United Kingdom: Financial Services Compensation Scheme

During the GFC, the UK altered its deposit insurance to reassure depositors (FSA 2007c). These changes included the abolition of partial deposit insurance coverage, known as co-insurance, and an increased deposit insurance cap (FSA 2007c; FSA 2008b). The FSCS did not change its coverage of other types of financial institution claims. Claims against insurance companies and investment businesses continued to have a co-insurance element (Edmonds 2010; FSA 2007a; FSCS n.d.).

The UK government took no additional measures following the full guarantee of deposits at Northern Rock in September 2007 and the abolition of co-insurance in October 2007. However, the government planned to pursue further changes to bolster consumer confidence (FSA 2007c). This ultimately led the FSA to review the FSCS’s limits and ultimately increase the guaranteed amount to GBP 50,000 in October 2008 (FSA 2008c).

In October 2008, when UK authorities increased the deposit insurance cap to GBP 50,000, the UK government adopted several additional measures. On October 8, 2008, HMT announced that the UK government would expand its liquidity facilities, making at least GBP 200 million available through the Special Liquidity Scheme (HMT 2008). The government also established a recapitalization facility through which it provided Tier-1 capital to eligible institutions (HMT 2008). Additionally, UK policymakers adopted a credit guarantee of short- and medium-term debt (HMT 2008). For more information on some of these programs, see Lawson (2021), Buchholtz (2021), and McNamara (2020).

The FSCS was established in December 2001, pursuant to the Financial Services and Markets Act of 2000, and replaced five previous compensation schemes (Edmonds 2010; United Kingdom Parliament 2000, pt. XV). As the UK’s regulator, the FSA set the rules for the deposit insurance system (FSA 2008b).

Under the Financial Services and Markets Act, in an emergency, the FSA could change its rules without going through the normal consultation process that the Act required (Edmonds 2010; United Kingdom Parliament 2000, sec. 155[7]). The law specifically said that the FSA may skip its normal procedures “if the Authority considers that the delay involved in complying with them would be prejudicial to the interests of consumers” (United Kingdom Parliament 2000, sec. 155[7]).

As such, on October 1, 2007, the FSA issued a rule to guarantee 100% of deposits up to GBP 35,000, effectively abolishing co-insurance (FSA 2007a). The FSA also issued a rule in October 2008 to increase the deposit insurance limit to GBP 50,000 (FSA 2008a).

The FSCS was responsible for administering the deposit insurance scheme (FSCS 2008b). It was an independent non-profit organization established under the Financial Services and Markets Act 2000 (FSCS 2008b).

A Board of Directors, appointed by the FSA, oversaw the FSCS (FSCS 2008b). Members had overlapping terms to “secure their independence from the FSA in the operation of the Scheme.” The Board had eight non-executive members with broad experience in banking, finance, and accounting; and two executive members: the organization’s chief executive and director of claims. The Chairman of the Board was also subject to HMT’s approval (FSCS 2008b). The FSCS was described as “independent from the FSA, although accountable to it” (FSCS 2008b).

As the UK’s primary regulator, the FSA determined the eligibility criteria and limits of the deposit insurance scheme (FSA 2008b). The FSCS also included an Audit Committee, which was responsible for the organization’s internal controls (FSCS 2008b).

The Tripartite Authorities cooperated with the FSCS to review the UK’s deposit insurance limit (FSA 2008c).

The FSCS was also subject to the UK Parliament, notably the House of Commons Treasury Committee (House of Commons: Treasury Committee 2009c). In its review of the FSCS, the Treasury Committee praised the FSCS for its creativity handling claims, especially in the face of unprecedented depositor claims (House of Commons: Treasury Committee 2009c).

On September 14, 2007, as Northern Rock faced funding difficulties, the UK government issued a public statement saying that it believed that Northern Rock was still solvent (FSA 2007b). FSA officials said it believed that the banking industry would be able “to withstand current market pressures” (FSA 2007b).

Given market uncertainty, the FSA abolished co-insurance, or partial deposit insurance, in the UK (FSA 2007c). This decision was meant to reassure depositors at a time when the banks were facing stress (FSA 2007c).

As financial market distress continued into 2008, the FSCS and the UK government communicated that their interventions appeared to be successful (BoE 2008b). Following the buyout of B&B in 2008, the FSCS and the BoE stressed that the banking system remained robust and that depositors were adequately protected (BoE 2008a). The FSCS emphasized that, following B&B’s failure, it was “business as usual for depositors and other customers of Bradford & Bingley, who need have no concerns about the safety of their money” (FSCS 2008a).

