FSCS: where does the buck stop?

by George Hatjoullis

FSCS : Nic Cicutti: Calm before the compensati...

FSCS : Nic Cicutti: Calm before the compensation storm (Photo credit: Investors Europe)

The Financial Services Compensation Scheme offers customers of UK licensed financial institutions some insurance. For bank depositors the insured sum is £85k per person per separately licensed institution. The Cyprus crisis has finally brought home to everyone sums above £85k are NOT insured, at least not by the FSCS.

The caveat of separately licensed institution is important. For example Halifax and Bank of Scotland have a joint license. An individual holding deposits in both banks is only insured for £85k in total. Hence if the sum of the two deposits exceeds £85k it is not insured.In contrast, National Westminster and Royal Bank of Scotland have separate licenses  The individual depositor is insured for up to £85k held in each bank. The total sum insured for one individual holding deposits in both banks is £170k. This should be widely understood by now but personal experience suggests it is not.

The question arises as to how is the FSCS funded? The website offers this explanation:

The FSCS is funded by the financial services industry on a pay-as-you-go basis. We levy firms each year on the basis of our estimates of the compensation we are likely to have to pay out in a financial year. If our estimates ever turned out to be too low, or we were required to make additional payments, we are able to borrow additional funds during the course of the year and/or make additional levies.

It does not say from whom they borrow or on what terms? It also rather begs an important question. What if the problem is systemic? The FSCS arrangement has an industry funded pot and can impose future levies to pay off debt. This seems adequate to fund individual institutional failures that occur in an otherwise well functioning financial system. In 2008 the system was not well-functioning. Had RBS and HBOS not been bailed out by the general taxpayer, the FSCS would have not had the funds to compensate the insured deposits, especially as the knock-on impact may have brought down even more UK banks and building societies. From whom would it have borrowed? The government stepped in with taxpayer cash and bailed both, forcing HBOS to merge with Lloyds.

The taxpayer-funded recapitalisation of the banks in the UK did not bail out the bankers or their bonuses, though this was a side effect. It bailed out your uninsured and insured deposits. It stopped a systemic banking crisis in its tracks and however severe the recession has been it would have been much more so without the government action. The total sum of bank deposits is always huge. The only institution that can cover this is the government. So whatever scheme is offered and what ever story is told the buck always stops with the government.

The UK authorities are busy trying to make systemic banking crisis less likely. The eurozone are also trying to form a single banking union. The question of bail-in of uninsured depositors is central to the debate in the eurozone and has been applied to Cyprus (This has been extensively discussed in earlier blogs). However, it will be impossible to completely eliminate the risk of systemic failure. In the UK we are reasonably confident that the government will use taxpayer money to stop such failure. We may all whine about it but it is far better tan allowing the failure to occur. The big question for the eurozone single banking union is where will the buck stop? If this is not unambiguously answered then in the long run the damage to eurozone banking may be severe.