What are interest rate swaps?

The Financial Services Authority launched an inquiry into the mis-selling of financial products to businesses. Photo: Press Association

Banks are facing another compensation bill today after a review of complex products sold to small businesses by the Financial Services Authority (FSA) found more than 90% had been mis-sold.

It is believed as many as 40,000 so-called interest rate swaps were mis-sold to small businesses since the end of 2001 after the Financial Services Authority (FSA) revealed last June it had uncovered "serious failings" in the sale of the products.

What are interest 'swaps'?

Interest rate swaps are complicated derivatives that might have been sold as protection - to act as a hedge - against a rise in interest rates, without the customer fully grasping the downside risks.

Some SMEs told the Financial Times that they were told that buying the swaps was a condition of taking out the loan, while others complained of high-pressure sales tactics and large fees to exit the swaps.

The policies were meant to protect companies from interest rate increases to stop the cost of loans spiralling out of control.

But what actually happened was, as interest rates ran to rock bottom and stayed there, the cost of the swaps went the other way, and became crippling. And, for some companies the cost to get out of the swap ran to millions.

Read: Insurance policies: Another mis-selling scandal?