Select Committee on Treasury Minutes of Evidence


Examination of Witnesses (Questions 1548 - 1559)

TUESDAY 18 DECEMBER 2007

MS ANGELA KNIGHT CBE AND MR ADRIAN COLES

  Q1548  Chairman: Good morning and welcome to the Committee. You are both very familiar with the Committee, but could you introduce yourselves for the shorthand writer, please.

  Ms Knight: Angela Knight, I am the Chief Executive of the British Bankers' Association.

  Mr Coles: I am Adrian Coles, I am Director General of the Building Societies Association.

  Q1549  Chairman: As you know, this inquiry is largely about financial stability, so my first question to you is: is it possible to design a system where payouts are made from a failing bank within days or weeks of a failure rather than months or years as at present? Is work going on on that? I notice that a representative from the IMA has suggested plugging the Bank of England into the ATM network in order to provide immediate access to funds up to the £35,000 limit if a bank were to fail.

  Ms Knight: Yes, I think it is possible to design a system, Chairman, whereby payouts can be quicker. The existing Financial Services Compensation Scheme has been designed primarily for investment products and not for deposit protection in terms of a quick payout scenario. If we look at the various options that are currently in operation in other countries, I think that there is there some information and some models which we could probably usefully consider here. We made brief mention of some of those within our submission to the Treasury on reform of the Deposit Protection Scheme, a copy of which we sent to yourself.

  Q1550  Chairman: Adrian, if you could just take that and add to the point that if depositors were to receive immediately their deposits from the FSCS, what implications would this have on depositors' status as creditors? Could creditor status be transferred to the FSCS?

  Mr Coles: Clearly it is possible to design a scheme where depositors get their money back immediately. That is exactly what happens in America with the Federal Deposit Insurance Corporation Scheme. They normally aim to get deposits in the hands of the depositors of a failing bank within 24 or 48 hours. The answer to your first question is absolutely yes, although it is fair to observe that in the American system most of the banks that have been saved over the last ten or so years have been very tiny institutions with deposits of only $10 million/$20 million/$50 million, much smaller than the sort of circumstances we are talking about in the UK at the moment. What tends to happen with the larger institution in the States is that the depositors do become creditors of an institution owned and controlled by FDIC, so again the answer to your question is, yes, this could be arranged if there was the desire to do that in the United Kingdom.

  Chairman: We hope to finish by half past ten so we are going to ask brief questions and receive brief answers so that we will get the maximum out of this session. Peter?

  Q1551  Peter Viggers: In your memorandum[1] you commented on the amount of liquidity made available by the Bank of England and contrasted that with the amount of liquidity made available by the European Central Bank and the Federal Reserve yet when asked a specific question by us, the Governor on 29 November said that: "The European Central Bank has not increased the amount of liquidity at all since the beginning of August." He said: "The Federal Reserve has not raised the total amount of liquidity very much," and then he went on to contrast that with the Bank of England: "The amount of liquidity that we are extending to the banking system is almost 30% higher. Can you explain that apparent conundrum?

  Ms Knight: I will try but I think you will have to redirect most of those questions back to the Governor of the Bank of England. In effect, what we had in the UK was a money market framework which was more constrained than that of the European Central Bank or that operated by the Fed. Thus for a UK bank accessing liquidity there were collateral rules which were much tighter and there was the so-called penal rate, which was not levied elsewhere. Whereas technically liquidity might have been available, it was unattractive to take it because of the costs involved and because of the lack of ability to offer up the broader range of collateral. It is interesting to note that now—in fact today—the market operation that is going to be undertaken by the Bank of England actually does adopt the collateral arrangements that we proposed and reduces the penal rate; it is now as we asked. I think perhaps one last thing to say is this: the BBA has had discussions with our fellow trade associations both in Europe and also in the US because of the differences that were operating in respective money markets and we too were aware that somehow the statistics at the bottom seemed to imply a different story than we were experiencing. We asked the question: what did it look like and how did it feel like for you? The answer that we got from all of them is that it looked like their central banks were standing behind the industry ready to provide liquidity as and when it was needed in a broader way that the UK which was more in line with that which the industry was requesting.

  Q1552  Mr Todd: The FSCS compensation scheme is designed primarily not to deal with the failure of a very large firm. How do we define the limits of what it is supposed to deal with and the apparent liabilities that the state presumably bears for firms that are so large that it cannot cope?

  Mr Coles: The current arrangements are quite clear. The scheme is designed to deal with the loss of up to about £4 billion because that is the maximum amount of money that will be available to be paid out to the depositors of a failing bank after the reforms that have been agreed earlier this year are implemented on 1 April 2008. So anything above £4 billion the Financial Services Compensation Scheme cannot help with. In fact, the current figure would be about £2.5 billion. How do we define how big an institution we want to save beyond that is very much more difficult. If you are looking at Northern Rock that is an institution that has clearly been defined as `too big to fail'. If you are looking at some of the smaller banks or smaller building societies, the actual dividing line becomes very difficult.

