Examination of Witnesses (Questions 1424
TUESDAY 11 DECEMBER 2007
Q1424 Chairman: Sir Callum, welcome
to you and your colleagues. We have met before. Can I ask why
you are pushing ahead with reforms to the FSCS funding ahead of
the Government's consultation on the future of the entire deposit
Sir Callum McCarthy: Chairman,
because for a long time we had in train changes, changes designed
to make the scheme more resilient and to give it better funding
power, and we thought that whatever changes come about from the
legislation the Government plans to introduce next year, it would
be sensible to make those changes in the meantime because we did
not think there would be any conflict between improvements we
are planning to make and had planned for some time and whatever
comes out of that legislation.
Q1425 Mr Todd: In the discussion
over the FSCS there has been debate over how to define the boundaries
of it and the implications in terms of moral hazard, both for
the depositor in not perhaps being fully aware of the products
they are purchasing and the method of protecting their deposit,
and also the financial institutions that they have placed their
deposits with. How do you address those?
Sir Callum McCarthy: The moral
hazard question was particularly predominant at the very early
stages of the scheme. When the scheme was first introduced in
the 1970s it was a 75% deposit insurance, and it only went up
to 90% relatively recently, and it is only post Northern Rock
that we have increased it to 100% for the first £35,000.
The difficulty is forming the right judgment on that because,
for example, if you look at the experience in the US during savings
and loan problems, it was quite clear that that resulted in some
distortion of behaviour and some serious moral hazard.
Q1426 Mr Todd: So what advice do
you give, because you have said there is a question of balance
to be struck here, is there not, in addressing how to design this,
both in terms of the concept of co-insurance, of the depositors
bearing some proportion of the risk and therefore incentivised
to understand what they are involved in, and also in terms of
the limit of protection on the deposit to encourage the financial
institutions to manage its affairs responsibly and not recklessly?
Sir Callum McCarthy: First, I
do not think that this is a science. There is no algorithm we
can apply to give you the right answer; it has to have elements
of judgment in it. We are looking at this very carefully. The
present £35,000 probably covers something like 95% of individual
depositors; it probably covers something like 50% of deposits,
and getting that balance right so you get the right protection
for individuals but do not encourage irresponsible behaviour by
institutions is what the judgment has to be.
Q1427 Mr Todd: Do you think that
the current limit, or the limit as it was, was properly understood
by consumers in the first place, because for this to have any
value consumers really have to understand the level of protection
that is offered, and I think I would not have been alone in not
knowing the details of this until Northern Rock filled our screensand
I tend to take the view that I am a reasonably well-informed consumer.
There must be many, many who knew nothing about it, and did not
know the limits or any co-insurance element within it?
Sir Callum McCarthy: That is true,
and I think one of the questions is how to explain the reality
and that reality is both a question of the amount of coverage,
when this no longer applies when there is co insurance, and also
the speed with which an individual can expect to receive a payment
under the deposit insurance.
Ms Minghella: It is important
that consumers understand the protection that is available to
them in the event of a failure, and that is why when a business
does fail we take steps to inform every consumer who is affected
that they have a right to claim on the scheme. We also do work
with a number of stakeholders, Consumer Advice Centres, Money
Advice Bureaux, journalists, and MPs, to try and bring the scheme
to general attention in advance.
Q1428 Mr Todd: Do you not think there
should be a clear obligation on a provider of a deposit-taking
service to communicate regularly with the person having that deposit
the limits of a scheme of this kind? Without wanting to spread
alarm about it they can couch it in appropriate terms of "in
the unlikely event" and all the other things, but surely
there should be an absolutely clear obligation placed on a business
to do that, and that has not been done.
Ms Minghella: I would agree with
you, Mr Todd, that a firm should have an obligation to communicate
with its customers; it does have that obligation at the point
of giving any explanatory information about a product, and I think
that could be further enforced.
Q1429 Mr Todd: What about the research
into institutions which might be safer than others? To what extent
do you think humans are able to make reasonable judgments to spot,
if you like, the Northern Rock circumstance and say: "Well,
I would perhaps rather not place my money there but in an institution
which might be regarded as safer"? To what extent does that
information exist in a way that consumers can regularly understand
and, if it does not, should the Financial Services Authority not
be providing that?
Sir Callum McCarthy: First, unlike,
say, the FDIC which does have a pre-funding basis and where the
contribution from the different institutions is adjusted according
to the assessment of risk given by the FDIC, we do not do that,
partly because we do not have a pre-funded system. One would have
to be quite careful about that process because it is not self-evident
that one wants all the time to be marking institutions up or down,
and there would have to be a considerable degree of care in how
any approach was taken to that.
