The Financial Services Authority says banks mis-sold specialist insurance known as interest rate swaps tied to thousands of small businesses.

The FSA said it had found "serious failings" in the sale of the products, designed to protect firms taking out loans against rising interest rates.

The FSA said it had reached agreement with Barclays, HSBC, Lloyds and RBS over providing "redress".

The mis-selling is the third case of serious malpractice at the UK's banks.

The FSA said it believed the swaps had had a "severe impact on a large number of these businesses".

It did not say how much money would be necessary to compensate the businesses involved.

Sandy Chen, from Cenkos Securities, estimated that the total cost to the banks collectively would be between £1.1bn to £1.4bn, with most of that falling on Barclays.

Around 28,000 interest rate protection products were sold to thousands of small businesses, starting in 2001.

The businesses affected should now be contacted by their bank to instruct them whether they are included in a review of these sales. Those which were found to have been the victims of mis-selling will eventually be offered compensation.

Assurances

The managing director of the FSA's conduct business unit, Martin Wheatley, said the practice had been costly for the victims: "For many small businesses this has been a difficult and distressing experience with many people's livelihoods affected," he said.

He added that the bosses of the banks, including Barclays chief executive Bob Diamond, had given a personal assurance they would sort out the problems caused.

The FSA has been investigating whether mis-selling took place for two months, and as part of that has been talking to some 100 businesses.

When Parliament debated the subject last week, the Aberconwy MP, Guto Bebb, said many business people did not understand the deals but trusted their bank managers, and many were told that without signing up they risked being refused credit.

Personal rewards

Swaps products vary in their complexity and the FSA said some of these can be appropriate when sold in the right circumstances.

But it said it had found a range of poor practices including:

•     lack of clarity about the costs of stopping a product

•     failure to check whether a customer understood the risk

•     selling based on personal rewards rather than on the businesses needs

The banks all released responses in the wake of the FSA announcement, saying they had co-operated with the FSA and would continue to work with it to resolve the matter. They said they had agreed to carry out a thorough assessment of sales of these products to certain customers.

Lloyds said that it had not sold these types of products widely, and therefore was not expecting the costs of redress to be substantial.

The FSA will now contact other banks which sold interest rate hedging products to see if similar mis-selling practices went on. These additional institutions were responsible for only a small proportion of the sales, the FSA said.

-BBC