British banks hit by new mis-selling scandal

Britain's leading banks are facing new allegations of mis-selling complex financial products to hundreds of small businesses despite them having little knowledge of what they were buying, a Sunday Telegraph investigation has revealed.

All of the UK's major banks, including Barclays and HSBC, as well as taxpayer-backed lenders Lloyds Banking Group and Royal Bank of Scotland, are facing legal action which could lead to billions of pounds of damages for small and medium-sized businesses.

The businesses claim the banks profited at their expense from pushing them to take out highly complex interest rate derivatives.

Many of the claimants spoken to by The Sunday Telegraph said they were not aware of the significant costs attached to the products that were supposed to protect loans from upward movements in interest rates.

When interest rates plunged after the 2008 financial crisis, businesses were left facing significant bills, with some of the derivatives costing business owners hundreds of thousands to millions of pounds.

The Sunday Telegraph can reveal that RBS was so concerned about the issue it launched an internal audit in January into its sale of interest rate derivatives to SME customers. It said this weekend that it was “satisfied” that sales “had been conducted in accordance” with its own its rules.

RBS is currently fighting a legal case in Edinburgh over claims it sold a small property development company, Grange Estates, an interest rate protection product the costs of which ended up forcing the company into administration.

“RBS has strict policies in place to ensure that interest rate swaps are sold properly,” a spokesman for the bank said. “We regularly carry out audits of our businesses to ensure our policies and procedures are robust, meet the relevant regulatory guidelines and are followed by staff.”

On Friday, a pre-trial hearing was held in Bristol Mercantile Court, where Barclays is facing legal action over claims it mis-sold an interest rate swap to a solicitors' firm. The case is due to go to court next month and Barclays has hired Sonia Tolaney QC, a leading London-based barrister, to defend itself.

Stuart Brothers, founder of law firm SRBlegal, which is leading the case against Barclays, said he was surprised at how hard Barclays was fighting, given the “relatively small amount of money” involved.

In a statement to The Sunday Telegraph, Barclays said: “Barclays is satisfied that it provides sufficient information to enable a client to make an informed, commercial decision about the products it offers.”

The allegation is that banks sold unnecessarily complex and inappropriate interest rate swap products to small business customers.

Paul Adcock, the owner of a Devon-based electrical retailer, was sold a highly-complex financial product known as an “asymmetric leveraged collar” by Barclays Capital, the lender's investment banking arm, after he took out a £970,000 loan from the bank.

Subsequent expert analysis of the deal suggests Barclays could have made an up-front profit on the product of as much as £100,000.

Mr Adcock says his business has had to shoulder about £180,000 in costs related to the swap.

“If you had asked me in 2007 if it was possible that your bank, that has supported you for so long, could have sold you a product that could cause so much damage, I would not believe you,” said Mr Adcock.

James Dean, managing director at Legal Plus in Bolton, is handling dozens of claims on behalf of small firms. He says he has seen hotels, bars, boarding kennels, care homes, garden centres, farmers, publicans and small shop owners all caught.

“They are not sharp suited companies,” he said. “They are ordinary businesses.”

Prof Michael Dempster, Professor Emeritus at the University of Cambridge's Centre for Financial Research and an expert on derivatives, designed many of the computer systems used by banks to price derivatives, such as interest swaps.

He said he was shocked by the products banks had sold to SMEs. “I liken it to going to bet on a horse race having fixed the result,” he said. “You're not guaranteed to win, but you have a heck of an edge on the punters.”

Many banks have already settled cases involving claims of interest rate swap mis-selling. Last year, HSBC is thought to have paid £250,000 to settle a case brought by a Scarborough chip shop, while RBS is also understood to have settled a case earlier this year.

Prof Dempster believes the size of claims faced by banks is likely to end up in the billions of pounds.

“I think this could be at least the same size as PPI [payments protections insurance],” he said, referring to the mis-selling of the products to retail customers.

How the derivatives sold by the banks work
At its most basic, banks offered clients what is called an interest rate swap. The bank would offer the right to fix the base rate on a loan at a certain level to ensure a rise in interest rates would not lead to a company's borrowing costs rising to a level they would be unable to pay.

London (UK) – 10 Mar 2012 - The Telegraph – This would be explained to the customer by comparing it to a form of insurance or fixed rate mortgage. What appears to have been less clear was that while the swap would compensate them if rates rose, it would cost them if rates fell.

