Four banks to begin interest rate swap compensation programme, FSA confirms

The announcement by the Financial Services Authority (FSA) follows its scrutiny of the banks' proposed approaches to reviewing sales. The regulator announced that it had found "serious failings" in the ways that Barclays, HSBC, Lloyds and RBS had sold IRHPs, or 'swaps', in June last year.

The work on the pilot review confirmed the regulator's initial findings of mis-selling, it said. Over 90% of 173 sales made to 'non-sophisticated' customers, such as individuals or small businesses, did not comply with at least one or more regulatory requirement, it said. Although it acknowledged that the "typically more complex" cases in the sample would not necessarily be representative of all sales, compensation would likely be due in a "significant proportion" of those 173 cases, it said.

Eligible customers would be contacted automatically by their banks, the FSA said.

"This marks significant progress in our review of these products," said Martin Wheatley, chief executive-designate of the new Financial Conduct Authority (FCA). "We believe that our work will ensure a fair and reasonable outcome for small and unsophisticated businesses. Small businesses will now see the result of the review as the banks look at their individual cases. Where redress is due, businesses will be put back into the position they should have been without the mis-sale."

Results of the FSA's review of sales by six other banks would be published by 14 February, the regulator said. Allied Irish Bank, Bank of Ireland, Clydesdale and Yorkshire banks, Co-operative Bank and Santander UK joined the review voluntarily after the FSA began its investigation of the larger banks.

IRHPs provide borrowers with protection against changes in interest rates by locking in net cash outflow to a fixed interest rate. The product is designed so that the swap provider, which is usually the bank that provided the underlying loan, covers the cost of increased payments if the interest rate rises while customers have to pay the bank if rates fall. Simple products merely fix an upper limit to the interest rate on a loan, while more complex 'structured collars' introduce a degree of interest rate speculation to the transaction. In all cases, customers risk having to make higher payments than anticipated if the market does not perform as expected.

In its June announcement, the FSA said that sales staff at the banks had failed to properly ascertain whether customers understood the risks associated with the product they were buying, and that some products had been 'over-hedged', meaning that the amount or duration of the arrangement was disproportionate to the underlying loan. Customers had also not been notified that large exit fees could apply if they wanted to cancel the arrangements.

In a report (20-page / 425KB PDF) setting out the principles the four banks had agreed to follow when conducting their reviews of individual sales, the FSA said that customers should be put "back in the position they would have been in had the breach of regulatory requirements not occurred". Potential redress could include cancelling the swap and refunding all payments, or transferring the customer to a more suitable product. However, no compensation will be given to customers if "it is reasonable to conclude that ... the customer would still have bought the same product, or the customer suffered no loss".

Banks will also be asked to consider customers' additional, or 'consequential', losses, which could include overdraft charges or the cost of additional borrowing needed to meet the repayments. For customers to be eligible for compensation, the loss must have been caused by the regulatory breach and "reasonably foreseeable" at the time the breach occurred.

The FSA has also revised its original eligibility criteria, in order to ensure that small businesses that were unlikely to understand the risk of the product that they purchased will be eligible to have the sale reviewed. It will now include those businesses, such as bed and breakfast businesses, which would previously have been ineligible due to their large numbers of seasonal workers. However more sophisticated small businesses, such as small subsidiaries of multi-national companies, will now be excluded.