Government to reform protection scheme

The Chancellor and regulators are looking at ways to tighten savers' guarantees. By James Moore
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The Independent Online

Radical reforms to the UK's depositer protection scheme and even insolvency law are set to be top of the agenda when Alistair Darling, the Chancellor, convenes a special committee to consider the Northern Rock crisis.

The committee will contain senior figures from the Bank of England and the Financial Services Authority and will look at ways to ensure that a repeat does not occur. The Bank has in part been stymied by the disclosure rules which required it to make public the emergency loan facility extended to Northern Rock to help it through the credit crunch.

In previous eras the whole thing would have been quietly sorted out behind closed doors before anyone knew there was a problem. People were only made aware that the Bank had acted months, or more likely, years later.

But the other key problem lies with Britain's Depositer Protection Scheme, now run by the Financial Services Compensation Scheme that was set up under the Financial Services & Markets Act. The scheme guarantees 100 per cent of deposits up to £2,000 and 90 per cent of the next £31,000 in the event of a bank failing. To put this into context, it is some way in excess of the EU minimum of 90 per cent of EU 20,000. In fact, the UK scheme is bettered in Europe only by France and Italy.

However, there are significant problems with the scheme. For a start it warns that it could take at least six months to process claims.

That, combined with the fact that you will lose 10 per cent of anything above the first £2000, made it perfectly logical for Rock savers to head for the exit until the Government's belated pledge to honour 100 per cent of deposits on Monday.

The system is starkly different in the US (and Canada). Insurance schemesthere promise to pay depositors immediately up to a maximum of about £50,000.

Depositors also have preferential status in the event a bank collapses. This means that there is no reason to head for the exit if there are concerns about a bank because depositors know they will be covered by an insurance scheme. Those with more than the maximum of $100,000 are advised to spread their cash around several institutions. The type of "runs", as seen with Northern Rock, are therefore much less likely because depositors are taken out of the equation.

The Bank of England is understood to have come to the conclusion that a system that no longer means depositors have a logical reason to desert an institution makes sense.

There remains an argument about "moral hazard" – a fear that if a Government or regulator offers too generous a guarantee then bankers will see no reason to behave in a prudent manner and start indulging in reckless behaviour such as offering over-generous interest rates to depositors in an attempt to collar market share. But a sensible maximum pay-out limit, it is believed, should deal with that problem. How this would go down with the industry – which will be called upon to fund any new arrangement – is yet to be seen.

Angela Knight, the chief executive of the British Bankers Association, did not want to be drawn last night saying she wanted to "take time to consider" the best way forward. "The British scheme is pretty good when you look at it in comparison to the rest of Europe," she said last night.

But Michael Fallon, the Conservative deputy chairman of the Treasury Select Committee, thinks changes need to be made. "Clearly the existing scheme is rather out of date," he said. "We need to put in place a system so consumers don't feel the need to withdraw their money like this." Mr Fallon said he would push for the committee to launch a full-scale enquiry into the Northern Rock situation when it meets this week.

A banking industry source agreed. The source said: "The reading of it now is that we have to have in place a system like the US. The problem is it will take time and it will also probably require legislation. That could take up to two years and the Chancellor may not want people to be reminded of this in the Queen's Speech if it all blows over."

The Government, however, would be extremely unwise to kick reform into the long grass as it has with so many other difficult issues. Because what has been striking about the Northern Rock debacle has been the graphic demonstration of the public's complete lack of trust in the Government and the financial regulatory authorities.

The FSA and Bank both stressed that the Rock was "well capitalised" and "solvent" with the emergency facility designed merely to see it through the short-term reluctance of banks to lend to each other sparked by the US sub-prime mortgage crisis.

Mr Fallon said: "The real problem is people didn't believe the financial authorities and that is a serious issue. It simply wouldn't have been the case 30 years ago."

Depositor protection around the world

Canada

The Canada Deposit Insurance Corporation covers savings of up to C$100,000 (£48,600). It is a federal Crown corporation created by the Canadian Parliament which insures all savings and current accounts held in Canadian dollars. All Canadian banks pay a premium into the institution. The CDIC says individuals do not have to do anything to get their money – it will "automatically pay the total amount of insured deposits" up to C$100,000 to individuals.

United states

The Federal Deposit Insurance Corporation is an independent agency created by Congress. It has several similarities to the CDIC in that it is an insurance-based system funded by banks which covers deposits up to $100,000 (£49,700). It currently has a fund of $49bn covering US deposits of $3 trillion. Like the CDIC, the FDIC pledges to operate immediately. However, the FDIC will usually take control, and sell the deposits, of a failed institution to a third-party bank, which would take on the customers automatically and enable them to reclaim their money seamlessly. In the US (and unlike the UK), depositors are a favoured creditor in the event of the failure of a bank.

European union

The European Union requires member states to put in place an arrangement for depositor protection which ensures a minimum level of guarantee covering at least 90 per cent of deposits and providing compensation of up to €20,000 (£13,900). Accession countries from the most recent expansion have until 2008 to put this in place, although only Estonia, Latvia and Lithuania have schemes offering less than the €20,000 guarantee. Other schemes vary wildly in terms of benefits offered. Italy is the most generous, with a scheme that covers 100 per cent of deposits up to €103,291.

Other examples include:

Ireland

The Deposit Protection Scheme operates under the auspices of Ireland's financial regulator, the Financial Services Regulatory Authority, an offshoot of the Irish central bank. The scheme is funded by banks and is less generous than its UK equivalent, offering a maximum pay-out to individuals of 90 per cent of their cash held on deposit, up to a maximum of €20,000. Individuals have to claim from the scheme, which says it will "provide details of the claims procedure and information you must supply" if a compensation process is "initiated by a court or by ourselves".

Denmark

The Guarantee Fund for Depositors & Investors is a private, independent institution established by act of Parliament which is funded by cash contributions and guarantees provided by banks, mortgage banks and investment companies, and the fund's accumulated profits. It covers deposits up to DKK300,000 (£28,000).

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