Banking Compensation

The Treasury/FSA consultation on compensation for bank customers closed last week but it is already looking as if it has been overtaken by events. In the present crisis governments and central banks on either side of the Atlantic are replacing the compensation rules anyway, with a much more pragmatic approach; If retail customers are involved, they’ll step in and protect them (Bradford and Bingley, Northern Rock and AIG), if no retail customers were hurt in the making of this debacle, the company can go to the wall (Lehman’s).  So doesn’t this make the policy set out in the compensation document, “Financial Stability and Depositor Protection”, redundant?

The present limit on compensation if a bank goes bust is £35,000 for each customer but the UK authorities have been consulting on whether this should be increased to £50,000, which would mirror the US scheme. However the run on the Rock was only halted after the Government fully guaranteed all Rock deposits, no matter how big, and ensured that consumers could get their money out immediately if they wanted. 

It’s true that a £50,000 limit will cover about 98% of UK accounts, but the authorities seem to be accepting already that any limit will create problems.  The 2% of accounts not fully protected could still lead to many thousands of people, heading for the high street with a carrier bag in hand. 

And what is the advice if you have more than the limit? We are told we should spread the excess around a number of other banks so that all our money is covered.  But anyone who has tried this will recognise it becomes an administrative nightmare.  If it is merely a question of administration surely the industry is in a better position to organise this than customers? Perhaps an enterprising bank could obtain a number of authorisations and spread the cash around for us.  If a bank set up a group of four authorised subsidiary banks it could presumably provide guarantees of four times the proposed limit, so £200,000, for its customers.

And introducing any limit of less than 100% of all deposits immediately makes any system much more complicated to administer. Individuals with more than one account with a bank must total up their deposits to keep within the limit. Then there is the issue of banks with a single authorisation providing accounts under different brand names.  HBOS is also Birmingham Midshires.  If you have more than the limit in two accounts under different brand names but it’s the same bank, you’ll lose money. And what happens to those people with large amounts of money short term in a bank account, for example on the sale of a property or obtaining an inheritance?  Should they risk losing everything above £50,000?

Sadly those responsible for the consultation document do not appear to have investigated the possibility of a 100% compensation scheme, preferring simply to increase the limit. The irony of this is that the greater the guarantee limit and the less interruption to account services, the lower the risk of a run on the bank. As Northern Rock demonstrated, if accounts are guaranteed 100% and there is no interruption in service, there is no reason to take your money out at all.