to their loans. Many of their customers are likely to have expected a schedule of charges similar to those of a standard loan or mortgage, and therefore won’t have budgeted for these unexpectedly high fees.
Clydesdale Bank plc, which trades as Yorkshire Bank on the high street, is owned by the National Australia Bank Group, and it seems that one of its loan products in particular could have been mis-sold to thousands of UK-based businesses. The Tailored Business Loan consisted of several over-the-counter derivative products, including dual-rate swaps.
HSBC are also heavily exposed to this latest banking scandal, and they have set aside an initial £1.2 billion as a result. Meanwhile, the FCA is overseeing a complete review of the system, which includes Barclays, Allied Irish Bank, The Bank of Ireland, Co-Op Bank Clydesdale Bank (Yorkshire Bank), Santander, The Lloyds Banking Group, Royal Bank of Scotland and HSBC – all of which have been heavily exposed to the mis-selling crisis.
What Can Affected Business Owners Do?
Business owners can prepare litigation with the help of specialist law firms in order to secure compensation for being mis-sold interest rate swap products. However, there are a number of options available before it comes to that, including negotiating with the bank directly, opting in to the FCA review and making a formal complaint to the financial ombudsman.
However, when efforts at securing compensation out of the courts have failed, enlisting the help of an interest rate swap litigation solicitor may be the only option left. In many cases, the initial consultation is offered free of charge, and it could be an important first step to making banks accountable for their appalling behaviour – as well as securing the compensation that businesses and their owners deserve.
27 February 2014.