The FSA said the mis-selling had been costly for many businesses

The Financial Services Authority says banks mis-sold specialist insurance known as interest rate swaps tied to thousands of small businesses.

The FSA said it had found "serious failings" in the sale of the products, designed to protect firms taking out loans against rising interest rates.

The FSA said it had reached agreement with Barclays, HSBC, Lloyds and RBS over providing "redress".

The mis-selling is the third case of serious malpractice at the UK's banks.

The FSA said it believed the swaps had had a "severe impact on a large number of these businesses".

It did not say how much money would be necessary to compensate the businesses involved.

Around 28,000 interest rate protection products were sold to thousands of small businesses, starting in 2001.

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Just when Britain's banks would have loved some positive publicity, the City watchdog - the Financial Services Authority - has said they were guilty of serious failings in the way they sold complicated products to small businesses”

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Robert Peston Business editor

The managing director of the FSA's conduct business unit, Martin Wheatley, said the practice had been costly. "For many small businesses this has been a difficult and distressing experience with many people's livelihoods affected," he said.

He added that the bosses of the banks, including Barclays chief executive Bob Diamond, had given a personal assurance they would sort out the problems caused.

The FSA has been investigating whether mis-selling took place for two months, and as part of that has been talking to some 100 businesses.

When Parliament debated the subject last week, the Aberconwy MP, Guto Bebb, said many business people did not understand the deals but trusted their bank managers, and many were told that without signing up they risked being refused credit.

Swaps products vary in their complexity and the FSA said some of these can be appropriate when sold in the right circumstances.

But it said it had found a range of poor practices including:

• lack of clarity about the costs of stopping a product
• failure to check whether a customer understood the risk
• selling based on personal rewards rather than on the businesses needs

The banks all released responses in the wake of the FSA announcement, saying they had co-operated with the FSA and would continue to work with it to resolve the matter. They said they had agreed to carry out a thorough assessment of sales of these products to certain customers.

Lloyds said that it had not sold these types of products widely, and therefore was not expecting the costs of redress to be substantial.