Exclusive: £22bn threat to banks in latest mis-selling ‘scandal’ that could rival PPI payouts

Liabilities threaten Government’s hopes of selling off stake in Lloyds

Political Correspondent

The Government’s aim of returning the entire Lloyds Banking Group to private ownership before the general election could be blown off-course by another mis-selling scandal.

An investigation by The Independent of the potential liabilities of British banks incurred from the mis-selling of interest rate protection products, known as swaps, has revealed that payouts could match the PPI scandal, which has so far cost them £22bn. Lloyds’ exposure has been estimated for The Independent to be a potential £5bn – and other UK banks could be similarly hit.

Until now estimates of the scale of the scandal have been limited to interest-rate hedging products (IRHPs) sold mostly to small and medium-sized businesses. But claims from so-called “sophisticated” clients – those with swaps valued above £10m or who employ 50 people or more – could push the total far higher.

The Independent, in conjunction with derivative analysts in the City who cannot be identified for legal reasons, examined high-value claims excluded from the Financial Conduct Authority’s recent review of mis-selling.

Read more: Comment - sell now or pay for it later, George

One analyst said: “This is potentially a bigger problem for UK banks than PPI. Profits from PPI sales somewhat offset the £22bn the banks were forced to pay out in compensation. But profits on swap derivatives could be dwarfed by high settlement costs.”

For the Government, keen to show that its economic competence is responsible for UK markets returning to rude health, the scale of alleged undisclosed mis-selling could dent its hope of restoring trust in banks. The Treasury and the FCA review focused only on businesses unlikely to understand the complex financial products they were sold. IRHPs were intended to offer predictability on loan interest repayments. But the size of the swaps was often bigger than the loans they protected.

When the credit crunch hit in 2008, and interest rates fell to historical lows, clients found they faced horrendous costs if they tried to exit the deal. Victims caught in the mis-selling were described by one former bank employee as “lambs to the slaughter”.

Lloyds and eight other major banks, including RBS and Barclays, have already set aside £3bn to cover mis-selling to clients the FCA called “non-sophisticated”. Around 90 per cent of these deals have been identified by the financial watchdog as not complying with financial regulations.

The Government holds 25 per cent of Lloyds. Lloyds’ chairman, Lord Blackwell, said he was preparing to “facilitate the earliest possible return of the company to full private ownership”. The Treasury views this as evidence “the mess” left by Labour is being cleared up. But even a whiff of residual problems will prove difficult for the Chancellor.

The limited IRHP review was carved out in a behind-closed-doors deal agreed between the FCA and the banks. Those with a turnover of more than £6.5m a year, with swaps worth £10m or more, were excluded. 

The FCA revealed this month it had identified 29,490 cases associated with swap deals. Almost 19,000 were assessed as “non-sophisticated”, with 10,475 “passing” the “sophisticated” test. Lloyds says its share of the 29,490 total is just above 1,500 with a similar ratio of 2:1 of non-sophisticated to sophisticated customers.

Although Lloyds told The Independent the suggestion there could be 500 claims linked to high-value swap mis-selling was “highly speculative” and “not credible”, the bank has nevertheless lined up an array of star financial law firms – including Herbert Smith Freehills, Hogan Lovells, Walker Morris, Addleshaw Goddard and Norton Rose Fulbright – to fight off claimants.

Attempts to contact the lawyers inside these firms ended mostly in statements saying they were unable to comment or calls not being returned.

Through legal documents lodged at the Royal Courts of Justice, examination of financial databases, and sources close to the law firms, The Independent has calculated the notional average of each high-value swap at around £20m.

The exposure of Lloyds can be estimated at 30 to 50 per cent of the notional swap value. This means a potential £5bn bill – which may affect the bank’s share price and cast doubt over any imminent return to private ownership.

One law firm, representing clients sold swaps of £10m to £200m, said redress depended on the years of payments, break costs and “consequential losses” – namely failed investments affected by mis-sold IRHPs. Huge legal costs are also factored in.

Although information on IRHPs is collated daily by banks’ trade desks, Lloyds refused to reveal the average value of claims lodged by “sophisticated” customers. A spokesman for Lloyds initially said: “How can we know? We aren’t liable. They knew what they were buying.”

A formal statement then added: “No provision has been recognised in relation to customers which are not covered by the agreement with the FCA, or incremental claims from customers within the scope of the review. These will be monitored and future provisions will be recognised to the extent an obligation resulting in a probable outflow is identified.”

Lloyds Group was described by some lawyers as being among the most “aggressive” of the banks in its sales of swaps. No claim against Lloyds has come to court. Out-of-court settlements covered by confidentiality clauses have kept the scale of the alleged problems from public examination.

Whitehall sources said David Cameron has been briefed on the scale of high-value mis-selling problems, and there is said to be fear at the top of the Government that a new debate on banking reform will be ignited.

The Commons Treasury Select Committee is currently looking at bank lending to small and medium enterprises. It is understood it is being pressurised to extend the scope of the investigation to look at the full exposure banks could have to IRHP mis-selling beyond the current FCA scheme. Pat McFadden, a former business minister, said: “I don’t think anyone can say for sure what the liability of the banks is going to be [on IRHPs] till this has been examined in detail.”

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