Q
160Mr.
Bone: On that last point, could the bondholders expect
compensation? Adrian
Coles: Yes. A compensation order is to be made, but I
do not think that it has been tabled yet. However, the Government say
that an order is to be made, as they did on Northern Rock. Again, that
throws us back to confidence in the valuation—when will it come
in? There is another difficulty. If you are a bondholder and you expect
to receive compensation—maybe it comes in a
year’s time—what if that bond is underlying a pension
scheme that is paying out annuities and all that in the meanwhile? So
there are lots of real effects for the investors and savers.
Stephen
Haddrill: I think that the test really is whether or
not, in a partial transfer, the creditors generally and particularly
the bondholders will be worse off than if it was done as an entirety. I
would like to see some assurance that things will be managed so that
that does not happen.
Q
161Mr.
Bone: I am supposed to be asking about the deposit
protection fund. In the USA and other countries, it is funded in
advance. Here, we have a pay-as-you-go system, or actually a
pay-afterwards system. Would it be practical to have a pre-funded
scheme? Stephen
Haddrill: It is clearly possible to have a pre-funded
scheme. We are nervous about it in relation to banking, for the reasons
that were largely given at the previous session, and we totally reject
it in relation to insurance. Of course, the FSCS at the moment operates
a single scheme, with cross-subsidy between different types of sector.
We are worried about it being introduced in banking and it then being
applied in some way to insurance.
The reason
that we do not like a pre-funded scheme in relation to insurance is
that you do not need it in insurance, because the payments you make are
spread over a very long period, as people make claims. You do not get a
run with a queue outside the insurance company as the annuities fall
due, and so on and so on. So you do not need to prepare in advance for
it. I think that it should be clear in the Bill that, if there is
pre-funding, it should be limited to bank deposit protection and not
applied across the other parts of the financial services
sector.
Q
162Mr.
Todd: We have seen the FSCS compensation limit go to
£50,000, and the European Commissioner has been talking about a
minimum of €100,000. Moral hazard has been discussed quite
extensively in the run-up to this legislation and there are two
possible moral hazards here. One is moral hazard among the providers,
on the basis that there is a collective insurance here in which there
may be an incentive for poor practice by one of the providers, because
they will not have to bear the total consequence of their foolishness.
The other is among depositors, which assumes that people race to the
best offer without proper regard for any risk analysis. However, that
of course is based on an assumption that people have the tools to work
out these things for themselves anyway.
We have not
heard from the two wingers in this four-man formation. Can we hear a
little bit from them, particularly on the second possible hazard, which
is the hazard of depositors racing to the top
rates? Teresa
Perchard: This is the main area of the Bill where
both Which? and Citizens Advice might have some input. However, it
needs to be looked at in the context of the introduction of a special
resolution regime, because, as I understand it, that is designed to
ensure that calls on the FSCS rarely happen, as it is designed to
ensure that somebody takes on the business, rather than letting it go
down, so that people have to queue up to get their money back on a
cheque and open an account with somebody else. That would be the
nightmare scenario.
So
one might look at things like pre-funding in the context of having a
special resolution regime. We have not expressed any view on the
pre-funding proposition,
but we are interested in what happens with the compensation scheme. The
appearance of unlimited compensation for Icelandic savers, with varying
limits across Europe, means that we now need to rethink the
£50,000 limit, although very few citizens advice bureau clients
will have more than £50,000. As you
suggested, it is quite brave to assume that consumers go shopping for
somewhere to put their savings safely, taking with them the sheet I
have before me from the Martin Lewis site, which shows exactly who owns
who. The £50,000 limit applies to a single registered
institution. There is a nice little string of the AA, the Bank of
Scotland, Birmingham Midshires, Saga, Halifax and Intelligent Finance,
which are all in one group and have now been swept up into another
conglomerate. You might have safely tucked away little bits of money up
to the £50,000 limit in different institutions and find that
while you thought you were doing the right thing, you were actually
trading with just one entity. The practice of having a limit works only
if institutions that are taking people’s savings say,
“Oh, you’ve exceeded the protected limit. We suggest that
you put the excess with another institution that is not in our
group.”
Q
163Mr.
