Bank of England looks to broaden reform of deposit guarantee scheme

The Bank of England is proposing to broaden reforms of its deposit guarantee scheme to better protect depositors in failing smaller banks after March’s collapse of Silicon Valley Bank’s UK arm highlighted significant weaknesses in the existing regime, according to people familiar with the situation.

The BoE was forced to warn UK customers with total balances of £6.7bn that they faced a week-long wait for their cash, as well as potential losses on balances of more than £85,000 after US regulators shut down SVB. In contrast, US depositors were reassured they could access all of their money straightaway.

The British approach provoked a fierce backlash among tech companies who dominated SVB UK’s client base and said they needed the money to pay bills. A crisis was ultimately avoided after HSBC stepped in almost immediately to rescue the UK business.

The potential for depositor losses spooked politicians and BoE officials, prompting the central bank to announce a review of the UK’s deposit guarantee scheme, known as the Financial Services Compensation Scheme.

The BoE’s initial work focused on raising the £85,000 insurance threshold in the UK, which is far below the US equivalent of $250,000, and ensuring more pre-funding of the FSCS so that depositors could get their money instantly rather than having to wait weeks.

But two people familiar with the BoE’s deliberations said officials were now proposing a broader review of how bank insolvencies were handled, which could see the FSCS used to stabilise smaller banks that did not hold the loss-absorbing capital that buffets depositors at bigger banks from losses.

Under the proposals, the FSCS could advance capital to a failed bank so that it would remain solvent until it was sold or shut, the people said.

That would then give the BoE comfort to lend money to the bank so it would have the liquidity to honour withdrawals from depositors, one of the people added, reducing the chances of a bank run.

The proposals, which were outlined by BoE governor Andrew Bailey in a virtual meeting with chancellor Jeremy Hunt in recent days, would also allow any defaults on loans from the central bank to be charged back to the FSCS.

A second person familiar with the situation told the Financial Times that these were “long-term plans” under consideration. The Treasury would consider the plans in more detail before advising ministers, the person said, adding “more widely we obviously support the [BoE] in its role to bolster financial stability”.

The BoE has not given any timescale for the deposit scheme review. Hunt and Bailey are due to meet again on June 6.

The additional cost of bearing the losses on money loaned to a failed bank is likely to prove unpopular in the financial services industry, which is already unhappy about having to fund the FSCS upfront. The UK’s building societies lobby group has described the cost of reviewing the deposit scheme as an “extra tax” that could reduce lending.

The government and the BoE declined to comment.