David Prosser: How Britain failed Icesave customers

Outlook Gordon Brown often talks about how politicians must take tough decisions, but he won't have faced too many dilemmas like the one that's troubled Icelandic President Ólafur Ragnar Grímsson in recent days. In deciding whether to ratify his parliament's vote to pay £3.1bn in compensation for the banking crisis to Britain and the Netherlands, President Grimsson risked enraging the three-quarters of his population who oppose the idea or the international community (blowing Iceland's chances of joining the European Union, its best hope of financial salvation).

You have to sympathise with Iceland. For Britain, the proposed payment of £2.4bn over 15 years will make only a tiny impression on the budget deficit. But the compensation package represents 40 per cent of Iceland's GDP and is the equivalent of £11,000 of debt for every citizen.

Still, the hard truth of the matter is that Iceland is obliged to make good on this money. For one thing, settling the compensation row was part of the deal it made with the International Monetary Fund when it got a bail-out from the scheme in the wake of its financial collapse. And even before then, Iceland had put on record its commitment to funding a deposit protection scheme for customers of its banks in the event of them losing money. It has to keep that promise.

The biggest villains in this story, however, are to be found closer to home. The UK Treasury and the Financial Services Authority utterly failed in their duties to protect British savers by letting Landsbanki and its UK subsidiary Icesave (and several other European banks) operate here in the way it did.

Three years ago, I wrote an article in the personal finance section of this newspaper explaining that Icesave customers ought to be aware that the bank was not fully regulated by the FSA but operated here through the passport system, which applied then to many banks from the European Economic Area. What this meant in practice (though it took days to wheedle this out of the authorities) was that in the event of Landsbanki going bust, savers would have to seek compensation from the Icelandic authorities, rather than applying to the UK's Financial Services Compensation Scheme.

Even before Northern Rock collapsed (the happy days when the possibility of bank failures seemed remote), that would not have been a satisfactory arrangement. But at the time I was explaining the rules to readers of The Independent, several months after Rock had gone under, the FSA and the Treasury were not in any way concerned. Six months later, they found themselves caught on the hook of the uncertainties over the way in which Icesave customers were protected – and the British taxpayer had to pick up the bill.