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Hidden Credit Liabilities: Role of the FCA

I beg to move,

That this House has considered hidden credit liabilities and the role of the Financial Conduct Authority.

I will explain the genesis of this debate, Sir Roger. I chair the all-party parliamentary group on investment fraud and fairer financial services. The group was established some years ago as a result of hon. Members being approached by constituents who had experienced scandals in the delivery of financial services and the failure of regulatory bodies to address their concerns. It was chaired effectively by the hon. Member for Harrow East (Bob Blackman), who has now gone on to greater things as the Chair of the Backbench Business Committee. I thank him for enabling this debate to take place.

The scandal that has come before our APPG is the use of hidden credit lines, which has caused such serious harm to so many small and medium-sized enterprises, and caused personal disasters for many individuals and their families. We have drawn on the evidence presented to us by constituents, specialist advisers and the reports of BankConfidential, a specialist whistleblowing service for banking staff. Put simply, the story commences with a large number of SMEs approaching their banks for a loan and some of the banks then attaching to the loan a derivative such as an interest swap, supposedly to protect the loan against the risk of interest rate changes, and establishing a hidden credit line.

Lorraine Morris, an expert and specialist derivative lawyer, gave evidence to us on what she found:

“My research confirms that, far from mitigating risk, these instruments were deliberately engineered to transfer significant, undisclosed, and uncapped risk directly onto the customer. The mechanism was the concealed creation of a credit-line liability, booked against the customer’s assets from day one. This contingent obligation was not a notional figure; it was a hard liability that directly impacted the customer’s credit grade”.

Generally, when such a loan is taken, there is an agreed loan-to-value covenant. According to Ms Morris, the application of the derivative and credit line mechanisms impacted on those covenants and

“pushed viable businesses into a state of artificial distress. The sale of products as ‘protection’ when their fundamental structure achieves the opposite is a profound and fraudulent misrepresentation.

It is a profound tragedy that these banking frauds have pushed individuals to the brink, resulting in devastating loss of life, ill-health and destruction of families. As a legal advocate for justice, I believe this affront to human dignity demands not only our deepest sorrow, but a relentless and unwavering pursuit of accountability.”

That is what we are about today.

To understand the behaviours of the banks more fully, we drew on the evidence provided by Ian Tyler, a former senior banking executive who has used derivatives since the 1980s to manage interest rate risk for some of the UK’s largest banks. I will quote Ian at some length. He explained:

“The fundamental truth that has been buried by the banks and the FCA is that when a bank executes an interest rate derivative, such as an interest rate swap, it is required by prudential regulation to mark a counterparty credit risk limit to cover the Potential Future Exposure. This credit limit is a hard credit limit as the exposure generates a risk weighted asset that requires the bank to hold capital in support.

All hard credit limits are typically included in a bank’s Loan to Value security covenant calculation and so the moment a customer executes a derivative their LTV % increases and this weakens their credit standing. This situation was made materially worse in…2008 when in response to the failure of Lehman Brothers, policy makers reduced Bank Rate to 0.5%. This…led to a material increase in the credit line marked for the derivative as both the Current Exposure and the Potential Future Exposure increased, pushing many SMEs into the position where their LTV % was in breach of their security covenant.

However, as the bank had invariably not told the customer about the derivative credit line, in clear breach of conduct regulation, the bank often forced a technical breach of loan covenant through some other mechanism and then transferred the business to their so-called Business Recovery Unit where most businesses were subsequently put into administration.”

Many in the Public Gallery would testify to that.

What was the motivation of the banks? Hidden credit liabilities generated huge up-front revenues, bonuses and commissions. Worse, when the financial crisis hit, they became a mechanism for destroying viable businesses, some already in breach of lending covenants on day one, because of the undisclosed liability that had been taken on. The potential financial upside was so significant that whistleblowers revealed that staff at the state-controlled NatWest Group were encouraged to send victory emails when they successfully brought down a business that could then be feasted upon, with the bank sometimes buying distressed assets directly from the victims of such frauds.

There are too many examples of that, and some of those affected are with us in the Public Gallery. Alongside the banks’ predatory behaviour, there has also been a catastrophic regulatory failure, associated with a deliberate policy by the Financial Conduct Authority and, before that the Financial Services Authority, of siding with the banks and often with Treasury policy under successive Governments, rather than the innocent business owners who were being fleeced at the time.

The FCA has repeatedly and deliberately failed to act. I will give one example of participants’ experience from our all-party group. In November 2022, Lord Prem Sikka, Steve Middleton of BankConfidential and banking derivatives expert Ian Tyler, whom I have quoted, met the FCA to explain the hidden credit liability scandal in detail. They related what The Times assistant business editor James Hurley described across four articles as financial and accounting fraud, including theft from Ulster Bank fixed-rate loan customers, and all the hard evidence was shared. In our view, the FCA should have immediately launched an inquiry at that stage. Instead, it let the NatWest Group mark its own homework. When the bank concluded it had done nothing wrong, the FCA took no meaningful action, even deploying the astonishing argument that the fraud that had occurred was not criminal fraud.

The FCA’s unfitness for purpose is not a new observation for many of us here. On 1 February 2016, Conservative MP Guto Bebb led a Commons debate on the motion,

“That this House believes that the Financial Conduct Authority in its current form is not fit for purpose”.

Nothing meaningful came out of that debate or has happened since. In many people’s eyes, that has left the FCA still not fit for purpose, with Parliament having failed in its duty to fix it.

Where was the Treasury in all of that? The Treasury turned a blind eye and its motivation was simple. It needed the banks to do whatever was necessary to shore up their balance sheets after the global financial crisis, having already made the taxpayer bail them out. As I mentioned, where that has occurred the financial and emotional consequences for victims have been devastating in the extreme. The scale of the carnage has been horrific, with widespread forced insolvencies; suicides and early deaths; thousands of repossessions; and broken families. Many business people were made to believe that they had failed through their own fault, when in reality tens of thousands of businesses were deliberately targeted for insolvency.