The latest interest rate swap scandal shows that as many as 40,000 small businesses may have been victims of banks mis-selling these financial instruments. The Financial Services Authority (FSA) has recently ordered banks to begin compensating businesses who were victims of this scheme. Financial analysts are estimating that the compensation order may cost UK banks as much as £10 billion pounds.

 

Interest Rate Swap Agreements (IRSA)

Individual businesses that signed up for Interest Rate Swap Agreements (IRSA) have been hit with hundreds of thousands of pounds in extra interest payments. Some businesses are now in dire financial situations. Others have been forced into administration. A few businesses shut their doors after they could no longer meet their financial obligations.

 

Banks sell these financial hedges, known as interest rate swaps, in order to minimize financial risks to businesses. This is essentially a contract that will compensate businesses if interest rates rise beyond a specific point. It acts as an offset against higher payments on a loan. The net effect of a rate swap is to stabilize the loan’s interest rate for businesses. Businesses claim that this did not happen. Instead, they were hit with higher interest rate payments after interest rates fell.

The FSA claims that banks sold these swaps with the implied guarantee that they were a no-cost hedging instrument. This, then, is at the core of the mis-selling allegations. Another factor in the FSA compensation order is the claim that banks didn’t inform businesses about exit fees that must be paid to buy out the contract. The FSA investigation found what it calls “major failings” by banks in the process of selling these swaps to businesses.

 

Interest Rate Swap Examples

About 30 business entrepreneurs recently attended a meeting at the Hilton Hotel in Leeds, which was sponsored by Bully Banks, a lobbying group established to give businesses a voice and a fair shake in the rapidly unfolding swap scandal.

Jon Welsby, owner of Bluesight in Filey, located at Hull, related how he took out an ISRA in 2008. The following year, after interest rates dropped dramatically, he was hammered with rising payments. He said it became obvious to him that the financial product he bought was not what he thought it was.

Welsby had bought a callable swap. After interest payments shot up, Welsby said he tried to exit the contract, but the bank refused.

Beyond the normal loan interest, Welsby was also slammed with an additional £13,000 in interest. The next month, in September 2011, that figure jumped to £16,955. This was only the beginning, though.

He got hit with a new valuation of his Bluesight portfolio that chopped off 60 percent of the value. The bank then smashed him with nearly £1 million in fees. This threw his business into receivership.

Sami Wasif is the co-owner of Hakkasan, a London Chinese restaurant, and he has been wrestling with the Royal Bank of Scotland since 2004. He said he wasn’t aware that the bank had sold him an interest rate swap. He accused the bank of making more than £200,000 in unauthorized withdrawals from his account.

Finally, fed up with the bank’s intransigence, Wasif publicly announced that he would stop making premium payments to the bank until the matter was settled. This stand made him a hero with mis-selling victims.

Mehmet Bay, a Turkish immigrant and patisserie owner, was sold a complex 20-year swap instrument called an interest rate enhanced collar. After the swap became expensive, Bay tried to cancel the contract. Barclays told him that the break fee would cost him £500,000. Bay is suing Barclays. The case is expected to start early in 2014.

Paul Adcock runs a small electronics business in Norfolk. Barclays sold Adcock’s Electronics a complicated swap that Adcock said is bleeding him dry. When he tried to cancel the derivative, Barclay demanded £130,000.

Mansel Beechey and his wife, Sandra, have been forced to scuttle their retirement plans. They own Yr Hen Liew Du, Bridge Street, Aberystwyth, and the Ship Inn, Liangrannog. They stand on the precipice of losing both businesses after getting hit with hidden interest in a rate swap agreement. The publicans face a fee payment of £200,000 if they pay off their loan early. They took out what they thought was a fixed-rate 15-year loan to pay for the Ship Inn, securing the loan with the other pub. Now they need to return to full-time work.

Goschalks Solicitors spokesman Nigel Beckwith encouraged businesses to act soon. A six-year limitation exists for businesses to make claims against banks mis-selling swap contracts. That time limit begins on the date the contract was signed.

 

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Tim Capper

Bringing you financial news and information in plain english for Maple Leaf Financial. My aim is to help readers understand these often complex financial instruments.