Todd: That is a slightly counter-intuitive piece of
advice. Teresa
Perchard: Absolutely. There has been a lot of debate
about whether the consumer should take some risk. It has been said that
consumers who simply want somewhere safe to put their accumulated
savings should take some risk. If no one will tell them where they can
keep their money safely, other than under the bed, it is difficult to
operate a limit. That is particularly true when limits vary across
Europe. It has become confusing for
consumers. Doug
Taylor: I am not convinced that moral hazard really
applies in the area of consumers putting money into simple personal
accounts or savings products. In reality, the different interest rates
on savings accounts are not dramatic. Individual consumers are chasing
the best that they can get. I do not think that they are being reckless
in placing their money in savings accounts. Indeed, prior to recent
events with Northern Rock, it would have been hard to find a consumer
who did not think that in putting money into a high street savings
account, they were putting it into something absolutely solid. I do not
think that moral hazard issues that apply in areas of investment apply
to personal accounts and savings. I do not think that consumers have
acted recklessly in this
area. On
the ability of consumers to navigate through the system and decide on a
high street bank, I do not think they are in a position to carry out
due diligence in terms of the liquidity and solvency of the big names.
They assume that the regulatory system will do that for them. When that
fails, a problem arises. At the end of the day the consumer will meet
the bill, either as customer or taxpayer. I hope that I have answered
your question on moral
hazard.
Q
164Mr.
Todd: There was the other element of the moral hazard
among providers. If you have a comprehensive insurance scheme paid for
not on a risk basis, but simply on volume activity, it can encourage
poor behaviour among some providers.
Guy
Sears: That is an interesting point whether you
support pre-funding or not. Perhaps pre-funding is one of those things
that should be axiomatic. It is seen as a cost of doing business. At
the moment, the compensation scheme is the cost of someone else doing
business. The point you make about the risk basis for collecting the
money is very interesting. Finding the right proxy for banks to reflect
that, whether it is pre or post-default, is an interesting
issue.
Q
165Dr.
Pugh: May I clarify what you have said? In connection with
Citizens Advice and Which? we are talking about small depositors
because those are the people whom those organisations
characteristically see when they have a problem. Two different concepts
have emerged so far. We were told by the banks in this morning’s
sitting that people are moving their accounts around quite cleverly. We
were told that they are trying to guess the market and put their
savings in safe places and are consulting the internet and looking at
charts such as the one you brandished a few moments ago. There is the
other perception that they are completely baffled by the system and
that they are likely to use products in Iceland, particularly when
ratings agencies say that it is perfectly safe to do so. Those are two
diametric images of the small depositor. Which do you think is the most
appropriate for legislators to take into
account? Teresa
Perchard: Most of the policy is played out in the
regulations on the scheme, and the legislation is changing the scheme
to provide more flexibility around what it does, what the compensation
is used for, to fund the special resolution regime or to invest it
partly and have flows of money in and out of the Bank of England. It
seems that we can make changes to the compensation limit quite easily
without
legislation.
Q
166Dr.
Pugh: But with no blanket
guarantee? Teresa
Perchard: Well, most CAB clients would be astonished
to have savings of £50,000, while some would be astonished to
have £500. The changes to the scheme protect many of the people
whom my organisation works with, but we are struck by the fact that
many people are now quite anxious about getting it right. Much media
coverage over the past year has created such high anxiety even about
putting money into a simple savings account that people are unsure
what to do.
The issue is
really about who owes who and when the limit actually kicks in. If
there is a limit, and it applies to a business, not an individual brand
with which a customer thinks they are trading, the brands that are
trading with their customers need to tell them when they have exceeded
the protected limit. I am not aware of financial institutions doing
that as a matter of course. Caveat emptor. The consumers cannot know
what they are not being told by the
supplier.
Q
167Dr.
