UPDATE 2-UK banks in mis-selling scandal pay out less than half of refund pot

* Compensation paid so far totals 1.5 bln stg

* Banks set aside 4 bln stg for customer payouts

* More than half of firms offered alternative products

* 36 percent of customers have yet to accept offers (Adds details on acceptance rates, FCA comment)

By Matt Scuffham

LONDON, Oct 14 (Reuters) - Britain's biggest banks have paidout less than 40 percent of the 4 billion pounds ($6.4 billion)set aside to cover the mis-selling of complex interest ratehedging products, according to data from the financialregulator.

The mis-selling is one of a number of scandals involvingBritish banks in the past five years and provoked a politicaland public backlash against an industry blamed by many for thefinancial crisis - during which the government spent 66 billionpounds of taxpayers' money rescuing Royal Bank of Scotland and Lloyds Banking Group.

Banks have also been accused of misdeeds ranging from theattempted rigging of benchmark interest rates to the mis-sellingof loan insurance, which alone has cost the industry 22 billionpounds in compensation.

The Financial Conduct Authority (FCA) last year orderedbanks to review 29,500 cases for possible mis-selling afterfinding "serious failings" in how interest rate swaps were soldto small businesses.

Banks, however, dismissed more than a third of the cases,with customers deemed sufficiently sophisticated to haveunderstood the products. More than half of those left underreview were then offered alternative hedging products ratherthan full cash compensation.

The products were supposed to protect smaller companiesagainst rising interest rates, but when rates fell the companieshad to pay extra charges, typically running to tens of thousandsof pounds. Companies also faced penalties to extricatethemselves from the deals, with many claiming they had not beenmade aware of the penalty clauses.

The FCA said on Tuesday that 1.5 billion pounds incompensation had been paid out so far in 9,858 cases settled byBritain's biggest four banks - Barclays, HSBC,Lloyds and RBS.

That included more than 300 million pounds to coverso-called consequential losses. Claims for such losseseffectively set the clock back to the point before the productswere sold and would require banks to compensate not just thedirect cost of the mis-sold contracts but any losses thatbusinesses have suffered as a result of entering the agreements.

That could include missed opportunities for firms to expandbecause they were tied into crippling monthly repayments on theswaps.

LIMITED SCOPE

Abhishek Sachdev, managing director of Vedanta Hedging,which advises businesses on hedging, said that where alternativeproducts were provided, firms that accepted them will have onlylimited scope for making subsequent claims for consequentiallosses.

"By making more alternative products, at a stroke the banksare not only reducing the amount of cash they're paying out,they are legitimately cutting off the basis for the majority ofthe consequential loss claims," he said.

The regulator said on Tuesday that banks had sent out 17,000decisions to customers, 14,000 of which included some element ofcash compensation. However, 36 percent of customers had yet toaccept the offers made to them.

The FCA said that, in addition to the 1.5 billion poundspaid out in direct compensation to customers, the banks had setaside funds from the 4-billion-pound pot to meet the cost ofclosing the original hedging contracts. That covers the loss ofpayments customers would have made to banks under their hedgingarrangements if they were still in place.

The regulator also said that the costs of employing morethan 3,000 people to carry out the review exercise and engagingindependent reviewers to look at every case were also includedin the banks' provisions.

The FCA data showed RBS has examined 7,353 cases in thereview, far more than any other bank. HSBC has reviewed 3,160cases, Barclays 2,902 and Lloyds 1,638. But RBS has set asidejust 1.4 billion pounds to compensate customers, less than the1.5 billion set aside by Barclays. Lloyds has set aside 580million and HSBC 566 million.

(1 US dollar = 0.6264 British pound) (Editing by David Goodman and Pravin Char)