4.3.6 The Financial Services Compensation Scheme (FSCS)
We now reach the last safety net for customers engaged in financial services business – the Financial Services Compensation Scheme (FSCS).
The scheme allows ‘eligible claimants’ to be paid financial compensation in the event of a default by a financial firm. As with the eligible complainants in respect of disputes procedures, the eligible claimants are those who are deemed to be the less financially sophisticated groups of customers of the defaulting entity – so, once again, we see how the regulatory framework is designed to help the most vulnerable participants in the business of financial services. The scheme does not, for example, afford protection to most other financial services firms, governments (both central and local), and large non-financial firms.
Note that the compensation being paid to customers here is in effect the same as an insurance pay-out and normally occurs when the relevant entity has become insolvent. So the ‘insurance’ claims under the FSCS typically (but not exclusively) relate to money placed in savings accounts offered by, and claims on insurance contracts provided by, the defaulting entity. Compensation is also provided in respect of certain protected investment business.
So, to have a legitimate claim for compensation, you must be both an eligible claimant and have a claim in respect of these specific ‘protected’ assets.
From the end of 2010, the maximum sum for protected (‘covered’) deposits under the scheme was raised from £50,000 to £85,000 per person per financial firm. Following the growth in value of the UK pound against the euro, this cover has been reduced to £75,000 from 2016 to align more closely with the €100,000 cover in the eurozone.
The maximum compensation for protected (‘covered’) investments is currently £50,000.
An additional provision of cover up to £1 million is also available to those who temporarily hold large sums in their bank accounts as a result of, say, completion of the purchase or sale of their property. Clearly if a bank defaults at such a point, the outcome would be disastrous for the customer, if only £75,000 of compensation was available.
The compensation arrangements only apply to authorised financial firms, and not to individual brands that the authorised firm uses to conduct through. So if a banking group comprises a number of bank brands that are all covered by a single authorisation, the compensation limit applies against the aggregate of the investments held with the component brands of the banking group. The limit does not apply to each of the component bank brands.
Certainly, savers and investors should be clear not only about which institutions they have placed their money with, but also about whether institutions are part of the same banking group. Additionally, being aware of the particular guarantee scheme that applies to the investments is also essential.
One feature of the compensation scheme is that payments are funded from levies on firms in the same financial group as the defaulting entity. There are eight groups of firms: deposit takers including banks and building societies; life assurance and pension providers; general insurers; general insurance intermediators; life assurance and pensions intermediators; investment firms; investment intermediators; and home finance providers. The levies are proportionate to the size of the firm in each group.
So the compensation bills that arose following the break-up of the Bradford & Bingley bank and from the Icelandic banking crisis have had to be met by other deposit-taking institutions in the UK – including the building societies. If you have a building society account (or if you are a shareholder in a bank), you will be able to check out the costs arising by reviewing the summary financial statements that they send out to customers. Many of these institutions – particularly the building societies – have complained that they are paying the costs for the poor business models and risk management of those failing institutions. Since building societies are owned by their customers (or members) – see the section on building societies in Week 1 – and since banks are owned by their shareholders, the reality is, of course, that these costs are effectively met by these members and shareholders.
So if you are a customer (member) of a building society or a shareholder of a bank that came through the recent financial crisis unscathed, the reality is that you have not entirely avoided the resultant financial costs of the crisis.
Nationwide’s criticism of the FSCS
In May 2009, the Nationwide – comfortably the largest building society in the UK – announced a 69 per cent fall in pre-tax profits to £212 million for its 2008/09 financial year. The then chief executive, Graham Beale, laid a major part of the blame for the fall in profits at the door of the FSCS. The charges levied on other deposit takers, resulting from the government rescue of the Bradford & Bingley in 2008, had hit Nationwide heavily, given that it had to pay into the compensation scheme proportionately to its share of the retail savings market. Nationwide’s large share of this market resulted in a charge by the FSCS of £241 million. The then chief executive said that the basis for the FSCS’s levies was flawed because it penalised conservative, low-risk firms such as Nationwide that used the retail savings market to fund its business more than the riskier wholesale markets.