Image caption The big four lenders will be followed by six others in the next two weeks

Four banks will now compensate tens of thousands of small businesses who were mis-sold complex insurance deals, says the Financial Services Authority.

In a pilot study, the FSA found that 90% of deals sold to "unsophisticated" customers broke at least one rule.

Some 40,000 "interest rate hedging products" (IRHPs) have been sold to small businesses since 2001.

Last summer, the FSA said several banks were guilty of mis-selling and decided that compensation should be paid.

Following last June's initial announcement that redress was due, the FSA ordered the banks to carry out the study to see precisely how it should be calculated.

The FSA says the four big banks involved - Barclays, HSBC, Lloyds and the Royal Bank of Scotland - will now have to work out how much their customers lost.

It is not yet clear how many businesses are likely to receive compensation.

"It depends whether a business would have bought that product anyway," says Martin Wheatley, the incoming chief executive of the new Financial Conduct Authority (FCA), which will replace the FSA later this year.

"In such cases, it's a case of 'caveat emptor' ['let the buyer beware'], but in other cases, the contract should be ripped up," he told the BBC.

One of the banks, Barclays, said: "Once final steps have been agreed by all parties we look forward to engaging with eligible customers to commence the review and redress process."

Who will get compensation?

The idea behind the original deals mis-sold to bank customers was to swap the variable interest rates on their loans for fixed rates, thus insuring the businesses if interest rates rose.

But in recent years, interest rates have fallen to record low levels, leaving many businesses paying an excessive interest rate on their loans, which many did not understand would happen when they took out their loans.

In some cases, there were also expensive fees to get out of the deals.

Media playback is unsupported on your device Media caption Martin Wheatley: "In many cases the products were absurdly complicated"

As a result of the pilot review, the FSA has now decided exactly how the banks should proceed, and has also revised the criteria for who can claim.

For instance, it was concerned that some companies, which might not have understood the complexity of the products they were being sold, might have been excluded from any redress.

For example, a bed and breakfast business may, on paper, look like a large operation, purely because it employs a large number of seasonal staff.

But it still may not have been sophisticated enough to fully understand the hedging policies it was sold.

The Federation of Small Businesses (FSB) has welcomed the decision to broaden the compensation criteria, but it is still concerned that payments to the banks have not been automatically suspended.

It is also worried that there is no clear way for businesses to appeal if they are refused compensation by their banks.

"With the pilot showing such a significant level of mis-selling, we are concerned that the FSA has not mandated that all payments are suspended when a firm enters into the scheme," said John Walker, the FSB's national chairman.

Principles of redress

The FSA has now established how compensation should be calculated.

There is a lack of clarity on what full redress looks like, with banks determining what constitutes consequential losses, and how an appeals process will work John Walker, Federation of Small Businesses

It says redress "should aim to put customers back in the position they would have been in, had the breach of regulatory requirements not occurred".

For full compensation, customers will have to show that they would not have bought an IRHP, had the sales rules not been broken.

If they would have bought a different kind of product from the one recommended, they might be offered partial compensation, depending on the losses they suffered.

But if the business suffered no loss, or if they would have bought the product anyway, had it not been improperly sold to them, they will be offered no compensation.

The British Bankers' Association (BBA), which represents all of the UK's banks, says that where customers have been treated unfairly, they will be compensated.

"Banks will be contacting those companies affected shortly, prioritising those with the greatest need," said BBA chief executive Anthony Browne.

"Any business which is currently facing financial distress and is seeking a suspension of payments should get in touch with their bank immediately."

"Consequential" losses

Some small business have complained of making huge losses beyond the money they were paying out on their loans.

Some said they had ended up having to sack staff, or sell assets, in order to save money to make the loan repayments.

These costs, known as "consequential losses," might also include overdraft charges or additional borrowing costs.

The banks will have to ask whether these losses were directly caused by their rule breaches and whether such losses were foreseeable at the time.

But John Walker, of the FSB, was sceptical about the process.

"There is a lack of clarity on what full redress looks like, with banks determining what constitutes consequential losses and how an appeals process will work," he said.

The FSA review only covers mis-selling by the first four banks identified.

A report on a further six banks will follow in the next few weeks.