Banking Bill

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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.
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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