Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 1424 - 1439)



  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 protection scheme?

  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 screens—and 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 risk.

  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 that?

  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 the case?

  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.

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