How Banks Profit From Swap Interest Rate Sales
Swaps interest rates should only be used by sophisticated business owners or individuals who want to bet or gamble on the movement of interest rates on banks loans. The speculative nature of such complex banking products are not for the risk adverse, But it is the risk adverse that many of the swap interest loans have been sold to small business owners. Business owners who want nothing to do with gambling on their future, their livelihood, their family and home were offered these products when they simply wanted a loan to help expand or set up their business.
How were interest swap business loans mis-sold?
They were sold on the pretence that they could fix the interest rate on the business loan to prvide security that the interest rates would not rise to the extent that they would be unable to afford the loan. It is similar to fixing the interest rate on a mortgage for a term. What was not explained was that the business swap loan was effectively sold on the market for a profit to the bank with severe exit charges, should the business owner want to end the m-ssold business loan early.
How Swap Are Sold
Simply put, when a business swap is sold, the bank then sells the swap loan on the open market. The banks have access to the market and are able to value the swap loan at the time the loan is sold. The bank armed with this information about the value of the swap loan, then sells it the small business owner, makes an appropriate interest rate hike so that an instant profit can be made. Non of the true valuation of the swap loan is made available to the small business owner and there are various techniques used by the banks to convince or persuade the small business owner to buy the swap loan.
On a swap loan of say, £1 million, the bank can make anything from £25,000 to £50,000 by selling the swap loan on the open market.
But swap deals can be much more complex and profitable for the banks. Thus, banks may convince the small business owner that if they took out a swap deal longer than the loan itself, they would benefit from greater reductions in the interest rates. Thus, a 10 year swap loan may have an interest rate at 8%, 20 years at 6% and a 30 years at 4% etc. On the example above, if a swap was for longer duration of say, 30 years, rather than £50,000 profit, the bank could stand to gain well over £100,000. Very profitable for a few hours work.
What Went Wrong With Swap Loans?
Due to the banking crisis the interest rates fell to historic lows. As business owners effectively bet against lower interest rates it meant they were required to pay crippling interest rate charges causing financial hardship, bankruptcy and closure. It must be remembered that the majority of business owners mis-sold interest rate swap loans had no idea that it was a speculative loan, a gamble. The swap loan was sold on the basis that it was simply a fixed loan, like a fixed mortgage.
Ending the Swap Loan
If the swap interest loan movement went against the bank, the standard term contract made it easy for the bank to terminate the swap loan and “get out of jail.” Contrast this position with the small business owner, where to terminate the swap business loan would mean unbelieveable prohibitive penalities. In one case reported in The Sunday Telegraph, a 5 year, £5 million swap loan would cost the small business owner the sum of £4.1 million to terminate the business swap loan early.