Apr 152013
 

The interest rate swap scandal will probably go down in British financial history as one of the more embarrassing moments when bank management let themselves be led by greed rather than smart business.

Like most schemes, the idea seemed great at the time and very profitable. However, society has a long history of tipping the scales when an abuse goes too far. And in the case of the interest rate swaps fiasco, that’s exactly what happened.

How the Swap Worked

Small businesses across the U.K. were brought into the scheme by multiple major banks, each competing with each other to catch as many “fish” as possible. The approach was simple. As a small business came into a bank asking for a commercial loan, the lender would apply an additional requirement that the business also buys an interest rate swap agreement as an insurance protection. This tool was market as a way of protecting the business if the loan interest rate should rise during the life of the loan. However, what was also buried in the agreement details was another requirement that the business would pay the bank a penalty fee should the interest rate involved drop. When the general market indexes driving the fluctuating rates did drop, most business owners thought their financing would get cheaper each month. Instead, the loan payments plus the penalties for the swap agreement became far more expensive.

The small businesses affected farms, small property developers, restaurants, family lodging businesses, repair and trade shops, and more. Each of them fell into the same pattern, agreeing to contracts with buried terms associated with swaps. And each one noted afterward that there was no clear warning of what would happen if the loan’s interest rate dropped versus went up.

Enter the Government

Fast forward to 2013 and the U.K. government through the Financial Services Authority is investigating the intentional mis-selling of business loans and the connected interest rate swaps. The ramifications can be huge and are expected to be as well. A handful of the major British banks are already putting aside millions of pounds to address expected settlements and payouts to make the issue go away.

According to the Financial Services Authority, close to 40,000 small businesses with variable-rate loans were affected by the swaps connected to loan contracts over the last ten years. And fixed rate loans were not exempted. Far more fixed rate loans were issued, potentially increasing the number of agreements involved to as many as 100,000 loan agreements but some expert estimates.

Much of the government’s concern centers around the issue that a product can be combined with another, making it a new financial tool that is unregulated. Once that happens, the banks don’t have to report the behavior, use or pattern of application to the government. That little loophole allowed the rate swap mis-selling to go on for so long until it became a widespread problem among thousands of businesses and pursued by hundreds of bank branches.

Settlements Ahead

The process of settlement is expected to be a tidal wave that just keeps getting bigger and bigger with added liabilities as more claims come forward. The most banks can hope for now that the government is involved is to slow the payout process so that it’s manageable and can be offset by new profits. One aspect that has so far worked in their favor is that the Authority has left the banks in charge of reviewing the claims of mis-selling and determining the settlements. However, if the banks can’t show a clear, fair treatment of the cases, which many critics think is unlikely, then the Authority will step in to do the job.

If you require further information regarding interest rate swap claims, Maple Leaf Financial is an impartial claims management company.

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