Barclays, RBS May Pay Billions Over Mis-Sold Derivatives

Barclays Plc, Royal Bank of Scotland Group Plc and Britain’s two other biggest banks may have to pay as much as 5 billion pounds ($7.92 billion) to compensate small businesses improperly sold interest-rate derivatives following a probe by the U.K. financial regulator.

The lenders, including Lloyds Banking Group Plc and HSBC Holdings Plc, have set aside about 740 million pounds to cover the claims. Analysts say the total charges for the industry may be much higher than that after the Financial Services Authority said it found “serious failings” in reviews of product sales.

The claims against lenders may turn into another costly scandal for U.K. banks still paying back customers wrongly sold insurance on personal loans. Banks have reserved more than 10 billion pounds to cover claims on payment-protection insurance, which was meant to cover payments on credit cards and mortgages in case of illness or unemployment.

Barclays may have to pay as much as 2.5 billion pounds to compensate customers over interest-rate derivatives, according to Cormac Leech, a banking analyst at Liberum Capital Ltd. in London. HSBC and RBS will need to earmark between 500 million pounds and 1 billion pounds, and Lloyds could face 250 million pounds to 500 million pounds in claims, he said.

Barclays said it has set aside 450 million pounds for redress, while HSBC earmarked $240 million. RBS, which has provisioned 50 million pounds so far, said in a statement today it will “meaningfully” increase that amount.

Lloyds has set aside 90 million pounds, according to Chirantan Barua, an analyst at Bernstein Research.

Hard Assessment

The impact “is hard to assess at this stage,” Barua said in a note to clients. “We do not see any material enhancements to the provisions that the banks have already taken.”

The FSA looked at 173 sales to non-sophisticated customers and found that more than 90 percent didn’t comply with rules.

Products included caps, where customers paid a premium to keep borrowing costs below a pre-defined maximum; swaps, where customers locked in a fixed rate; and more complex combinations like collars, which kept payments within a fixed range. When interest rates fell, the market value of many swap and collar products plunged, leaving customers out of pocket.

“The products that they sold were just absurdly complex,” Martin Wheatley, an FSA managing director, said on BBC Radio 4 today. If small businesses can show “the break costs weren’t clearly stated or understated or there was a mismatch with the size of the loan,” there would be a case for compensation.

Banks offered derivatives to small business and individual customers over concerns that they might not be able to service loans if interest rates rose.

‘Right Thing’

Ian Gordon, an analyst at Investec Plc, said the total charges for the industry may be less than 2 billion pounds and likely closer to 1 billion pounds.

“We don’t see the amounts as overly material -- certainly not in relation to PPI,” he said.

Lloyds said it’s “committed to doing the right thing.”

“Following the review we will provide redress as quickly as possible to those small business customers where detriment is identified,” the London based bank said in a statement.

The four banks sold 28,000 of the products since 2001, according to the FSA.

A significant portion of the 173 cases reviewed by the FSA are likely to result in compensation to the customer, the regulator said.

“This review is firmly focused on the particular circumstances of each sale,” Wheatley said in a statement.


The four banks will now do a full review of their sales of the products to customers unlikely to understand the risks. Such clients could be bed and breakfast businesses, not small subsidiaries of large corporations or special-purpose vehicles that had access to financial advice, according to the FSA.

“We will work with our customers to ensure a fair and timely resolution of these issues,” RBS said in a statement.

The banks didn’t always disclose the costs of exiting the products, failed to ask if the customers understood the risk, advised hedging that didn’t match the underlying product, and gave employees incentives to drive the sales.

The FSA said it expects the four banks to finish their review within six months and should prioritize cases for customers who are struggling financially. Banks with larger reviews of the sales dating back to the end of 2001 may take as long as 12 months, the regulator said.

Barclays will “put things right” where it hasn’t met the “expected standards,” the bank said in an e-mailed statement. “We look forward to engaging with eligible customers.”

HSBC said it will write to customers soon with details of the review and tell them later whether they may be compensated.

The FSA is also reviewing the sales of interest-rate hedging products by Allied Irish Banks Plc’s U.K. unit, Bank of Ireland, Clydesdale Bank Plc, Yorkshire Bank Plc, Co-Operative Bank Plc and Banco Santander SA’s U.K. unit.

“Where customers have suffered unfairly the banks have all agreed that they will put it right,” said Anthony Browne, the chief executive of the British Bankers’ Association, a lobby group for the finance industry.

(Updates with RBS statement in fifth paragraph.)
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