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Bank deposits guarantee and protection

What is the Bank Deposit Guarantee?

The UK Bank Deposit Guarantee is the level of deposits held in British bank accounts that is legally guaranteed by the Government.

The deposit guarantee scheme was implemented in the UK in 1995 following a review of the banking sector by the Financial Services Authority (FSA), HM Treasury and the Bank of England. The purpose of the scheme is to protect the deposits held in all UK credit institutions and to uphold the stability of the banking system.

The Financial Services Compensation Scheme (FSCS) is the organisation responsible for the Bank Deposit Guarantee scheme in the UK.

Financial Services Compensation Scheme

The Financial Services Compensation Scheme (FSCS) is an independent body that provides the ultimate safety net for Britain's savers and investors.

Set up under the Financial Services and Markets Act 2000 (FSMA), the FSCS is a compensation fund of last resort for customers of financial services firms authorised by the FSA or previous financial regulators.

The FSCS is activated (compensation paid out) when an authorised firm, such as a bank, building society or credit union is declared in default, meaning it is unable, or likely to be unable, to repay its depositors.

What is covered by the FSCS?

The Financial Services Authority (FSA) is responsible for the rules governing the FSCS. Therefore, all business transactions conducted by FSA-authorised firms are covered by the FSCS. European firms (authorised by their home state regulator) that operate in the UK may also be covered.

In addition to deposits (the FSCS is responsible for the UK's Bank Deposit Guarantee scheme), the Financial Services Compensation Scheme also protects:

• Insurance policies
• Investment business
• Insurance broking (for business on or after 14 January 2005)
• Mortgage advice and arranging (for business on or after 31 October 2004)

Changes to Compensation Levels

On October 3rd 2008, the Financial Services Authority (FSA) announced an increase to the compensation limit for UK bank deposits from £35,000 to £50,000. The rise was implemented by the government on October 7th 2008.

This means that each saver's first £50,000 per institution is now fully protected under the Financial Services Compensation Scheme (FSCS), while customers with joint accounts are eligible to claim up to £100,000 in the event of their bank or building society failing (declared in default). As cash deposits are protected per institution, not per account, it is important for savers to understand who is actually operating their account to ensure they receive the maximum protection.

Prior to October 2007, the FSCS had previously guaranteed savings deposits of up to £31,700 (100% of the first £2,000 and 90% of the next £33,000). The compensation limit was then increased to £35,000 (100% of £35,000) per person, per institution on October 1st 2007 following the Northern Rock fiasco.

Under the new rules, depositors may still receive a share of their savings above £50,000 back following any distribution of assets as part of the insolvency process for a failed bank. The amount received is determined by the insolvency practitioner and any recovery would vary according to the circumstances of the failure.

Factors behind the increase

The government's decision to increase the level of compensation for bank depositors is in response to mounting evidence that savers are defecting to Irish banks in the wake of the nation's eye-catching savings promise. Irish banks have reported a surge in deposits since the country moved to guarantee all bank deposits for two years.

The increase was also driven by last year's Northern Rock crisis that saw thousands of savers rush to pull their cash from Northern Rock accounts in fear that the bank was about to collapse.

UK British Bank Bailout summary

On October 5th 2008, the British government announced a £50 billion rescue package for UK banking institutions.

After considering a variety of ways of injecting cash into ailing banks to help them rebuild their financial position, Chancellor Alistair Darling revealed that the government had agreed to spend up to £50 billion of taxpayers' money buying shares in UK banking institutions.

Full details of the £50 billion bank bailout were released in a London Stock Exchange announcement on the 6 October 2008. According to the statement, the bailout consists of:

• An immediate loan of £25 billion for eight UK lenders, in order to boost their regulatory capital.
• An extra £25 billion loan, in return for preference shares in these lenders (shares that pay a high, fixed rate of interest and rank ahead of ordinary shares).
• The Bank of England's Special Liquidity scheme will be increased from £100 billion to £200 billion, allowing lenders to borrow short term from the Bank by pledging high-quality assets (usually packages of mortgages or other loans).
• Up to £250 billion in loan guarantees will be available at commercial rates of interest, and for a fee, in order to persuade banks to 'unfreeze' the inter-bank lending market.

*This means that banks might resume the process of lending to one another as they are guaranteed the repayment of a loan in the event of the borrowed party going bust.

The following UK lenders have signed up to the government's bailout scheme:

• Abbey (owned by Spanish bank Santander)
• Barclays
• HBOS (set to be taken over by Lloyds TSB)
• HSBC
• Lloyds TSB
• Nationwide BS
• Royal Bank of Scotland
• Standard Chartered

By signing up to the scheme, however, bank bosses must agree to a new charter on executive pay and ordinary share dividends. In addition, future returns to bank shareholders will be lower, thanks to dividend cuts and the dilution of their stakes.

HM Treasury confirmed that other banks and building societies can request to join this safety net.

Risks involved

The government's new banking investment is far from guaranteed, with industry experts saying it could make or lose money for UK taxpayers based on the length of the impending recession. Banks would be hit by bad debts if the recession is longer and harsher than expected, resulting in taxpayers bearing substantial losses from their new semi-nationalised banks.

But the government has made a smart move by buying preference shares in the banks. These pay a dividend and rank above ordinary shares in any break-up, making them a safer bet.

The move should bring an end to the current panic about the security of British banks, although uncertainty still remains over the long-term future.

What it means to UK taxpayers

There are around 25 million households in the UK, meaning that the £50 billion rescue works out at £2,000 per household added to national debt. In effect, this partial nationalisation gives us all a stake in these lenders.

But the major worry is that lenders could take taxpayers' hard-earned money and then lend it back to them at steep rates of interest.