As the banking crisis has gone from bad to worse, savers have understandably become rather obsessed with the protection that the Financial Services Compensation Scheme (FSCS) offers. When the credit crunch kicked off, the scheme was inadequate, guaranteeing 100 per cent of only the first £2,000, and 90 per cent of the next £33,000. That was soon increased to 100 per cent of the first £35,000, then this week, to the first £50,000.
But one rather alarming condition of the scheme, which has so far escaped most people's attention, is that these payouts may be made net of any borrowing with the same institution. In other words, if you've got £20,000 on deposit, and £20,000 in loans and credit card debt with the same company, you could theoretically end up getting nothing back if your bank went to the wall.
Of the British banks that have run into trouble none have been allowed to go bankrupt – as the Government has stepped in and either engineered a takeover or nationalised the bank. This has meant that no British saver has had to make a direct claim on the FSCS.
Icesave will be the first bank whose savers will have to apply to the FSCS, but as this is only a savings bank, the issue of deducting any borrowings won't come into play.
But what happens if a small building society or credit union is allowed to collapse? If it's small enough, the Government may take the view that it might be easier for it to simply call in the liquidators and let customers claim their money back from the FSCS. Nationwide may have stepped in to rescue the Cheshire and Derbyshire building societies, but there may come a time when there are no potential buyers, and another nationalisation becomes unpalatable. If that's the case, it's possible that those who have debt with the same institution will lose all their savings.
I don't think it will come to this, because even if the Government did let a small institution collapse, there would be such a stink about people's lost savings that the Treasury would probably come to the rescue again. But this is yet another example of just how badly the FSCS was designed.
A well-designed depositors' protection scheme should never have to be called upon. The British scheme, however, was so badly put together that millions of savers have been moving their cash frantically about over the past few months and may now even be thinking about moving their borrowings as well.
There's also a problem in the time it takes the scheme to pay out. Although Icesave customers can take heart from the fact their money is safe, and guaranteed by the British Government, as I write, there's still no indication of when this money will be paid out. It is now five days since Icesave closed its doors, yet thousands of these savers had their money in "instant access" accounts so that they could get their hands on it whenever they needed to. In the US, the depositors' protection scheme pays out in a matter of days – but under the current set-up of the FSCS, there's no provision to ensure that payouts are made in a timely fashion.
Tinkering with compensation limits, as the Government has been doing over the past few weeks, is important. But until the compensation scheme can guarantee payments will be made within days, and that borrowings will not be a factor, the FSCS will not be able to provide banking customers with peace of mind.
*Last week, I said that British depositors with Bank of Cyprus were only covered by the Cypriot depositors' protection scheme, up to a limit of just €20,000 (£15,830). In fact, Bank of Cyprus is also signed up to the UK Financial Services Compensation Scheme top-up plan, which means that depositors in the UK with more than €20,000 would be reimbursed for the remainder of their savings – up to a limit of £50,000 – by the FSCS.