Pugh: But is it not worse than that? Even when the bank is
taken into the safe hands of the state, the small investor is often the
last person to find out exactly what has happened. I was contacted by
constituents who were Lloyds TSB customers, so dutifully I went on to
the Lloyds TSB website to see what it was saying, the gist of which
was, “Watch this space”. I did not think
that that was wholly satisfactory. A pensioner depending on a limited
amount of interest from a savings account at Lloyds TSB would
presumably take a similar view that, whatever arrangements were made
when taking banks into partial state control or whatever salvation is
offered to banks, the small investor needs to be told up
front. Teresa
Perchard: In our response to the Treasury
consultation, we highlighted the need for good communication with
people who rely on tax credit payments and benefit payments into their
bank accounts. Those people rely on a very small amount of income
coming in, so they have to budget weekly. If they have to open a new
account elsewhere, disruption to that income flow will cause debts. In
any situation in which a bank is failing and people can no longer gain
access to their money, it is those people on the lowest incomes who are
drawing on it frequently who will be hit very
hard. The
whole compensation scheme needs to be geared around not just a
leisurely way to send out cheques to people, but a way to maintain
payments in and out of the account. That is why the special resolution
regime is actually capable of offering consumers in that situation more
stability than a beefed-up Financial Services Compensation Scheme. It
looks to ensure that banking continues by taking control of the bank
services, so that customers’ accounts are not disrupted. Making
sure that it does not happen or that bank account services are managed
is in the better interests of consumers than fixing up a compensation
scheme, although that is needed as an absolute
backdrop.
Q
168Dr.
Pugh: My last question is to Mr. Taylor. What
changes in the Financial Services Compensation Scheme are the most
important to restore the public’s confidence in the safety of
their deposits?
Doug
Taylor: May I preface my remarks by referring to a
point that was raised
earlier? In
terms of the financial capability of consumers in the UK, we can look
no further than the FSA’s baseline study, which showed that 40
per cent. of consumers with an equity ISA did not realise that it would
be affected by movements in stocks and shares, and 16 per cent. of
people with a cash ISA thought that it could be affected by movements
in stocks and shares. I make that point simply to illustrate that, to
establish something that consumers can understand, we need to start
from where consumers are rather than where we might like them to be.
Indeed, we would like to see consumers more active in using the market
to get a better deal and to create a highly competitive financial
services world but, where we stand at the moment, the level of
understanding is perhaps lower than we would like it to
be.
Q
169Dr.
Pugh: May I stop you there? Whose job is it to address
that low level of financial literacy? Is it the institutions
themselves, the state, or
who? Doug
Taylor: The FSA is now doing a considerable amount of
work on the issue of financial capability, and the Thoresen review,
which reported recently and which dealt with the creation of an advice
network to help people on the first rung of understanding, is
important. Work is being done in schools by organisations such as
the Personal Finance Education Group. A whole series of actions can take
place, and I think that the answer to the question is that it is the
responsibility of a large number of people to try to improve
capability. We
should understand that it will take some considerable time before
people’s capability moves up significantly. Therefore, in the
short to medium term, we need to do whatever we can to make information
and the way that people interact with it as simple as
possible. We
have raised a number of issues that we think would help the
compensation scheme. One of them, which has already been referred to by
Teresa, is the question of whether the scheme works on the basis of a
brand or a licence. It is difficult to believe that consumers can
navigate their way through to where an individual limit will end, given
that a number of what they might see as separate brands operate under
the same licence. Teresa illustrated that with the example of AA, Saga
and HBOS, which are all part of the same stable. Issues around
consumers’ understanding need to be addressed, and we strongly
believe that any limit should be related to brand. That would allow
consumers at least to have a view, if they were getting to the limit,
of where it
was. There
is also an issue related to temporary high balances. For example, if
someone were to sell a house or receive a legacy, they could have a sum
of money in an account for a short time, and it would be unfortunate if
that happened to coincide with a bank failure. Something needs to be
done in that area. We have advocated that institutions should look to
the wholesale market to
secure insurance, and that the FSA should create a rule so that that
happens for particular areas such as temporary
balances. The
third issue is to do with whether payments should be gross or net. We
strongly believe that it is better to make payments gross rather than
net. A net payment could potentially wipe out the liquidity of the
consumer immediately. That would mean that if they had planned anything
from a home improvement to paying university fees, they would find
themselves bereft of cash. I listened to the session this morning, and
I concur that paying gross would also help in speeding up any
compensation payments. It would make it simpler for financial
institutions to calculate the
amount. The
fourth and final issue is that of banks that are passported into the UK
system, and what should be done about them. We believe that any bank
not currently authorised and regulated in the UK should be, so that
consumers can have confidence that the system operates across the board
in the UK. Indeed, that might require consideration of whether that
part of the scheme should be pre-funded so that any default would not
eventually fall on the UK
taxpayer.
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