King: Banks must fund deposit protection

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The Governor of the Bank of England insisted yesterday that banks should provide up-front funding for a revamped depositor protection scheme.

Mervyn King told the Treasury Select Committee that banks should pay an amount based on their risk profile to encourage them to act responsibly.

"I don't think it's a good idea to offer 100 per cent insurance up to, say, £50,000 without any element of a risk-based premium at all and to do that you need some element of pre-funding."

Asked by the MPs what an "element" meant, Mr King replied: "That is a debate I would like to see." The premium could be a few basis points of a bank's deposits or "many more basis points" and would be "certainly into the billions", he said.

The United States Federal Deposit Insurance Corporation charges banks upfront according to their level of risk.

Throughout the credit crunch Mr King has stressed the need to guard against "moral hazard" – creating incentives for banks to act recklessly – and his testimony indicated that he believed pre-funding of the scheme was necessary to avoid such a situation.

Banks have resisted the idea of pre-funding the scheme at a time when they are short of capital.

Mr King has repeatedly said that inadequate protection of deposits by the Government was partly to blame for the run on Northern Rock. The Government has since increased 100 per cent protection from £2,000 to £35,000 and is considering raising the figure to £50,000.

The Treasury issued a consultation document yesterday on banking reform, proposing that the Financial Services Authority should have the power to decide when to put a failing bank under closer supervision or into a special resolution regime. Power over "pulling the trigger" has been the subject of a turf war between the Bank and the FSA. Mr King told the committee he was disappointed at the decision.

"It's true that I would have preferred an outcome in which either the Financial Services Authority or the Bank of England could have initiated the trigger. We will not have the right to initiate the trigger," the Governor said. "We will have the right to make a written recommendation to the FSA so that they pull the trigger. That's clearly not the same thing."

Mr King said the authorities' powers to prevent further financial shocks were limited because "there are very few tools to deal with excessive greed or hubris". He said that periods of apparent financial stability can be seen as buildups to crises and that banks should add to their capital reserves during good times. After running their capital ratios thinly to boost returns to shareholders, banks including HBOS and Royal Bank of Scotland have had to seek extra funds to boost their capital buffers.

The committee told Kitty Ussher, the Economic Secretary to the Treasury, that proposals for banking reform were "a muddle" because issues such as protection for customers of foreign banks in the UK were unclear. The legislation is due in October.