Exclusive: Banks Braced For New Mis-selling Scandal

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Barclays (LSE: BARC.L - news) will tomorrow be drawn into another huge City mis-selling scandal that threatens to intensify the pressure on Bob Diamond, its under-fire chief executive.

I can reveal that the Financial Services Authority (FSA) is preparing a statement revealing it has uncovered evidence that many small business customers (SMEs) were the victims of inappropriate selling of interest rate swap products and that the major high street banks will write to every customer who was sold them.

The City regulator is in talks today with the major banks about its proposed statement, which is being scheduled for tomorrow morning. It could lead to another compensation bill for the country’s biggest banks running potentially to hundreds of millions or even billions of pounds.

I’m also told that the banks may agree to a moratorium on the sale of the swaps  - although it is unlikely that many people will be buying them at the moment given where interest rates are - and to pursuing customers who have been left facing large bills from the ultra-low interest rate environment.

I should point out that the details of the FSA statement are still being thrashed out today and that depending on the outcome of the discussions with banks, it may make more limited comments on the issue or proceed to a more formal inquiry.

"It (the content of the FSA’s statement) is still very much a moving target,” an insider at the City regulator told me.

What is beyond doubt is that the FSA has completed an initial review of the sale of the interest rate swap products, which were designed to protect those who bought them against steep changes in interest rates by hedging their exposure to such movements.

Many business owners have complained that they were unfairly saddled with huge penalties from the slashing of interest rates to record lows in the aftermath of the banking crisis.

I have learnt that in recent days the FSA has asked the major high street lenders which sold interest rate swaps – led by Barclays and the taxpayer-controlled Royal Bank of Scotland (LSE: RBS.L - news) – to commit to writing to the hundreds of thousands of SME customers who took out these swap products.

The communications with customers will be divided into two categories: those who were sold relatively simple products, who are expected to have the opportunity for their cases to be reviewed; and those who were sold more complex products or were unlikely to have understood the downside risk they were taking on.

As I understand it, under the scenario being discussed by the FSA and the major banks, those who fall into the second category will be told that their case will be reviewed by an independent assessor and that they will be compensated appropriately if there is evidence of mis-selling.

The compensation would be calculated from the difference between the loss suffered by a customer and the cost of a simple fixed-rate loan from the same bank.

To be clear, derivatives products of this nature by definition carry a financial risk if rates move sharply in the opposite direction to that which is being insured against.

The conclusion that the FSA has uncovered new evidence of misselling deals a devastating blow to the banking industry in the aftermath of yesterday’s £290m fine imposed on Barclays for fixing the key benchmark interest rate Libor.

The FSA and the major banks declined to comment.