One thing is guaranteed, the banks’ financially enterprising ability to mis-sell the most simple of products. After exactly 14 days into 2015, Enterprise Finance Guarantee (EFG) Loans are fast making their way onto the roll of dishonour of another banking mis-selling scandal with a flurry of media coverage. Here we go again….
Imagine the scenario. You are a small business trying to earn a living in the midst of a recession. Cash flow is tight, bank credit is tight, but you need a loan to repay your mounting overdraft or maybe to grow your business. Your friendly Relationship Manager (who you trust and think advises you) approaches you with a new deal just too good to be missed.
The bank has this type of loan whereby if you default, then the government will step in and guarantee 75% of the value of the loan. So you as the borrower are only liable for 25%.
In numbers: you borrow £1,000,000 from your bank. You default. You believe that the government steps in and pays the bank £750,000 and you end up owing the bank only £250,000. Ah, but you think there must be a catch?
Correct. There is. You need to pay a 2% premium on the value of the loan every year (in addition to a slightly higher lending margin).
In numbers, you pay the bank £20,000 + lending margin + 0.5% base rate each year. Still a great deal, right…?
The government pays the bank!
…well it would be, except for the fact that if you do default, the government doesn’t actually step in for you, the business at all. No, you will still owe the bank £1,000,000 (+ interest). The government pays the bank £750,000, leaving the bank exposed to only £250,000.
What you thought was a great deal for you has turned out to be a great deal for the bank.
Purpose of the EFG Scheme
The EFG scheme was set up to assist those SMEs that would otherwise find it difficult to obtain credit by allowing businesses to borrow up to £1.2 million from their bank or specialist lending institution. The 2% premium payable per annum does not provide any insurance for the business borrower, but is an additional administrative/arrangement fee to reflect the higher risk profile of the borrower. So the scheme is very much, in principle, a ‘credit driven’ scheme enabling government backed funding to provide funds to businesses with a weaker credit profile or insufficient security to access ‘normal’ bank funding. All makes sense in principle, but in application, problems started to occur.
Some lenders withdrew, without notice, the overdraft facility from the business and then replaced this with an EFG loan. Typically, the bank would also secure a charge over the assets of the business. By using the EFG scheme, banks were able to reduce their risk and liabilities (and hence regulatory capital) yet in the event of a default, could seek the director’s personal assets using threats of, or actual IVA’s, bankruptcy and in some instances, could force the business into administration or liquidation and seize their assets.
How big is the potential problem?
EFG loans started to be provided to SMEs from November 2008. It wasn’t just the high street banks that provided the loans but also specialist finance houses, with some 43 lending institutions signing up to the scheme. £2.0 billion has been lent across the EFG scheme to 20,000 loans, so this has the potential to mushroom.
What redress could look like is currently uncertain. It could be the bank is on the hook for 75% of the default amount, rather than the 25%. It could be that the 2% premium per annum could be refunded, or that the higher lending margin incurred under the scheme was not necessary. Then you have interest and consequential losses on top of these amounts, which could be significant depending on how the business was ‘administered’ by the bank.
RBS Internal Review of EFG Loan Mis-selling
Of the 43 lending institutions on the EFG Loan list, it is believed that RBS were the most active users of the scheme with lending more than £900 million to 9,000 SMEs. With an increasing number of complaints received (and potentially concerns raised in the Tomlinson report about EFG loans), RBS conducted an internal investigation and identified and admitted “failings” in the way it sold the EFG Loans. From a sample of files, RBS:
- “identified a number of instances where we have not properly explained to customers how borrower and guarantor liabilities work under the EFG scheme”.
RBS further added that it would be implementing a:
- “thorough and proactive review of affected and potentially affected customers to ensure they are put back in the position they believed they would have been in”.
Watch this space!
Let’s hope that the review process is significantly more thorough, fair and reasonable than some of the Determinations I’ve seen produced in the FCA’s Interest Rate Hedging Product Review scheme. Hopefully there will not be any ‘EFG Loan’ for ‘EFG Loan’ alternative product replacements as part of the formula for redress and that customers are actually put back in the position they would have been in….watch this space.