Depositor protection and the BoE’s latest paper
The paper which the Bank of England published yesterday (Depositor Protection: consultation paper CP20/14) touches only on some relatively minor aspects of deposit protection, but runs the risk of confusing the public into believing that the key issues are being addressed. Already press reports are suggesting that temporary high balances of up to £1m are now guaranteed, while the paper sets out the basis under which such amounts (“THBs”) may be protected in future under a very restricted set of circumstances.
While details on the computer systems financial institutions need to use in order to manage compensation payments are no doubt of pressing concern to regulators and banks, what the public need to know is not touched upon in this paper (except as far as it affects THBs). It is simple. What is the resolution regime that will apply to “larger deposits” i.e. those over the FSCS limit (i.e. the £85,000 in most cases, with the larger, but still finite, amount for eligible THBs)?
It is clear that no one knows the answer. Will larger deposits be treated on the same level as senior unsecured bonds, and be bailed in once equity and subordinated capital has been exhausted, or will bondholders be next in the queue, before such depositors? Since s.13 Financial Service (Banking Reform) Act 2013 (which passed effectively unchallenged) larger deposits are subordinated to the FSCS subrogation rights, so the amount recovered in a Companies Act winding up is likely to be far less than before; and since the Bank of England has for many years let banks borrow secured from one another, recovery rates are further diminished.
In practice resolution will not follow such rules. The recovery rate for larger deposits depends entirely on the whim of the regulatory authorities, Bank of England, Treasury and ultimately the Chancellor: what they will actually do in practice is not known. But there are widespread assumptions, which sit oddly with the legal framework. That is how banks can continue to raise deposits paying the same rate above as below the FSCS limit, a position which no rational depositor would accept if he didn’t believe that all deposits will in practice be protected. But what if that belief evaporates? Paradoxically a special rule for THBs may well bring home to the public the fragility of the confidence they have displayed until now. A cynic might even wonder if the rule is a prelude to a change in the Realpolitik, so that a medium sized bank or building society would be allowed to default with the loss of fewer votes to the party that permits this (who will claim that ordinary people were fully protected). This may be the new mansion tax.
The press reports suggest that the new measures will help avoid a Northern Rock-style panic: they will not. People panic not because it will take 20 days rather than 7 to recover the first £85,000 of their deposit, but because they suddenly realise they may never see the rest of it. And the large corporates whose deposits are now to be eligible will derive little comfort from the first £85,000 of a £100 million deposit being safe.
There is an urgent need for the position of bank depositors to be clarified, not confused.