FSCS officials conceded that public awareness of the scheme was low during the crisis, and its independent investigator noted a lack of clarity in its communication with depositors about ongoing claims and claim decisions (FSCS 2009).

Prior to October 1, 2007, the FSCS guaranteed depositors GBP 2,000 in full and 90% of amounts up to GBP 35,000 (FSA 2007c). In total, this guaranteed depositors up to GBP 31,700 (FSA 2007c). This amount would be netted against a depositor’s liabilities to a bank, which led to uncertainties following Northern Rock, as depositors were unaware of their true level of coverage (IADI 2013). As a result of market uncertainty, on October 1, 2007, the FSA eliminated the partial coverage of deposits above GBP 2,000, instead fully guaranteeing deposits up to GBP 35,000 (FSA 2007c).

On October 3, 2008, due to continued financial stress, the FSA increased the deposit insurance cap from GBP 35,000 to GBP 50,000 per depositor (FSA 2008b). This increase took effect on October 7, 2008 (FSA 2008b).

In July 2009, the FSA passed a rule requiring that payouts be made on gross deposits, as opposed to being netted against a depositors’ liabilities (FSA 2009). This change came into effect on December 31, 2010.

On December 17, 2010, the FSCS further increased the deposit insurance cap to GBP 85,000 (FSA 2010). This was in line with other European countries’ EUR 100,000 limit (FSA 2010). The GBP 85,000 cap went into effect on December 31, 2010, and remained in place as of 2022 (FSA 2010; FSCS n.d.).

The FSCS's insurance limits applied to the aggregate amount of claims in each subclass of protected claims, not to each account. For example, an individual with multiple deposit accounts would only be insured up to GBP 35,000 (as of October 1, 2007) for all of their deposits at a bank. But an individual with money in both a deposit account and an investment account at the same bank would receive protection from different schemes. The deposit account would be covered by the GBP 35,000 guarantee on bank deposits; the investment account would be covered by 100% of the first GBP 30,000 and 90% of the next GBP 20,000, the limits that applied to investment accounts (Edmonds 2010).

The financial services industry funded the FSCS through fees (FSA 2008b). Historically, UK law did not allow the FSCS to maintain a standing deposit insurance fund (FSCS 2009). Rather, the FSCS was required to estimate its expected obligations for the fiscal year and then charge authorized institutions accordingly (FSCS 2009). Financial institutions were divided into subclasses, upon which fees were levied (FSCS 2010). If the FSCS ran a surplus, repayments would be made to authorized institutions (Edmonds 2010).

Given the magnitude of the failures during the GFC, the FSCS required loans from the BoE and HMT (FSCS 2009). The BoE provided the FSCS with a short-term loan in response to the failures of B&B, Heritable, KSF, Icesave, and London Scottish (FSCS 2010; House of Commons: Treasury Committee 2009a). The principal owed to the BoE totaled GBP 20.46 billion (FSCS 2010). When HMT refinanced the loan, the principal was reduced to GBP 19.99 billion (FSCS 2010). The loans were made on an interest-only basis for the first three years, with the interest calculated at the 12-month LIBOR plus 30 basis points (FSCS 2010). To repay these loans, the FSCS levied additional fees on the deposit-taking subclass of institutions (FSCS 2010). In 2009, the FSCS levied a fee of GBP 406 million to cover the loan interest from 2008 to 2010 (FSCS 2010).

The FSCS expected to repay the principal of the loan by 2012 (FSCS 2010). By March 2016, after the FSCS’s loans were refinanced, all loans had been repaid, except those associated with the failure of B&B (FSCS 2016). The remaining balance was paid off by 2018 (FSCS 2018).

Since Iceland only protected Icelanders’ deposits in the GFC, the FSCS paid out UK depositors at Icelandic bank subsidiaries in the UK (FSCS 2010; Haarde 2008). The UK later pursued legal action to reimburse the government, in what became known as the Icesave dispute (J&S 2016). The European Free Trade Association Court ruled that Iceland did not have to repay foreign governments, but that foreign governments had first priority to Landsbanki’s estate in January 2013 (J&S 2016). The estate made its final payment in 2016 (J&S 2016).

