Deposit Guarantees: Does it matter what the actual level is?

On the last day of the year, the Telegraph confirmed one of the central elements of this blog's blueprint for saving the global financial system.  Specifically, it confirmed how depositors view deposit insurance.

The Telegraph ran an interesting article showing that four out of five UK depositors don't know the compensation limits for the government's deposit guarantee program.

Why should they given that in times of financial crisis, policymakers extend the guarantee to cover all deposits?

What makes the article interesting is that it highlights the difference between the implied 100% deposit guarantee -- if there is a crisis, no depositor will lose money -- and the actual level of deposit guarantees.

The bottom line is that depositors assume a 100% guarantee.

Since the Great Depression and the introduction of deposit guarantees, there has been an implied 100% deposit guarantee in times of financial crisis.  As FDR said in his March 1933 fireside chat following the US bank holiday, it is safer to put your money in a bank than into your mattress.

In point of fact, since then governments have acted as if there is a 100% deposit guarantee.  Just look at what happen at the start of the financial crisis in 2008/2009.  Global policymakers pledged the full faith and credit of the government in the form of blanket deposit protection.  Case in point, Northern Rock in the UK.

Compare and contrast this with the actual level of deposit guarantees.  Deposits above this level are at risk to the solvency of the financial institution if the institution is not considered Too Big to Fail.

The reason for talking about implied versus actual level of deposit guarantee is to highlight how depositors already assume they are covered.  This is one of the reasons that the Eurozone banks have not experienced a major run on their deposits [if depositors think their money is protected, they don't care about the bank's balance sheet].

Requiring banks to provide ultra transparency and disclose on an ongoing basis their current asset, liability and off-balance sheet exposure details, would reveal all the bad debt in the financial system.  Once revealed, this bad debt can then be addressed.

At the same time, depositors already assume they are protected, so the banks can continue to operate with significant negative book equity.

One year after its introduction, only 21pc of consumers are aware of the compensation limit for deposits and savings, new research by the Financial Services Compensation Scheme (FSCS) shows. 

On 31 December 2010 new rules were introduced across Europe which increased compensation limits to €100,000 (£85,000). Despite the uncertain climate, four in five of those questioned were not aware the limit was £85,000, with 45pc admitting they didn't know it. However the awareness level of 21pc is up from the 17pc of people who knew the improved limit ahead of it coming into operation a year ago. 

Last week, the Financial Services Authority stepped in to ensure that all banks, building societies and credit unions prominently display how much compensation savers could claim in the event of an institution failing. 

Ever since the Northern Rock debacle in 2007, savers have feared that their life savings could be in danger if a bank collapsed. Yet, despite these fears, many are still in the dark on the compensation scheme and how their money is protected....

Mark Neale, chief executive of the FSCS, said:"The £85,000 limit is good news for every saver in the country, with 99pc of accounts now covered. Although there have been no high profile failures over the last 12 months it is important for financial stability that savers are aware of the protection that is available to them. 

"As only those financial institutions authorised by the FSA are covered by the FSCS guarantee it is vital that customers check their financial products are safe and remain within the limit. Although the industry has made significant progress in the information it provides to consumers about the FSCS, there is still much more to do. 

"What is more, the FSCS can now undertake to return money to most savers in seven days of a failure. So not only will no one lose a penny of protected, deposits up to the £85,000 limit, people can also count on getting their money back quickly." 

The importance of knowing the limit was exposed in 2011 as a small number of depositors with a failed institution had funds over the protected limit but only received £85,000 from the FSCS.