Plan to guard UK savings

Source: Post-Rock revamp to guard savings

In the aftermath of the Northern Rock collapse, UK lenders face the real possibility of having to put billions of pounds into a new system designed to guard and compensate individuals in the event of a banking collapse. Chancellor Alistair Darling will launch a three-month consultation on legislation that includes, among other things, the idea that banks fund the compensation scheme for depositors in advance.

This plan is very unpopular with banks because it forces them to create a significant compensation fund when existing capital is incredibly tight. Mr. Darling admits that the plan has “significant disadvantages. ” One banking executive described the plan as “a very significant IOU the government is handing to the banking sector.” MPs on the Treasury select committee feel banks should pre-fund the scheme to reassure customers and immediately compensate them in the event of a banking collapse. An alternate plan would allow banks to retain the “pay as you go” approach where banks rely on loans to finance compensation in the event of a collapse.

Mr. Darling’s consultation will consider whether the current level of compensation (100% for the first £ 35,000) should be extended to include sums as high as £ 100,000. Banks want to keep the figure at £ 35,000, reasoning that this amount will cover approximately 97% of consumers.

In addition, the consultation plan includes requiring banks to have a system in place to inform the Financial Services Authority at “short notice” of their liquidity situation. In the event that a bank is failing, there are proposals for a banking insolvency regime that will allow authorities to remove the failing bank from the market, protecting depositers’ money and redistributing parts of the failing business to another bank.

Questions for discussion
1. Is a prefunded compensation plan the best idea, or does it place too large of a burden on an already strained banking industry?