  Q1553  Mr Todd: Do you think there is an argument for transparency about where that line lies?

  Mr Coles: Think there are two issues regarding transparency. First of all, should there be an indication to depositors about the size of the guarantee—£25,000 or, as we have in the UK now, £35,000—and the second issue is should there be an indication of the size of the fund that is available to support in the event of a bank failure in relation to the size of the bank. I think that would also be important information for a depositor to know.

  Q1554  Mr Todd: The protection scheme was clearly largely unknown to depositors themselves. Do you think that banks have a clear obligation to display on their products exactly where the guarantee lies and to what extent it is?

  Ms Knight: I think you can actually express that question rather more widely: is there a well-known explanation of the various protections given by the Financial Services Compensation Scheme to the broad range of individuals who engage in a variety of ways with the financial services industry? The answer is that, whilst it is no secret, I do not think that there is necessarily the sort of pulsating clarity which we needed look at now. Certainly so far as the banks are concerned, we have, not surprisingly, had a significant amount of discussion on this and have said to the FSA that we want to engage on this point of explanation. What I also would say though is that the attention has been paid on prevention and I think in this instance we should be looking at prevention. The question is often asked "did individuals understand that there was some deposit protection or not?" Certainly they got the hang of that relatively quickly with the Northern Rock, as we are all well aware.

  Q1555  Mr Todd: I think awareness will be wider now!

  Ms Knight: There is greater awareness now and in one respect that is a good thing because it means that we can play into that awareness with providing knowledge. As I say, we have said to the FSA quite clearly that the banks want to engage on this. We do not just think it is for one part of the industry. We think that there is a broad question that needs to be asked and answered and that is: how do we describe to the individuals how they are protected?

  Q1556  Mr Todd: You listed four elements of a protection scheme that you felt were required. Do you think the scheme does actually meet those four elements of requirement?

  Ms Knight: I think the key to all this is actually speed of payout and I think it is the speed of payout that we need to address. That might require a mixture of scheme rule changes but also might require some legislative changes to allow earlier intervention with a deposit taker that has got into difficulty.

  Mr Coles: I think the speed of payout issue is related to the size of the institution. As I said, if you look at America, they pay out within 24 to 48 hours. If you look at the payments that our own Financial Services Compensation Scheme has made to depositors of credit unions, typically those payments are being made in seven to ten days, so for small institutions we are almost meeting the standards in America. For much larger institutions it is much more difficult.

  Q1557  Mr Todd: Lastly, do you think co-insurance has no great value because it simply muddies the water and confuses the customer as to what extent of risk they are actually bearing?

  Ms Knight: I think co-insurance still does have a place. It is the point at which it start which is worthy of debate. Interestingly, I think it is the Netherlands which has just gone through that discussion (because co-insurance is quite common there) and in so doing they lifted their deposit protection scheme to the equivalent of about £25,000 in full and then over that it was co-insurance up to about the level we are at the moment in the UK. So there is a role but it is the point at which it starts.

  Q1558  Mr Todd: That means that transparency is all the more critical so that people clearly understand what they are buying into.

  Ms Knight: I think this is all part of your earlier question, if I may say, about how we explain.

  Mr Coles: The complexity of the co-insurance is a difficult thing. When we had a limit, apparently, of £31,700, that was extremely difficult to explain to the depositor.

  Q1559  Mr Fallon: Ms Knight, the banks have been extremely profitable in the last few years, yet you have been hiding behind a scheme that nobody really understands and that is not really properly funded. The Chancellor's guarantee for Northern Rock depositors would not have been necessary if we had had a properly funded upfront scheme with notices in every branch in every bank telling people exactly how quickly they can get their money out.

  Ms Knight: Interestingly of course, there has just been a full discussion about the whole of the Financial Services Compensation Scheme and the Deposit Protection Scheme, undertaken by the FSA with the assistance of consultants, and they came up with the current limits and current arrangements that we have. I think the reality is that it is certainly possible to be able to use a deposit protection route for certain sizes of institutions that take deposits, but over a certain amount—and if we look again elsewhere around the world—you are into bigger issues than a protection scheme can properly cater for. On the question of whether it is properly funded, one of the things that we have here in the UK is embedded within the legislation is a requirement, an obligation if you like, on the FSCS to make demands for payments into it when it knows the extent of its liabilities. It is not as if you have a scheme where the industry is asked to put some money in and then everybody goes away for 12 months or whatever. There is a requirement and that is a requirement that has to be fulfilled for the FSCS to make demands from the relevant part of the industry if it requires funds.


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