Bank of England considers major reform of deposit guarantee scheme

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The Bank of England is considering a major overhaul of its deposit guarantee scheme, including boosting the amount covered for businesses and forcing banks to pre-fund the system to a greater extent to ensure faster access to cash when a lender collapses.

The UK’s Financial Services Compensation Scheme is being urgently reviewed after the rapid failure of Silicon Valley Bank last month, when billions were withdrawn in panic from SVB’s UK subsidiary overnight, people briefed on the BoE’s thinking told the Financial Times.

Regulators are concerned that the guarantee’s current £85,000 limit only covers about two-thirds of deposits and that the relatively low level of pre-funding means there is a delay of at least a week for customers to regain access to their cash, the people said.

They added that these shortcomings undermine confidence in the FSCS and reduce its effectiveness in preventing bank runs. However, increasing the threshold and increasing the level of pre-funding would be costly to lenders, who have long lobbied the Treasury against such changes.

The BoE declined to comment.

The flaws in the UK’s rules compared with the US were thrown into sharp relief as SVB spiralled into insolvency in mid-March. Regulators on both sides of the Atlantic moved quickly to pledge that customers would not suffer losses to stabilise the global financial system.

US authorities were able to promise that all insured and uninsured deposits would be protected and people could have access to their money by the next working day because the Federal Deposit Insurance Corporation pre-funds its guarantee programme via insurance premiums paid by banks. The US also guarantees deposits up to $250,000, compared to the UK’s £85,000.

The UK also has lower levels of advance funding for the FSCS, which resulted in the Prudential Regulation Authority, the part of the BoE that regulates financial services, warning customers they faced a wait of at least seven days for their cash if SVB’s UK arm went bankrupt.

In the event, the government brokered a deal over the weekend to sell SVB UK to HSBC for £1, so clients were not locked out of their accounts.

Nevertheless, the close call has prompted BoE governor Andrew Bailey and Jeremy Hunt, the chancellor, to call publicly for the system to be reformed, with both floating the idea of raising the amount guaranteed, which was set in 2017.

“We need to look at deposit insurance and keep that under review,” Hunt told the Financial Times last week. If supervisors recommend that the limit is boosted “it will come across my desk as to how we finance that increase”.

Regulators are considering increasing the amount insured for small businesses, which need consistent access to cash to pay suppliers and staff, the people said. For many, the current level is simply too low to make a difference.

An alternative under consideration could be to increase the amount guaranteed for specific uses, such as working capital, one of the people said.

The need to boost the £85,000 limit for individuals is less pressing, but that will also be reviewed, they added.

A higher level of pre-funding in the UK could also be required to speed up payouts. This could be raised by charging banks higher premiums based on their size and risk, which one person involved conceded could “open a can of worms”.

“Such ruminations are not surprising,” said Numis analyst Jonathan Pierce, who estimates that UK deposit protection currently covers only 65 per cent of retail and small-business balances and about 50 per cent of all deposits including larger corporates.

“Any increase in deposit protection would add ‘one-off’ costs to banks and is one of the more potentially important consequences of recent events,” Pierce added.

Under a plan agreed when the UK was still part of the EU, banks had until 2024 to build a pre-fund equal to 0.8 per cent of covered deposits. In the US, at the end of 2022, the FDIC’s fund had $128.2bn in reserve, equivalent to 1.27 per cent of insured funds, and it plans to increase this to 2 per cent over time.

Making deposit insurance more robust would also boost confidence in the UK’s smaller banks. They are not required to build the same level of loss-absorbing capital buffers as their larger rivals and therefore offer less protection to uninsured deposits if they fail.

They also face higher costs to issue long-term debt, which has only been made worse by a reduction in appetite for financial bonds after the collapses of SVB and Credit Suisse.

Noting these difficulties, BoE governor Bailey said in a speech last week: “I think the answer here lies in the world of deposit insurance.”