Bank Deposit Protection in the UK
by George Hatjoullis
The surprising aspect of the banking crisis is that, in the UK, no unsecured deposit, that is a deposit in excess of £85k today, was lost. One could argue, as I have repeatedly in these blogs, that the government rescue of UK failing banks bailed out the unsecured depositors and senior bondholders rather than the popular myth that it bailed out the ‘bankers’. Shareholders lost money, bankers lost jobs and junior bondholders lost money. Unsecured depositors, who are also taxpayers, lost nothing. They bailed themselves out. However, what does truth have to do with politics, journalism and envy. Cyprus shows what might have happened in the UK.
Cypriot depositors were not so lucky. Unsecured depositors were bailed- in to recapitalize the banks. It did not matter who the depositors were or why they had unsecured balances. They were bailed in with devastating consequences. Many were just buying and selling property in which to live and are now homeless and money-less. The thrust of the EU Banking Union proposal is to make unsecured deposits available to recapitalize failing banks throughout the EU. I have repeatedly argued in these blogs that this needs to come with the introduction of insured transaction accounts which allow temporary transaction balances that exceed the insured amount to be covered by the FSCS. The Bank of England appear to be making a definite move in this direction.
The BoE proposals for enhanced depositor protection are contained in this paper (http://www.bankofengland.co.uk/pra/Documents/publications/cp/2014/cp2014.pdf) but it is worth highlighting an reproducing their proposals on Temporary High Balances.
C. Protection for temporary high balances
Recast DGSD requirement
2.16 Article 6 of the recast DGSD requires that temporary DGS coverage is provided for at least three months and no longer than twelve months for certain deposits. These are categorised as temporary high balances (THBs) and include:
- (i) deposits resulting from real estate transactions for private residential purposes;
- (ii) deposits that serve social purposes defined in national law and are linked to particular life events of a depositor such as marriage, divorce, retirement, dismissal, redundancy, invalidity or death; and
- (iii) deposits that serve purposes defined in national law and are based on the payment of insurance benefits or compensation for criminal injuries or wrongful conviction.
2.17 This coverage would be available where a depositor has more than £85,000 deposited with a deposit-taker, and all or part of the deposit in excess of £85,000 is a THB.
Temporary high balance (THB) categories
2.18 The PRA’s proposed rules set out the categories of deposits that the PRA expects would benefit from this additional protection (see Appendix 2). Further detail is set out in the statement of policy (see Appendix 3).
(1) Based on 2013 property data from the Land Registry.
2.19 The PRA considers that providing a relatively high level of temporary protection to all individuals with deposits that qualify supports depositor confidence, and can thereby contribute to the safety and soundness of firms. However, in the interests of proportionality, there should be a maximum limit per THB. Accordingly, the PRA’s proposed rules set a limit of £1 million on this additional protection but with an exception for deposits relating to personal injury compensation, where the PRA proposes that protection should be unlimited given the nature of the claims. A £1 million limit would cover approximately 99% of house sales (the most common THB category) in England and Wales and 92% in London.(1) The PRA proposes applying this limit on a‘per event per deposit-taker’ basis, so that a depositor may claim compensation up to the £1 million limit in relation to each event that has occurred which gives rise to a THB.
2.20 The PRA’s proposed rules set out a time limit of six months for this additional protection, beginning on the date on which the deposit was first transferred into the depositor’s account or the date on which it became legally transferable to the depositor (whichever is later). The PRA considers that this period of coverage strikes the right balance between giving depositors sufficient time to split their deposits between institutions and the increased costs to levy payers.
2.21 The PRA proposes that deposit-takers should not be required to mark and verify THBs prior to default. Although depositors would receive their THB payment faster under an approach in which such balances were verified prior to a failure, the PRA considers that this would impose an onerous requirement on firms. The PRA is of the view that this would not be proportionate to the benefits of repaying these balances within the faster payout deadline. Even in a system where balances were verified in advance, a procedure would still be needed after the default had taken place to allow customers to claim THB protection where they had failed to register their THB with their deposit-taker in advance. Instead, the PRA proposes that depositors with THBs should have to provide proof of the THB to the FSCS if their bank defaults. The FSCS would use the SCV file to identify individuals with balances in excess of the compensation limit and inform them that they may be entitled to additional cover. The FSCS would provide the depositor with information on what constitutes a THB and the level of evidence required to verify the balance. These depositors would receive £85,000 within the faster payout deadline.
