The Impact of Interest Rate Swaps

In a rising market environment, an interest rate swap could prove to be of real benefit to a business. In a declining market however, it can have devastating results.

In its simplest form, the essence of a vanilla interest rate swap means should interest rates increase above the fixed rate the lender pays the difference. Should interest rates fall below, the client is required to make up the difference.

Lenders failed to highlight this risk to clients who agreed to the “swap”.

This means, in the current climate, not only are SMEs unable to benefit from the historically low Bank of England base rate, they are also liable for the cost of the swap. These crippling repayments have led to many SMEs going out of business.

Win win for lenders | Lose lose for clients

Given the many disadvantages to interest rate swaps, the majority of clients were always in a lose lose situation. After interest rates plummeted and payments increased, clients who looked to cancel the policy were greeted by substantial exit fees – often 50% of the total loan.

There was also the lack of cohesion between the loan and the swap; SMEs were forced to commit to an interest rate swap which would exceed the term of the loan. This meant, even when the loan was repaid, the customer was still paying for the swap.

Lenders did this under the pretext that the SMEs would be likely to required a new loan when they came up for repayment. However, banks made no guarantee to relend the money if required thus leaving many SMEs stuck with an expensive swap for a loan the bank refuses to renew.

Meanwhile lenders were in a win win; even if interest rates did increase they had the right to cancel the policy at any point without penalty; a privilege which did not extend to the customer.

If you are a SME who took out an interest rate swap product which you did not understand, was not fully explained to you or was forced upon you, you may be entitled to redress.