UK financial institution calls for full deposit insurance

Nationwide Building Society, a UK financial institution, answered the question of why was there a run on Northern Rock while calling for full deposit insurance.

As reported by the Telegraph, Nationwide would like full deposit insurance for all financial institutions so as to eliminate the confusion that triggered the run on Northern Rock.

The reason for the run was that Northern Rock depositors knew that their deposits were guaranteed up to a certain level, but were confused over what this level was.

Remember, with deposit insurance, depositors don't care about the performance of the bank.  They only care they can get their money back.

Nationwide Building Society has been lobbying for clearer and more comprehensive protection for depositors for over a year now, and is stepping up efforts ahead of publication of the new Financial Services Bill. 

Under current arrangements, savings are only insured up to a maximum of £85,000 per person per bank or building society. Above that, savers would face losses if the company failed. 

However, Graham Beale, Nationwide’s chief executive, told The Daily Telegraph: “[Protection] should apply to all deposits, not just those less than £85,000.” 

In 2007, confusion over the level of protection sparked the run that brought down Northern Rock, as depositors queued to withdraw their money until the Chancellor promised every penny would be backed by the taxpayer. 

Changes are now being made to the law to enshrine “depositor preference”, which will put insured deposits ahead of other bondholders in the creditor hierarchy to guarantee savers get £85,000 back within days of a bank’s collapse. 

However, Nationwide, the UK’s second largest savings provider with £125bn in deposits, wants the law extended to cover all retail savings to avoid confusion. “The consumer message of full depositor preference is much more powerful and comprehensible,” Mr Beale said.

 Full depositor protection is now implicit based on the government's action in 2007.

The mutual is backed by the Building Societies Association but its position sets it against the banking industry, which does not even back “depositor preference” for the first £85,000. 

Banks claim the £85,000 is protected by the industry insurance scheme so there is no need for a complex legal change that puts other creditors more at risk and may consequently push up banks’ costs. 

“Depositor preference gives customers no added protection and increases substantially the losses of other creditors,” the British Bankers’ Association said in its Parliamentary submission.

It is not surprising that UK banks do not want depositors to have preference.  They know that it is really the taxpayer that is guaranteeing the deposits.

For example, in the US, the FDIC has unlimited ability to draw from the US Treasury to cover losses on its deposit guarantee.

The lack of preference increases the potential for loss on the deposits with the benefit accruing to the other creditors and therefore to the bankers in terms of cheaper funding.  That is why in the US deposit insurance scheme the FDIC has preference over other creditors.