Mr Sants: We might add that in
making the decision to go to the 100% of the £35,000 we were
reflecting a belief that it is probably unrealistic to expect
the consumer to have the necessary information and ability to
judge funding risk I think possibly that would be asking too much
of the consumer. I certainly think in our view it would obviously
be something we could discuss and take views on as we go through
the next stage of the process, but our current thinking, and it
certainly was behind the 100%, is that it is a little too ambitious
to expect the consumers to have detailed understanding of funding
Q1430 Mr Todd: You do not think even
a rudimentary information provision would be of value?
Mr Sants: I think that is highly
debatable, to be honest. We have discussed in this group before,
of course, the complexities of the events that overtook Northern
Rock, and I think a rudimentary description of funding issues
might well cause more issues.
Q1431 Mr Todd: I think I can appreciate
that. We had a discussion with two academics on the issue of the
role that depositor protection might have as a financial stability
tool, and their view was essentially that this was a matter of
social policy, really, and had no particular role in terms of
financial stability. Would you agree with that?
Sir Callum McCarthy: I am not
sure if I would completely agree with that because I think if
there is greater understanding of the position of individual depositors,
if they know they are 100% covered up to a certain amount, if
they know they get very rapid repayment, it is much less likely
that there will be a retail run, and that has implications again
for financial stability. So I think it is not just a question
of the social aspects of this, though those are important
Q1432 Mr Todd: It is consumer confidence
Sir Callum McCarthy: Yes.
Q1433 Mr Todd: which, if it
is absent, certainly has an effect on financial stability.
Sir Callum McCarthy: Yes.
Q1434 Mr Todd: But the primary aim
of this scheme I think was described as widows and orphans. It
certainly extends to a lot more than widows and orphans but the
principle is of people of relatively modest means having their
savings properly protected so they need not worry about them,
and providing a scheme which, for example, encompassed the deposits
of businesses or relatively wealthy individuals should not be
an objective. Is that reasonable?
Sir Callum McCarthy: Broadly I
would agree with that. The basis is it is unreasonable to expect
ordinary individuals to assess matters.
Q1435 Mr Todd: Fair enough. Lastly,
obviously a depositor protection scheme of this kind cannot protect
against all possible circumstances of failure, and there is a
recognition that if a very major financial institution failed
then it would not be adequate to cope with that circumstance.
How should that be expressed?
Sir Callum McCarthy: It is important
that, even if there were a very large failure, people should know
that the guarantee that they had received would be met, but that
essentially would have to be met in the last resort by Government.
Q1436 John Thurso: Prior to October
this year the scheme would only cover 90% deposits between £2,000
and £35,000. I understand the rationale for deciding upon
an upper limit figure but I do not understand the rationale for
an intermediary band of only 90%. What is the rationale behind
Sir Callum McCarthy: The rationale
was a view of the moral hazard and the importance of some degree
of co-insurance, in a sentence.
Q1437 John Thurso: Do you think it
is appropriate that the individual depositor at the under £35,000
level should be obliged to partake in that moral hazard, given
clearly the Government have decided since October that is not
Sir Callum McCarthy: In answer
to a previous question I explained that the background of the
introduction of this scheme started off at 75% then went up to
90%. Originally it did not have any fixed element at all and if
you look at the development of it you can see where it started
from and where it has moved to.
Q1438 John Thurso: UK banking generally
over the last 12-15 years has enjoyed a long run of very strong
profits, and it may be not for me to guess where the markets are
going but there was reason to suspect they might be going into
a cyclical downturn. The compensation scheme appears to lack funds
to do its job. Is that correct?
Ms Minghella: The compensation
scheme has a very strong levying power, and it has been further
improved by the Financial Services Authority's recently announced
changes so that from 1 April next year we will be able to levy
£4 billion per year according to need. We are not constructed,
the Statute does not allow us to be constructed, as a pre-funded
scheme, we can only levy on a pay-as-you-go basis, but the £4
billion a year we believe will enable us to deal certainly with
a wider range of failures than we can now and will be sufficient
to deal with the sort of failures we would normally expect.
Q1439 John Thurso: That levy would
normally have a degree of ex ante in it as opposed to ex post
funding for the future?
Ms Minghella: It will not be an
ex ante levy mechanism because we will just levy each year for
the failures we can see ahead on the basis of our forecasts.