Deposit Insurance in the UK
by George Hatjoullis
Most people will know that on the January 1, 2016, deposit insurance in the UK will fall to £75k from £85k. What they may not know is why. The change is required under the European Union Deposit Guarantee Schemes Directive. This fixes insurance at €100k. Non-eurozone countries must initially convert this to local currency at the rate prevailing on July 3, 2015 and then review and amend every five years. Hence;
The first review shall not take place before 3 July 2020 unless unforeseen events necessitate an earlier review.
The EURGBP rate was around 0.71 (€1 buys 71p) on July 3 so quite where £75k came from is unclear. Strictly speaking the insured deposit limit should have been £71k.Moreover, the rate closed close to .70 on Friday 20, so currently UK depositors have £5k more protection than their eurozone counterparts. Perhaps the Bank of England used the average rate at which it expects EURGBP to trade over the next 5 years (which is interesting!).
The Directive also allows a temporary deposit high balances insurance of up to £1m for 12 months from the time of the deposit, for qualifying balances. The UK has opted for a 6 month limit. The qualification is not wholly precise but certainly includes house sale, equity release, divorce settlement or redundancy package. Not a great deal of use if you are selling a house in London but better than nothing. There are several implications from these changes that I have alluded to before but are worth repeating in this context.
First, if you deposit money with a branch of a eurozone bank you are covered for only €100k and this will translate into sterling at the prevailing exchange rate when any claim is made. Hence, if for example, you are attracted to the rates offered by RCI Bank (in sterling) you should note it is a branch of RCI and your cover is €100k or £70k at the moment (and changing everyday). In contrast, Bank of Cyprus UK is a subsidiary and covered by the FSCS and your cover will be £75k and fixed for 5 years (probably). It all depends upon which authority is licensing the deposit taker.
Second, the introduction of the temporary high balances is a tacit admission that no bank is too big to fail and that uninsured deposits are, in principle, exposed if a bank becomes subject to resolution. In other words, if it fails the taxpayer is not going to bail out the unsecured creditors (such as uninsured depositors). So if your wealth exceeds £75k you may need to think hard about just holding it as cash in a deposit. I should also add that you cannot automatically net-out money you owe the bank. Whatever you owed the bank you will still owe!
Each individual is allowed £75k so joint accounts have £150k of cover. Moreover, you can deposit in as many separately licensed banks as you like. This is a bit clumsy but will cover most people. Businesses may have a problem. In the Cyprus experience businesses lost deposits and the payments system which had a very severe economic impact. This is why I have suggested the introduction of a Central Bank account which would effectively offer full insurance (at a price).
One implication is that large balance accounts will tend to concentrate in well capitalised banks. Another is that larger balances will tend to seek other risk free forms. For the individual in the UK this means National Savings or Gilts. The guarantor is the state. National Savings are well known to the average UK saver but Gilts less so.
Individuals do hold Gilts but usually via bond funds. This may involve a tax implication unknown to the investor. The taxation of the fund depends upon many factors. The taxation of individual holdings of Gilts is simple. Capital gain tax is not levied on Gilts. Income tax is levied on the coupon that is paid out periodically (usually twice a year). If one combines this with the fact that Gilts typically are redeemed at par (100) one gets an interesting tax effect.
For example, on November 20 the Treasury Gilt 2020 2% closed at a clean price (without accrued interest) of £103.46. If you buy £100 nominal you will only get £100 nominal back at maturity even though it will cost you £103.46 to buy. In return you get £2 p.a. paid as two £1 instalments until maturity. You will pay income tax at your marginal rate on the £2 and lose £3.46 for certain on your investment. You cannot use this loss against any other CGT gains. At the moment all gilts trade above par so their is a tax penalty for individual investors holding gilts. If interest rates rise the price of this bond will fall. If the price falls below £100 there is a tax advantage to buying the bond because there will be a capital gain at maturity which is not taxed. In both cases you get what you pay for (the income stream capitalised at the prevailing structure of interest rates) but the after tax return may be quite different.
If you look at Gilt prices you will see that most are above par at the moment and thus tax penalised for individuals. In effect individuals are taking some capital as income and paying income tax on the capital. The reason is, investors that are neutral between CGT and income tax dominate the market. The Bank of England is a case in point through QE but also large funds. The demand for Gilts has been strong since the financial crisis. Gilts are the main risk free asset available to big investors.
The current set of Gilt prices implies a path of future short term interest rates. The implication is that short term rates will not rise very fast, or very, far for a long time. In part this reflects a benign inflation outlook. In part it reflects government intentions to limit supply through balanced budgets. In part it reflects QE. However, it also reflects the lack of risk free assets as the implication of the loss of too-big-to-fail status for banks is recognised.