EXCLUSIVE: UK Banks' Solvency Led to FSA's 'Diluted' Review on Mis-Selling Derivatives

The Financial Services Authority (FSA) did not recognise the size or importance of banks mis-selling derivatives to businesses as early as last year and has privately expressed concerns that stringent restrictions on banks selling certain products to customers or ratified compensation plans and amounts will threaten the solvency of the UK's largest banks.

A well-placed senior source close to the FSA probe into UK banks mis-selling complex derivatives to small-to-medium enterprises (SMEs), revealed emails and details of private discussions exclusively to the IBTimes UK, that the FSA did not acknowledge the size or importance of the situation as early as September 2011.

"When the FSA was contacted about 20 to 30 cases of businesses being mis-sold complex derivatives products last year, they said that that they didn't think that this was a big enough issue for the regulator to look into," says the source. "[The FSA said this] across several emails in September and October 2011."

The source said that after it became clear that there was an issue and the mis-selling of derivatives could affect around 28,000 customers in the UK, it rushed through a review of the situation, which led to a "diluted" outcome.

The source added that since the FSA review in June this year and the subsequent crackdown on sales incentives published at the beginning of this week, the FSA has expressed privately that the reason it has not clamped down harder or ruled for a compensation scale is because it is concerned about the health of the UK banking system.

"While Wheatley's review and the recent report focus on banks' sales incentives is a step in the right direction, both reports do not go far enough to penalise the banks, compensate the customers or prevent the banks from selling lots of other types of derivatives products," said the source. "The FSA has expressed in private meetings, several times, that the reason it hasn't come down harder on the banks themselves is because the situation is a lot more complex than they anticipated and if they put a lot of restrictions on the banks, there will be a question of whether the banks can remain solvent."

FSA spokesman Joseph Eyre told the IBTimes UK: "This is wholly incorrect. Discussions with the banks have been wholly focused on getting the right outcome for those people who bought these products and insuring that there is a thorough review of their sales."

Another source close to the FSA but who wanted to remain anonymous due to the sensitivity of discussions told the IBTimes UK: "There have not been any discussions to suggest that banks' solvency has played in the mis-selling of derivatives review."

On 5 September, the FSA managing director and CEO designate of the Financial Conduct Authority revealed that he wanted to clamp down on banks sales rewards in order to prevent future cases of mis-selling of derivatives to consumers.

Following the Payment Protection Insurance (PPI) scandal, which will cost UK banks around £6bn in compensation payments, and most recently the mis-selling of interest rate swap agreements (IRSA), Martin Wheatley revealed the regulator has put together battle plans to tackle banks' sales incentive schemes. Too often those schemes result in customers being sold products they do not need or cannot use, while boosting the earnings of the salesperson.

"What we found is not pretty. Most of the incentive schemes we looked at were likely to drive people to mis-sell in order to meet targets and receive a bonus, and these risks were not being properly managed," said Wheatley.

This follows on from an FSA ruling published in June, that the FSA banned HSBC, Barclays, Lloyds and RBS from selling interest rate swap agreements (IRSA) to SMEs) after it found "serious failings" in the way the banks sold these products.

On 30 June, a day after the FSA released its findings on the four banks, Wheatley spoke to The Telegraph. "Though he is careful to avoid direct criticism of the current organisation, Wheatley makes a pointed reference to the conflicting objectives of the FSA, which was expected to ensure the financial soundness of the banking system as well as acting as its policeman," said the report.

"We won't be having to compromise our views based on whether the bank is likely to be prudentially sound," he told the Telegraph. "That is a completely different focus from saying we've got to make sure banks look after their customers fairly. In a sense, I wouldn't say that the FSA got it wrong, but it just had a different set of conflicting objectives."