Memorandum from the Financial Services
Compensation Scheme (FSCS)
1. This memorandum is submitted to the Committee
as part of its inquiry into the Banking Crisis and in advance
of the FSA and FSCS evidence session on 25 February.
2. This memorandum covers the role played
by FSCS in responding to recent banking failures, including:
the FSCS response to the crisis;
the compensation dimensions of each
bank default, including the costs of each;
financing the compensation payouts;
recoveries and the position of FSCS
as a creditor; and
strengthening the compensation framework.
THE FSCS RESPONSE
3. The current financial crisis has generated
unprecedented demands on FSCS. Since 27 September 2008, five banks
have been declared in default by the FSA. Bradford and Bingley
plc was the first, declared on 27 September 2008, closely followed
by Heritable Bank plc, Kaupthing Singer and Friedlander Limited
and Landsbanki Islands hf (Icesave) on 7 and 8 October. London
Scottish Bank plc went into default on 30 November. The declaration
of default has triggered FSCS protection in each case.
4. To put the size and nature of the increased
demands on FSCS in context, it is worth noting that in the seven
years from its inception in December 2001 to September 2008, FSCS
had paid out just over £1 billion in compensation on its
own behalf mainly relating to insurance and investment failures.
In the five months since September 2008, FSCS has already paid
about £20 billion for the five bank defaults, largely on
its own behalf but in part on behalf of H M Government (HMG) and
in respect of the liability of the Icelandic Deposit and Investors
5. The compensation was paid to protect
the holders of approximately 3 million bank accounts, and has
involved three bulk account transfer payments, and the processing
of more than 200,000 individual claims so far. These volumes stand
in stark comparison with the previous year, in which FSCS received
16,490 claims. They demanded that FSCS take a new approach to
compensation within the context of the Banking Special Provisions
Act and also in responding to failures across jurisdictions.
6. In relation to each default, FSCS has
a primary obligation to ensure that those entitled to compensation
from FSCS receive it as soon as possible. FSCS is also required
to ensure that it secures such recoveries for levypayers as are
reasonably practicable and cost effective to pursue. Each of the
defaults has been different and has required a different response
from FSCS: these are detailed further below.
Bradford and Bingley plc
7. FSCS contributed £14 billion to
the cost of transferring the retail deposit book to Abbey on 29
September 2008, pursuant to an Order made by H M Treasury (HMT)
under the Banking (Special Provisions) Act 2008. This gave depositors
complete continuity of banking services in relation to 2.5m accounts,
without having to engage individually with the compensation process.
8. The £14 billion payment represented
an estimate of the gross cost of compensation, had FSCS processed
individual claims from all the bank's customers in the normal
way. That cost is now being validated by FSCS and the results
will determine whether or not there is more for FSCS to pay or
a refund to FSCS to be made.
Kaupthing Singer and Friedlander Ltd (KSF)
9. KSF is a UK subsidiary of an Icelandic
bank, Kaupthing, and went into administration on 8 October 2008.
FSCS contributed £2.5 billion to cover the cost of transferring
the firm's 157,000 online accounts, known as Kaupthing Edge accounts,
to ING. This amount paid is subject to a validation exercise,
similar to that being carried out for Bradford and Bingley.
10. In addition, FSCS is also handling individual
claims for compensation in respect of KSF accounts not transferred
to ING. So far, over 4800 claims have been received and are being
processed as quickly as possible. In excess of £27 million
has now been paid in compensation in respect of the non-Edge accounts.
11. A claimant entitled under FSA rules
to FSCS protection will be entitled to up to £50k from FSCS.
HMG has agreed to pay such claimants compensation for losses above
£50k and FSCS is administering those payments on HMG's behalf.
Heritable Bank plc
12. Like KSF, Heritable is a UK subsidiary
of an Icelandic bank, in this case Landsbanki, and went into administration
on 7 October 2008. The position is very similar to KSF but on
a smaller scale: 22,000 accounts were transferred to ING at a
cost to FSCS of £0.5 billion and FSCS is currently processing
claims for the remaining eligible claimants. Approximately 350
manual claims have so far been received. Again, FSCS is paying
compensation as required under FSA rules, and is administering
top up payments for HMG for amounts over £50k to those entitled
to FSCS protection. Sums paid in respect of accounts not transferred
to ING amount to about £7 million.
13. The default of Icesave on 8 October
has presented the biggest operational challenge for FSCS. Icesave
was the UK internet branch of Landsbanki, an Icelandic bank with
an EEA passport. The bank had "topped up" into FSCS,
meaning that the Icelandic Deposit and Investors Guarantee Fund
is liable for the first 20,887 of any claim, and FSCS for
the amount above that to the UK limit of £50k.
14. As reported in the media at the time,
the Icelandic fund did not step forward at the point of failure
to receive claims in respect of Icesave. In the event, FSCS stepped
in with HMG to make sure that the 214,000 people with money deposited
in the UK branch of Icesave could receive compensation.
15. FSCS developed and put an online claims
system based on the Icesave internet banking platform into effect
in November and more than 190,000 people successfully transacted
electronically using this quick web-based process.
16. The remaining customers have made manual
claims. Over 17,000 payments have been made to them so far and
further payments will follow as quickly as possible. Most outstanding
claims are not due for payment at this time, as they relate to
fixed term deposits which have not yet matured. A total of £3.7
billion has so far been paid in compensation for this default.
