City watchdog warns on mis-selling

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As many as 40,000 complex financial products could have been mis-sold to small businesses, according to the City watchdog's latest estimate of the scale of the banking scandal.

The Financial Services Authority (FSA) confirmed it had increased its estimate of the number of so-called interest rate swap arrangements that were sold by more than 40%, up from 28,000 initially.

The new figure comes after the regulator was supplied with new information by the banks and suggests the industry could be facing a hefty compensation bill.

Three of Britain's biggest banks - Barclays, HSBC and Royal Bank of Scotland - have already set aside around £630 million to cover the cost of potential mis-selling claims.

The FSA revealed in June that it found "serious failings" in the sale of the interest rate swap products to small businesses.

The products are complicated derivatives that may have been sold as protection - or to act as a hedge - against a rise in interest rates without the customer fully grasping the downside risks.

Banks are working with the FSA to begin the compensation process and the major players have now launched pilots where a sample number of cases are reviewed to assess if mis-selling took place and potential compensation.

They have around a month to report back to the FSA before a full-scale review of all cases begins.

The FSA said while it wanted compensation to be arranged as soon as possible, it was crucial banks were using the right approach to review cases.

An FSA spokesman said: "The FSA is determined this process will happen as quickly as possible, but it is essential we get the right methodology in place first and that we are confident this will deliver the right outcome for customers."

Barclays, HSBC, Lloyds and Royal Bank of Scotland have already agreed to compensate customers where the mis-selling occurred.

As well as offering redress directly for those customers who bought the most complex products, the banks have also agreed to stop marketing certain interest rate products to retail customers.

In its initial investigations, the FSA found poor sales tactics including failing to provide sufficient information on the hefty exit costs involved, failure to gauge the customers' understanding of risk and found rewards and incentives were a driver of these practices.

The FSA stresses that not all businesses will be owed redress, but for those that are, the exact redress will vary from customer to customer.

This exercise will be scrutinised by an independent reviewer at each bank appointed under the FSA's powers.

It believes as many as 700 independent reviewers will need to appointed by the banks, with each case taking around one to three days to review.