Banks have also been accused of failing to mention the “break costs” of exiting the swap should a customer wish to terminate the agreement. It is here that the complexities of the swap market become apparent. While the customer was told the protection was “zero cost” this was not so.

Take the example of a five-year loan for £1m taken out in 2007. In this example the customer wants to fix their rate for the duration of the loan. The bank, with its sophisticated pricing systems, would look at the swap market and get the price of buying the equivalent swap. The rate at the time might be 5.2pc, however the bank, wanting to make a profit and knowing the customer has no access to swap market prices, would quote the customer a cost of anything from 5.5pc to 6pc.

If the customer agreed to the swap, the bank would instantly lay off the risk by selling the swap in the market and locking in a profit for itself of between 30 basis points and 80 basis points. In the case of a £1m, five-year swap, the bank would effectively get a customer to buy a swap worth £200,000 for a cost of £225,000 to £250,000. The bank would immediately claim this profit by selling on the swap into the market, netting itself a gain of between £25,000 to £50,000.

However, many banks did not stop here. In some cases the bank would offer the customer a “cheaper” rate by suggesting they take out a hedge for a longer duration than their loan. The customer would be told that if they did this - in some cases businesses took out 10-year, 20-year and even 30-years swaps - they could achieve a lower interest rate. For example, while a five-year rate might be offered at 6.25pc, a 10-year would be offered at 5.9pc, 20-years at 4.95pc, and 30-years at 3pc.

Again, the customer, with no access to swap pricing data, had no idea of the additional profits the bank would make by offering a longer-dated swap. While a profit of about £25,000 might be the norm on a £1m 5-year swap, if the customer were to take out a 30-year swap, the banks were often making a profit of up to £100,000 on the deal from the moment it was agreed.

Some banks would offer swaps for a greater amount than the actual loan being taken out, as well as offering more complex products, such as “multi-callable swaps”, known in the industry as Bermudans.

Here a bank could generate profits of about £250,000 from swaps sold against £1m five-year loans, simply by taking advantage of the customer's ignorance of swap market prices. In some cases, salesmen even charged upfront “arrangement fees” of £35,000 even though the bank might be making a huge upfront profit from mis-pricing the swap it was selling.

For the customer problems did not become clear until they tried to cancel. One case uncovered by The Sunday Telegraph, and currently the subject of a complaint, involves a businessman who took out a five-year loan for £5m and was left with a break cost of terminating the 30-year swap of £4.1m.

Bank mis-selling victims: from the chippy to the small hotel

High street banks stand accused of exploiting small businesses by selling them costly and complex financial products that made huge profits for banks while crippling once sound firms

London (UK) – 10 Mar 2012 - The Telegraph – All full up and happy,” smiles the white haired lady in the window seat, passing one of Winking Willy's waitres-ses her plate. She had just polished off the Scarborough café's £7.90 special - cod, chips, bread and butter and cup of tea.

It is Tuesday lunchtime, the sun is out and the famous Yorkshire town's seafront is busy. Willy's is three quarters full - families and pensioners tucking into its simple fare with enthusiasm.

The only distraction is the noise of the builders refurbishing Willy's second-floor dining room. All in all, business seems good.

But behind the scenes the family business has just emerged from a four-year-long encounter with the world of complex capital markets derivatives and investment banking that saw owners David and Marilyn MacGregor ultimately take their bank, HSBC, to court.

In a plot that would appeal to Scarborough's most famous resident, playwright Alan Ayckbourn, the family fryer's plucky challenge to the sharp suits of Canary Wharf could have ended in tears. Yet they lived to tell their tale - or at least they would have done if their out of court settlement had not included a gagging order.

The MacGregor's experience is not an isolated one. It is shared by hundreds, and possibly thousands, of small firms across the country.

The high street banks stand accused of exploiting the small businesses' trust, using their standing as adviser to sell highly profitable and complex financial products to some of the smallest firms in Britain.

Traditional standard variable rate commercial loans came packaged with complex bets on the movement of interest rates that were sold on by the bank's investment banking divisions for huge profits.

Presented as a “no-cost” form of insurance to protect the businesses against adverse movements in interest rates, these unregulated swap instruments turned into significant liabilities. Falling base rates were meant to help small businesses but with these products they generated charges that devoured savings and destroyed some once-sound family firms.

To be continued