London Scottish Bank plc
17. This bank failed on 30 November and
is in administration. It had approximately 9,500 people all holding
either fixed term deposit or notice accounts worth over £0.27
billion. Over 9,000 individual claims have so far been received,
and the vast majority of claimants are now being paid shortly
after the maturity date of their deposits. Eligible claims below
£50k are being met by FSCS, and FSCS is acting as HMG's agent
in paying eligible claims to the extent that they exceed the FSCS
Financing the compensation payments
18. As the Committee will be aware, FSCS
does not maintain a large standing fund to meet claims when need:
pre-funding is not permitted under current legislation. Rather,
FSCS raises levies each year to enable it to meet its anticipated
obligations in respect of compensation costs in the following
12 months and to meet management expenses in the current financial
year. FSCS can raise additional levies at any point, as necessary,
subject to the Management Expenses Levy Limits and levy limits
for compensation costs fixed by FSA rules. FSCS can also use recoveries
from a failed firm to reduce the levies it needs to raise. We
say more about recoveries below.
19. In relation to the five defaults, FSCS
originally borrowed the necessary funds through separate short-term
facilities from the Bank of England (BoE) and (for London Scottish)
from HMT. The BoE facilities have since been re-financed with
longer term loans from HMT.
20. All the loan facilities are on an interest-only
basis for the first three years, with the interest rate set monthly
at 12 month LIBOR plus 30 basis points during this period. FSCS
will pay interest in arrears, with interest for the period to
31 March each year being payable on 1 October of that year. So,
for the period to 31 March 2009, interest will be payable by 1
October 2009, and so on.
21. Having taken due account of the potential
impact on deposit takers of current and future FSCS levies, the
Authorities have agreed that the total amount levied to meet interest
and other operational costs arising from the five defaults will,
in the next three years, not exceed £1 billion per annum.
Any interest costs above this cap will be waived by HMT rather
than recharged later. This means that levies in the first three
years for the five defaults will fall on the deposit-taking class
of levypayers only.
22. Principal of the loans will only become
payable in the first three years to the extent that FSCS receives
any recoveries from the estates of the failed banks. Otherwise,
FSCS will begin the repayment of principal in three years' time,
to a repayment schedule to be agreed with HM Treasury in the light
of prevailing market conditions at that time.
23. Bradford and Bingley continues to operate
in solvent run-off in respect of its pre-existing mortgage book.
As a significant creditor of the Bradford and Bingley estate,
FSCS is entitled to a substantial portion of the recoveries. The
Order under which FSCS payment was made stipulates that FSCS should
be no worse off in relation to recoveries than if Bradford and
Bingley had been placed in liquidation. FSCS is in dialogue with
HMT about how the estate will be run down and expects to review
regularly the progress of Bradford and Bingley's business plan
with HMT with a view to ensuring appropriate returns for the FSCS
24. For Heritable, KSF and London Scottish,
FSCS is playing a major role on the creditors committee, working
with Ernst and Young the administrators to ensure the best possible
recoveries for the insolvent estates, and FSCS as principal creditor.
25. Landsbanki is in a special process in
Iceland but is not following the usual Icelandic insolvency process.
FSCS is working to ensure that the maximum possible recoveries
26. All these recovery processes are likely
to take several years to complete.
Strengthening the framework
27. FSCS has been working very closely with
the Tripartite Authorities to develop a stronger framework to
deal with banks in difficulty and to deliver compensation to depositors
if a firm goes into default. The events of the past few months
have demonstrated the importance of that work, the legislative
reforms which are now making their way through Parliament and
the rule changes on which the FSA is currently consulting. Some
of the key elements are set out below.
28. Compensation by deposit transfer:
The Banking Act 2009 enables FSCS to continue to make compensation
payments by funding deposit transfers as applied in Bradford and
Bingley, and in part in KSF and Heritable. This spares the need
for individual applications and can help deliver continuity of
29. Funding: Access to Government
funding enables speedier payments to be made than could be achieved
through the levying process. The provision in the Banking Act
2009 to allow FSCS access to the National Loans Fund will smooth
the operation of the current short term funding arrangements still
further in future. The Banking Act 2009 allows pre-funding to
be introduced and we will work with the Authorities to consider
whether changes to the current funding arrangements are desirable.
30. Proposals to facilitate compensation
payments within seven days. The current FSA proposals are designed
to make the compensation process quicker than has been possible
on recent defaults. Although there is a package of reforms all
of which are important to speeding up payout, the most crucial
is the one which requires deposit takers to maintain a single
customer viewie complete, accurate and up to date data
about how much each eligible customer is owed. The FSA is consulting
on rule changes for this purpose now and FSCS will invest over
the next 18 months in systems changes designed to ensure that
bank data can be uploaded smoothly into FSCS systems in the event
31. Inter-agency liaison: A close
working relationship is required between FSCS and the Tripartite
Authorities when firms appear to be vulnerable to real difficulty.
Existing arrangements between FSCS and the Tripartite Authorities
are being updated to reflect changes resulting from the Banking
32. At the European level, the Icesave experience
demonstrates that the current topping up arrangements under the
Deposit Guarantee Schemes Directive can be problematic in practice.
We continue to work with the Tripartite Authorities and our European
counterparts to address the challenges presented by the current
33. Greater consumer awareness: the FSA
is consulting on rules to require firms to make clear disclosure
about the compensation status of their accounts. In addition,
FSA and FSCS will be working together with the industry to increase
consumer awareness and understanding of the Scheme.
16 February 2009