Bank account turnover
2.23 Payments flowing into and out of an account may make it difficult to determine what portion of a depositor’s money retains THB protection since the date that the THB was paid in. The PRA’s proposed rules set out that depositors are eligible for THB protection during the coverage period to the value of the original THB amount, regardless of the pattern of subsequent payments into and out of the account.
2.24 The PRA’s proposed rules set out that if the THB is transferred to another deposit-taker, the corresponding THB cover would also transfer, although the coverage period will not begin again. Due to the wide variety of relevant factors in establishing whether the transferred amount is linked to the original THB, the PRA proposes that the FSCS is given discretion to determine this. The PRA’s proposed DGS statement of policy sets out a number of considerations to which the PRA expects that the FSCS should have regard when making this determination (see Appendix 3).
10 TEMPORARY HIGH BALANCES
10.1 This Chapter applies only to the FSCS.
10.2 In order to qualify as a temporary high balance, a part of an eligible deposit in excess of
£85,000 must meet the following additional criteria:
(1) it comprises:
(a) monies deposited in preparation for the purchase of a private residential
property (or an interest in a private residential property) by the depositor;
(b) monies which represent the proceeds of sale of a private residential property
(or an interest in a private residential property) of the depositor; or
(c) proceeds of an equity release by the depositor in a private residential
(2) it comprises sums paid to the depositor in respect of:
(a) benefits payable under an insurance policy;
(b) a claim for compensation for personal (including criminal) injury;
(c) State benefits paid in respect of a disability or incapacity;
(d) a claim for compensation for wrongful conviction;
(e) a claim for compensation for unfair dismissal;
(f) their redundancy (whether voluntary or compulsory);
(g) their marriage or civil partnership;
(h) their divorce or dissolution of their civil partnership; or
(i) benefits payable on retirement.
- (3) it comprises sums paid to the depositor in respect of:
- (a) benefits payable on death;
- (b) a claim for compensation in respect of a person’s death; or
- (c) a legacy or other distribution from the estate of a deceased person.
- (4) it is held in an account on behalf of the personal representatives of a deceased person for the purpose of realising and administering the deceased’s estate.
- (5) it otherwise serves a social purpose provided for in the law of a part of the United Kingdom, which is linked to the marriage, civil partnership, divorce, dissolution of civil partnership, retirement, incapacity or death of an individual.
- 10.3 Following the compensation date, the FSCS must review the single customer view of each depositor with the DGS member and provide written notice to an individual with aggregate eligible deposits in excess of £85,000 of the following:
- (1) that the depositor may be entitled to additional compensation if all or part of the eligible deposit in excess of £85,000 qualifies as a temporary high balance;
- (2) that in order to claim such additional compensation, the depositor must provide the FSCS with a written application and evidence supporting the depositor’s claim that all or part of the eligible deposit in excess of £85,000 qualifies as a temporary high balance;
- (3) that the depositor may make more than one claim for a temporary high balance if there are multiple events giving rise to a temporary high balance; and
- (4) the date by which such written application and supporting evidence should be submitted to the FSCS.
- 10.4 The FSCS must pay compensation to a depositor in respect of a temporary high balance in accordance with 4.3 if it is satisfied that there is a sufficient link between an event giving rise to a temporary high balance and the part of the eligible deposit in excess of £85,000, taking into account the following considerations:
- (1) the written application and evidence provided by the depositor under 10.3; and
- (2) any other information that the FSCS considers relevant.
- 10.5 The FSCS must pay compensation to a depositor in accordance with 4.3 in respect ofeach temporary high balance that the depositor has with any one DGS member.