The FSCS covered depositors who held deposits in authorized firms, including banks, building societies, and credit unions (FSCS 2008b). As the UK’s regulator, the FSA was responsible for determining the eligibility criteria for the FSCS’s scheme (FSA 2008b). The October 2007 rule change did not apply to depositors whose institution was in default before October 1, 2007 (FSA 2007a).

The FSCS guaranteed deposits held with eligible institutions, including foreign currency deposits (FSCS 2010; FSCS 2008b). The coverage did not include electronic money (FSA 2008c).^F“Electronic money” included “monetary value, as represented by a claim on the issuer, which is: (a) stored on an electronic device; (b) issued on receipt of funds; and (c) accepted as a means of payment by persons other than the issuer” (FSA 2008c). Years later, the FSCS’s coverage was extended to all businesses, apart from a few exceptions, including the deposits held by financial institutions and governments, following another EU Directive (Directive 2014/49/EC 2014).

The FSCS was not allowed to have a standing deposit insurance fund (FSCS 2009). Rather, the FSCS estimated its obligations for a 12-month period and then charged a levy on eligible institutions (FSCS 2009). If the FSCS ran a surplus, repayments would be made to authorized institutions (Edmonds 2010).

These annual fees were based on the type of institutions, which were divided into five subclasses: deposit, general insurance, life and pension, investment, and home finance (FSCS 2010). Institutions were placed into their relevant subclass depending on the type of service that the FSA had authorized them to conduct (FSCS 2010). Institutions could fall into more than one subclass (FSCS 2010).

All subclasses contributed to the FSCS’s base costs, which were proportional to the fees these institutions paid to the FSA (FSCS 2010). Costs associated with assessing claims and making payments were charged to a relevant subclass, as opposed to all institutions covered by the FSCS (FSCS 2010). There was an annual limit for these subclass-specific fees, after which the FSCS noted it was unfeasible for a single subclass to bear the compensation costs (FSCS 2010). When this limit was reached, the fees were shared more generally by the pool of FSCS-insured institutions (FSCS 2010). This model supposed that a subclass’s levies would meet the compensation required from that subclass’s defaults, up to a certain threshold (FSCS 2010).

To fulfill its obligations during the GFC, the FSCS borrowed money from the BoE and HMT (FSCS 2009). In July 2009, the FSCS announced an additional levy on the deposit-taking subclass of institutions to cover the interest on these loans (FSCS 2010). The annual levy totaled GBP 406 million, which covered the interest accrued from 2008 to 2010 (FSCS 2010). The FSCS expected to repay the principal of the loan by 2012 (FSCS 2010). By March 2016, after the FSCS’s loans were refinanced, all loans had been repaid, except those associated with the failure of B&B (FSCS 2016). In 2017, HMT authorized a GBP 11.8 billion sale of B&B loans, which generated a GBP 11 billion repayment for the FSCS (FSCS 2017). The remaining balance was paid off by 2018 (FSCS 2018).

The FSCS guarantee would be activated if an institution was unable to fulfill its depositor redemptions or if the FSA believed that an institution would be unable to meet its obligations (FSCS 2008b). The FSCS would then pay depositors up to the given deposit insurance cap (FSCS 2008b). The FSCS would then liquidate the failed institution’s assets, with its proceeds repaying the FSCS (FSCS 2008b). House of Commons staff said that the “sheer scale of payments required overwhelmed” the FSCS during the GFC (Edmonds 2010). In its 2008–2009 annual report, the FSCS also noted that some depositors experienced delays during the payout process (FSCS 2009). The FSCS attributed such difficulties to challenges obtaining comprehensive depositor information (FSCS 2009). The FSCS’s Independent Investigator further highlighted these delays and the lack of clear correspondence with depositors about the progress of a claim or specific decisions about a claim (FSCS 2009). The FSCS addressed these challenges in its 2009-2010 annual report, saying that it would target payouts within “seven days and in no more than 20 working days” beginning in January 2011 (FSCS 2010).

Other than fees, there were no additional conditions associated with the FSCS’s guarantee.

The deposit insurance increase to GBP 50,000 was meant to be permanent (FSA 2008b). However, in 2010, UK authorities increased the deposit insurance cap again to GBP 85,000 to match the guarantee provided by countries in the European Economic Area (EEA) (FSA 2010). As of 2022, the deposit insurance limit in the UK stood at GBP 85,000 (FSCS n.d.).