25 September 2008

Guidance on the security of bank deposits


David Dannreuther
Partner | UK

Usual Position

When funds are deposited with a bank or building society ownership of the money passes from the depositor to the bank. The bank does not hold the money on trust. The bank simply owes the depositor a contractual duty to repay the depositor his money. In the event of a bank's insolvency the depositor is an unsecured creditor and may not be able to recover all or any of the funds he deposited.

Am I given any protection in the event of my bank going insolvent?

When a bank becomes insolvent the protection that deposit holders receive is limited. In the UK there is a statutory scheme known as the Financial Services Compensation Scheme (the 'FSCS') which offers some safeguards. This protects up to £35,000 per person. This is regardless of how many accounts you have with the bank or whether you are a single or joint account holder. However, if you are a joint account holder, the FSCS assumes you hold the money equally and, therefore, each account holder has an individual claim up to £35,000 on the money held in the joint account. The claim will have any debt owed by you to the bank set-off against it.

The FSA has recently stated that they are considering increasing the limit to £50,000 on the same basis.

Does every depositor get this protection?

No. The depositor must be either an individual, small company or trust. Guidance suggests that small companies would be those able to meet two of the following conditions:

  • that turnover is not more than £6.5 million; 
  • the company's balance sheet total is not more than £3.26 million; and 
  • the total number of employees is not more than 50.

Larger companies do not qualify for this protection.

What if I have different accounts with a number of banks in one banking group?

This depends on the FSA authorisation of each individual bank. If all the banks in the group are individually authorised then you are protected up to £35,000 per bank with which you hold one or more accounts. If all the banks in the group take their authorisation through the parent bank then, no matter how many accounts are held within the banking group, you are protected only to a single total of £35,000.

Is there any way for me to receive more money back if I had over £35,000 with a bank?

It is only the initial £35,000 which is protected. For deposits in excess of this the only other way in which money could be recovered is the normal insolvency process. This can be a long, drawn-out affair and there is no guarantee you will receive anything at all from the winding up of the bank.

What if my bank is a UK branch of a European bank?

Each European Economic Area country is required to put a deposit protection scheme similar to the FSCS in place. You would be able to claim under the appropriate country's scheme. If that scheme's maximum protected amount is below that of the UK's, the FSCS will make up the difference if the bank in question has elected to join the FSCS.

The FSCS does not apply to deposits held in the Channel Islands or the Isle of Man.

What would I do if I wanted to make a claim?

The FSCS would send a claim form to each customer of the insolvent bank to bring a claim. The FSCS would aim to process all claims within six months from the bank's declaration of insolvency.

What about my deposits in banks abroad?

The UK position is mirrored in the US with the Federal Deposit Insurance Corporation which offers compensation up to a limit of $100,000 per person.
In Switzerland there is no comparable compensation scheme. However, the Swiss banking law provides that banks cannot lend out more than 50% of the amounts deposited. In addition, Swiss bankruptcy law provides for privileged status to CHF 30,000 per person the result of which is to make such compensation virtually guaranteed up to that amount. By law, these payments must be made within 90 days of the closure of the bank. However, these payments are restricted to a combined maximum that can be made in relation to any one bank of CHF 4billion. If this will not be enough to cover all claims, each claim is given a corresponding proportion of the CHF 4 billion.
It is recommended that you seek further specific advice about your foreign bank deposits.

Is there anything else I can do to protect my money?

There are a number of strategies one could adopt to minimise your bank deposits' exposure to the risk of insolvency.

The FSCS upper limit of £35,000 only applies to cash deposits. Insurance and Pension products enjoy a much greater level of protection. The FSCS will refund 90% of the value of certain types of these products (such as guaranteed growth bonds) in the event of insolvency. Investing in these would provide greater security.

Secondly, one could invest in 'AAA' rated money market funds. These are typically units in authorised unit trusts or other regulated collective investment schemes which invest in a number of different cash and near cash investments to minimize the risk of any particular institution becoming insolvent. Regulated schemes are subject to detailed regulatory provision on risk-spreading.

Thirdly, one should consider a deposit taking institution more closely to determine its financial position. Northern Rock's problem arose from lending more funds than it had on deposit and so having to borrow money. Some banks have adopted more cautious strategies. For example, some banks have confirmed to us that they only lend out up to 50% of their total deposits and as such are unlikely to find themselves in the same position as Northern Rock.

Fourthly, one could utilise a bank custodian. Where the bank is custodian, it assumes responsibility for the safekeeping and administration of deposits. The custodian can also hold equities, bonds and other securities. A custodian will often take out collateral to cover the credit risk of its deposits. This means that in the event of the bank holding the deposits becoming insolvent, the custodian bank will have a proprietary right to the collateral. This will enable the custodian to repay the depositor in full. In this way, a second layer of protection is given to the deposit, which would now only be at risk if both the custodian and the collateral giver became insolvent. Generally the custodian will hold clients' assets on the basis that they are segregated from its own assets, but this will need to be checked by reference to the relevant custodian agreement.

Finally, one could create a trust over cash deposited with a custodian bank acting as trustee. This would result in the segregation of the deposited money into a separate account over which a trust is created by the custodian in favour of the depositor. By virtue of the trust the depositor has a proprietary right over the segregated funds. This means in the event of the custodian's insolvency the segregated funds will be safe and the deposit will not be lost. If the money were lost due to the insolvency of the fund holding bank the depositor will have an action in breach of trust against the custodian. This may allow them to recover the deposited fund.

However, custodian accounts are expensive to establish and run and so are only economically viable for funds over £10 million. Furthermore, the greater protection given to the money by the trust means a lower rate of return on the fund.

David Dannreuther Partner | London

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