- 10.6 The FSCS may pay compensation in respect of a temporary high balance to a person who makes a claim on behalf of another person if the FSCS is satisfied that the person on whose behalf the claim is made would have been paid compensation by the FSCS in respect of that temporary high balance had the person been able to make the claim themselves, or to pursue their application for compensation further.
- 10.7 The protection for temporary high balances under 4.3 shall run for a period of six months from the later of:
(1) the first date on which a temporary high balance is credited to a depositor’s account, or to a client account on a person’s behalf; and
(2) the first date on which the temporary high balance becomes legally transferable to the depositor.
[Note: Art. 6(2) of the DGSD]
10.8 The FSCS must, within three months of the compensation date, pay to the depositor a sum representing the amount due to the depositor in respect of the temporary high balance unless one or more of 10.9 to 10.11 applies.
[Note: Art. 8(5)(d) of the DGSD]
- 10.9 The FSCS may defer payment in respect of a temporary high balance for a period inexcess of the period specified in 10.8 where:
- (1) the depositor provides the written application and evidence referred to in 10.3 to the FSCS more than two months following the date of the written notice from the FSCS under 10.3; or
- (2) one or more of the circumstances set out in 9.4(1) – (4), (5) and (6) arise.
- 10.10 If the FSCS considers that the written application and evidence provided by a depositor under 10.3 does not demonstrate a sufficient link between an event giving rise to a temporary high balance and the eligible deposit in excess of £85,000, the FSCS must write promptly to that depositor to:
- (1) request any additional information that the FSCS considers necessary to determine the claim (within such time as the FSCS may specify); or
- (2) confirm that the FSCS has determined that the deposit is not a temporary high balance, setting out the reasons for its determination and a summary of any right to request a review of the determination.
- 10.11 If the written application or evidence provided by the depositor under 10.3 contains any material inaccuracy or omission, the FSCS may reject the claim for compensation unless this is considered by the FSCS to be wholly unintentional. The FSCS must give written reasons for rejecting the claim together with a summary of any right to appeal the decision to reject the application.
- 10.12 Where all or part of a temporary high balance is transferred to another DGS member after the start of the coverage period referred to in 10.7, the FSCS must pay compensation if it considers that the transferred deposit is sufficiently linked to the temporary high balance. The transfer shall not affect the coverage period referred to in 10.7.
The proposals as laid out here seem quite clumsy and may make it operationally difficult and costly to implement but the intent is sound. It might make more sense to introduce, as I have argued, a transaction account that is fully insured indefinitely and up to any amount. However, the account would be subject to a negative interest rate that could be used to finance the levy for the FSCS. The effect of negative interest rate would be to minimise such balances except in times of extreme concern about bank failure. However, it is precisely in such times that introducing some mechanism for deposits not to leave banks is valuable. It would be operationally simpler. The banking jurisdiction that provides an effective solution to the security of transaction balances will steal a march on its competitors.
Submission to the BoE 7/10/14
The proposal to introduce THB protection is sound but the proposed implementation unnecessarily clumsy and leaves depositors with potentially some doubt about whether they will be covered. The doubt rather defeats the object. Would it not be operationally simpler and less ambiguous to identify a class of bank account to be known as a ‘transaction account’. The account can contain excess funds up to whatever limit is deemed appropriate and for whatever time period is deemed necessary. The time limit could be simply policed through a FIFO arrangement. In order to minimise abuse and to finance the increased deposit protection levy payable to the FSCS, it would carry a fee, possibly structured as a negative interest rate. This would disincentivize the holding of excess balances except in such circumstances as fear of bank failure, which is precisely when such accounts would serve a purpose in calming depositor fears. There would be no ambiguity about whether funds are protected. Moreover, the BoE could vary the terms ( duration and amount and cost) in times of systemic crisis. The accounts could be available for any excess balances thus being administratively simpler for all concerned and the tendency to inappropriate use controlled via the fee structure. The existence of such a class of bank accounts would confer a comparative advantage on any banking jurisdiction offering same.The need for such accounts has been indicated by events following the banking crisis and more recently by the chaotic and destructive resolution of the Cyprus banking crisis.
Not that I imagine they will pay any attention to me!