Interest-rate swaps: Banks face small business fightback
- 29 June 2012
- From the section Business
The banks are in hot water again.
Major High Street lenders have been selling complex financial contracts to small business clients without properly explaining the risks involved.
The products were offered to thousands of small firms - including pub owners, haulage firms, care-home operators and vets - when they asked their bank to take out a loan.
The borrowers were told that the product would provide an "insurance" or "hedge" against the risk of interest rates rising.
But with interest rates having instead fallen since 2008 to historic lows, many of these businesses have discovered they are now sitting on tens of thousands of pounds in losses.
What have the banks been doing?
Small businesses claim to have been sold "Interest Rate Swap Agreements" and other complicated interest rate hedging products such as "collars" or "caps and floors" without being properly told the risks they were taking.
Many borrowers claim that they were pressurised into buying these products. They say the "hedge" was made a condition of the loan they needed being granted, and that in some cases they were given very little time to make a decision.
What are the risks of these products?
The hedges were supposed to protect borrowers from the risk of interest rates going up.
But the quid pro quo was that borrowers paid more when interest rates fell. After 2008, the Bank of England slashed interest rates to help out struggling borrowers - but these borrowers did not benefit from cheaper interest rates because of their hedges.
What's more, borrowers have found themselves stuck with these hedges. For example, some businesses have tried to shrink their businesses in response to the tough trading conditions, by selling off properties and using the proceeds to pay off their loans. But when they have asked to cancel the hedges for these loans, they have sometimes been told they must pay tens of thousands of pounds in cancellation costs.
Some products also contained additional risks. For example, the lender - but not the borrower - had the right to cancel the hedge without paying any compensation.
In the case of an electrical retailer who has spoken to BBC business editor Robert Peston, the borrower actually ended up paying a higher interest rate on the hedge as the Bank of England cut lending rates below a trigger level.
Why do some businesses claim these products were inappropriate?
In many cases, borrowers say they have ended up with hedges for loans that do not even exist.
For example, some claim they were told to take out hedges for significantly more than the amount of money they were actually borrowing.
In other cases, borrowers say they were pushed into taking out hedges that would last many more years than their loans, because the bank said they were likely to reborrow the loans when they came up for repayment.
But the bank made no commitment to relend them the money. So the borrower faces the risk of being stuck in an expensive hedge for a loan the bank refuses to renew.
In one case that has been settled out of court, the borrower even claimed that their bank had already agreed to cap their monthly loan repayments - meaning there was no need for an interest rate hedge at all.
How widespread are the allegations?
The Financial Conduct Authority (FCA) said 40,000 of these products were sold by four banks - Barclays, HSBC, Lloyds and RBS.
After ordering the banks to set up reviews, the FCA reported that the first compensation offers were accepted at the end of August 2013. In September 2013, it said that a further 2,000 letters offering compensation were being sent out.
Jeremy Roe, who runs a chain of holiday cottages, founded the Bully-banks campaign website after he said he himself fell victim to mis-selling.
He says that hundreds of aggrieved businesses have registered on his website since it was highlighted by the Daily Telegraph, although he has no idea how large the problem could turn out to be.
What can businesses do about it?
The four banks - Barclays, HSBC, Lloyds and RBS - are now each setting up a review of the cases of potential mis-selling. The banks are prioritising those in financial difficulty.
Those businesses affected will be contacted by the bank to tell them that they are eligible to be part of these reviews, if they agree to it. They might have to provide some information to the bank.
In due course, the bank will propose "fair and reasonable" redress on a case-by-case basis, which will reviewed and agreed by the independent reviewer.
If the business are not satisfied with this offer then they can refer the complaint to the Financial Ombudsman Service. However, if the business is unhappy, and thinks that it has suffered losses of more than £150,000, then it may have to take its case to the civil courts.
Some customers who purchased caps are not included in the scope of the review unless they complain to their bank.
Mr Roe, of Bully-banks, recommends businesses collect as much documentary evidence as possible - legal documents, sales materials provided by the banks, and email records.
He also points out that borrowers have a right to demand that their bank provide them with transcripts of any telephone conversations they have had with bank representatives, which the banks routinely record.
Any business in hardship can apply to have its loan repayments suspended while the reviews are taking place.
Should small businesses avoid these products in future?
Interest rates can go up as well as down. Indeed, interest rates cannot go a lot lower - the Bank of England can only cut them a further 0.5% before they hit zero. Rising interest rates can be a real risk for businesses, as they were in the 1970s.
However, financial adviser James Ducker says anyone considering entering into one of these transactions should speak to an expert to get independent advice - so the banks know they cannot charge a huge profit.
"Swaps can be a useful service which to help insulate business customers against fluctuations in interest rates," according to the British Bankers' Association.
"As with every other purchase, customers should consider if this is the right product for them, shop around and be sure they fully understand what they are signing up to before making a commitment."
However, a number of banks have said that they sold these complex products to relatively few businesses.
Barclays, HSBC, Lloyds and RBS have also all agreed to stop marketing structured collars to retail clients.