Financial Services Compensation Scheme FSCS: Investor Protection

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So just how safe are your private savings in your local high street bank or building society?

As recent events have shown, the UK Government did not allow any major bank or building society to fail.

As long as you stick to the major banks and building societies your money should be safe.

But, in the past, smaller UK banks have been allowed to fail. Six went bust in 1990-1991 alone. These included:

• BCCI
• British & Commonwealth 
• Edington and Chancery.

So beware!

Going for an extra ¹/₂% return could cost you dearly if you do not take advantage of the UK rules surrounding the FSCS - the Financial Services Compensation Scheme. 

'Moral Hazard' is the concept that when things go wrong a penalty must exist for those who take higher risk in anticipation of higher return.

It is this concept that means I have no sympathy for those unfortunate people who placed their savings with offshore banks, such as those of Iceland.

Suppose the Government guaranteed all deposits in every type of Financial Institution: depositors would rush to get the highest return, whatever the risk.

The result: the sensible investor who stayed with lower-return, lower-risk investments would end up subsidising the reckless investor who placed his money for maximum return, regardless of risk.

That's why no Government would, or should, give an across-the-board complete guarantee of all depositors' money.

The UK Financial Services Compensation Scheme (FSCS) is but one financial compensation scheme, worldwide. It is a Financial Services Authority (FSA) compensation scheme. It has been in place for some time and was strengthened in October 2007 following the Northern Rock crisis.

Before that, 100% of the first £2,000 of deposits, and 90% of the next £33,000 were protected.

On 1st October 2007, it was extended to cover the full amount of the first £35,000 per UK bank, building society or credit union, per customer.

Since 7th October 2008, the threshold has covered the first £50,000 per bank, building society or Credit Union.

However, only net deposits are covered.

This means that if you have £50,000 deposited and also have a £20,000 loan with the same bank, then only the net amount of £30,000 would be compensated.

Any informed investor should ensure that any loan is with a bank etc., that does not hold their savings.

They should also split their deposits between different banks, building societies etc., so that no more than £50,000 is held within any one institution.

Married couples should seriously consider splitting any joint accounts, with more than £50,000 balance, so that there is no reason, in the future, for a Government to determine that a joint account is one customer and not two.

From 31 December 2010, 100% of the first £85,000 of deposits, per person per firm, is covered. 

The FSCS scheme was strengthened because of the recent banking crisis.

• Northern Rock and Bradford and Bingley managed to get themselves into such liquidity problems that they were effectively taken over by the Government - with our money.
• HBOS merged with Lloyds because of the difficulties they had got themselves into.
  Unfortunately for Lloyds this caused them difficulties in turn - to the extent that the Government had to loan to these two institutions a total of £20billion. 
• Royal Bank of Scotland (RBS) also fell foul of their investments in sub-prime US mortgage loans and had to go begging to the Government for £20billion themselves. 

All this was underpinned by our tax pounds.

But you will note that none were allowed to actually go bust.

The track record of building societies is better.

No depositor has lost money in recent times.

When a building society has found trading conditions adverse to their capabilities, they have been swallowed up by their larger competitors.

But again there is no guarantee that this will always happen in the future.

The Dunfermline Building Society fell fowl of the banking crisis in 2007-8 and its good assets were transferred to Nationwide. However, the Dunfermline was then put into administration so that its bad debts could be monetised over time.

The Financial Services Authority regulates the financial services industry, which includes banks and building societies. 

Real risk does exist in the banking system.

It provides the element of 'moral hazard' essential if the wise are not to be penalised by being forced to bail out the foolish.

So stick to the tried and trusted names on the high street.

And don't be tempted by higher returns offered by offshore banks, unless you are prepared to accept the risks that this strategy involves. Investor compensation is not about protecting the foolhardy. The FSCS is about ensuring the average investor is protected should a financial institution default on its obligations.