Banks face £1.5bn payout for mis-selling interest rate products

Watchdog says that 90 per cent of cases it reviewed showed that rules had been broken

Britain's big banks are facing another billion-pound-plus hit after the City watchdog told them to review all sales of controversial interest rate hedging products that have crippled some small businesses.

The demand immediately caused Royal Bank of Scotland to warn that it will increase provisions related to the scandal from the £50m already set aside. Details will be revealed when it reports full-year results.

The Financial Services Authority said in a review of 173 cases that banks had broken at least one rule in more than 90 per cent.

In addition to RBS, Barclays, HSBC and Lloyds will have to review all interest rate hedging product sales and pay compensation to victims of mis-selling.

Interest rate swaps were a derivative sold as a protection against rising interest rates alongside small business loans. But there is a sting in the tail: when interest rates unexpectedly plunged in response to the financial crisis, firms that bought them were hit with huge bills.

While the cost of the mounting scandal is unlikely to approach the £10bn set aside so far to compensate people mis-sold payment protection insurance, experts believe that as many as 40,000 small firms could be in line for payments, which could hit £1.5bn.

Martin Wheatley, the chief executive-designate of the Financial Conduct Authority, which is to replace the FSA, said: "Where redress is due, businesses will be put back into the position they should have been without the mis-sale. But it is important to remember that this review is firmly focused on the particular circumstances of each sale. These will determine whether there were failings in the sales process."

He was backed by the Financial Secretary to the Treasury, Greg Clark, who said: "Small businesses, in particular, should have been able to regard their banks as long-standing partners and advisers. Instead some of them were conned. Today's announcement reflects the new regulatory approach the Government is introducing to ensure that consumers are better protected."

The British Bankers' Association said the review would provide "clarity", and analysts noted that the while the mis-selling appears to have been widespread and so potentially costly, the tone of the FSA's announcement was less aggressive than statements on PPI mis-selling.

Ian Gordon, a banking analyst at Investec, said: "Today's statement from the FSA is inconclusive. Some may be alarmed by the claim that 'over 90 per cent of the [reviewed] sales did not comply with at least one or more regulatory requirement', but there appears to be some sense of balance. Although a costly review of all interest rate swap sales is now underway, unlike PPI, there is not an near-automatic presumption of guilt."

Another seven banks including Allied Irish and Santander UK are expected to launch reviews of mis-selling.