According to forecasts, there’s a storm brewing over a vast number of interest rate swaps that have allegedly been missold. The possibility that claims may start flooding in has recently been publicised by mainstream press and this has led the Treasury to the decision that a review of the selling procedure is in order.
The Treasury are set to review whether the interest rate swaps were sold in an understandable and clear way. Interest rate swaps were initially offered to large financial companies so that they could hedge against the rises in interest rates. However, in 2006, banks started to target owner-managed SMEs like property developers, farmers, care homes, pubs, restaurants and hotels that needed loans.
They were promoted as a form of protection against rises in interest rates and were often included as conditions of the loans. Often, the recipients of these loans weren’t used to complex procedures such as interest rate swaps and simply chose to believe that the bank was operating in their interest.
The most common type of swap included a ‘collar’ and a ‘cap’, the lower and upper interest rate payable, respectively. SMEs were informed that if the interest rates were to rise above the cap then they’d be saving the difference. However, in most cases, the banks appeared to neglect to mention what would happen when the rates fell below the collar.
In some cases, SMEs would simply pay the collar amount, in others, the rate would be increased back to the amount of the cap. This meant that a high number of SMEs were paying high interest rates while competitors were getting low interest variable rates. Another problem that has emerged with this type of swap is that when rates rose above the cap, many banks were terminating swaps and moving them to higher rates.