Interest rate swap mis-selling redress costs set to swell

PaulReflect
May 27, 2013

The Financial Conduct Authority is investigating interest rate swap mis-selling after taking over from the Financial Services Authority. Although the main banks responsible for mis selling the swaps have already set aside funds for redress, it’s estimated that the eventual costs will eclipse those already reserved for compensation. The scandal has become so controversial that the Government has been urged to intervene, after reports that few customers have been compensated so far.

Plunged into debt

Customers were encouraged to sign up for interest rate swaps after being told that the services would essentially fix interest rates for them, protecting them if they rose after taking out a loan with the banks. Under interest rate swaps, if interest rates did rise, customers would see the resulting costs being offset by money that they would be paid by the bank. Conversely, if interest rates fell, customers were expected to compensate the banks to make up the shortfall. Few people however predicted that interest rates would fall to historic lows as the credit crunch began to bite. These record lows meant that customers were forced to pay out vast sums of cash to offset the reduction in interest rates, which plunged many businesses headlong into debt.

Locked into the contracts

What was even more troubling for customers running small businesses was they soon found that the fees required to end the contracts often ran into four figures, meaning that they were essentially trapped into the contracts. Even worse was the fact that swaps and loans were in fact two different products, meaning that even when a loan was paid off, customers were being forced to continue to pay. It’s claimed that the banks employed a series of underhand tactics when getting customers to sign up for interest rate swaps, such as refusing to offer more appropriate alternatives, failing to explain the risks and failing to acknowledge the fact that loans and swaps were two different products.

Sophisticated or unsophisticated

It’s been estimated after a pilot scheme that around 90% of customers signing up for interest rate hedging products, such as an interest rate collar, were mis sold them. Various underhand tactics have been cited, including bank staff telling customers that they could only take out loans on the basis that they agreed to the swaps. It’s said that there is an important distinction between ‘unsophisticated’ and ‘sophisticated’ customers, with the latter likely to have been in a position of understanding the complex terms they were signing up for.