UK banks: increasing deposit insurance would promote competition

Without conveying a sense of safety, a bank is no longer a bank. That point was underlined when frightened depositors pulled funds from Silicon Valley Bank, Credit Suisse and others. In response, US regulators selectively extended deposit guarantees, amid calls for an across-the-board expansion. The debate reached the UK this week when the Bank of England Governor and the Chancellor raised the prospect of higher limits on deposit insurance.

The current £85,000 level is well below the $250,000 (£200,000) of protection most US depositors receive. Increasing the limit makes sense, given that only about 65 per cent of UK retail and small business deposits are currently covered. Doing so would reduce the amount of funds at risk of flight during times of banking stress. The costs are unlikely to be material to UK bank earnings. A bigger threat may lie in structural changes highlighted by recent crises.

The current UK Financial Services Compensation Scheme (FSCS) is a mutual agreement funded by banks. Charges levied on the UK banks over time cover the shortfall between compensation paid by the FSCS and subsequent recoveries from failed banks.

Recent failures show that bank runs can now occur in hours, not days. Bank governor Andrew Bailey thinks banks might now need to hold higher levels of liquidity. This is pertinent when the Bank of England is unwinding its quantitative easing programme, notes Jonathan Pierce at Numis.

The Bank is trimming its balance sheet and removing cash from the system at a rate of £80bn a year. Next year’s repayment of pandemic-era emergency lending facilities will increase the drain. This will depress liquidity ratios at banks and reduce deposits as gilts are sold back to the private sector.

That could mean greater competition for fewer deposits. Higher deposit insurance might increase this as flight to quality risks fall. The result would be lower net interest margins for banks.