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How Bank of England plans to prevent SVB-like bank runs

Bank of England LONDON, UNITED KINGDOM - 2022/09/28: General view of the Bank of England in the City of London, the capital's financial district. Bank of England has announced an emergency 65 billion pound bond-buying programme to calm markets. (Photo by Vuk Valcic/SOPA Images/LightRocket via Getty Images)
The Bank of England is considering a major overhaul of its deposit guarantee scheme. Photo: Getty (SOPA Images via Getty Images)

The Bank of England (BoE) is considering an overhaul of its deposit guarantee scheme in the wake of the global banking crisis, including boosting the amount covered for businesses.

Reforms under consideration include raising the amount covered for businesses from the current £85,000 limit, as well as forcing banks to pre-fund the system to a greater extent to speed up payouts, the FT reported.

What is the deposit guarantee scheme?

If your bank, building society or credit union goes bust, you’re entitled to compensation through the Financial Services Compensation Scheme (FSCS).

Under current rules, the guarantee limit is set at £85,000, which covers only about two-thirds of deposits of businesses.

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The FSCS will only pay out its maximum of £85,000 per person for each "authorised institution" or banking group. This means that even if you have different accounts with the same bank, if it goes bust, you’re only entitled to a maximum of £85,000.

Read more: Silicon Valley Bank’s UK arm lost 30% of its deposits in a single day

Some bank brands are owned by a larger bank company. For example, First Direct is owned by HSBC (HSBA.L).

So, if you had £80,000 with First Direct and £10,000 with HSBC, you would have a total of £90,000 with HSBC Bank. That means £5,000 wouldn’t be covered by the FSCS.

However, the rules state that the guarantee is “up to £85,000 per eligible person, per bank, building society or credit union.”

This means that if you have separate accounts across different banks — that do not share the same ultimate owner — that money is guaranteed up to the maximum limit. Also, If you have a joint account, the FSCS deposit protection limit is £170,000.

If a bank or building society fails, FSCS will automatically pay back customers’ money within seven days in most cases. The Deposit Guarantee Schemes Directive allows 10 days to repay money.

Silicon Valley Bank collapse pushes for action

The BoE’s deposit guarantee scheme came under scrutiny recently following the collapse of Silicon Valley Bank (SVB) and its UK arm.

The system has relatively low pre-funding, causing a delay of at least a week for customers to regain access to their cash in case of an SVB-alike event. This undermines the confidence in and thus the effectiveness of the scheme.

Read more: What are your rights when your bank branch closes?

BoE governor Andrew Bailey said last week that the UK central bank was considering improvements to its approach to depositor pay-outs for smaller banks, with a focus on the speed of the pay-outs.

"Going further and considering increasing deposit protection limits could have cost implications for the banking sector as a whole. As with all things relating to bank resolution, there is no free lunch,” Bailey said on Wednesday in Washington where he was attending meetings of the International Monetary Fund (IMF).

He said UK banks were solid and "well capitalised, liquid and able to serve their customers and support the economy".

FDIC representatives Luis Mayorga and Igor Fayermark speak with customers outside of the Silicon Valley Bank headquarters in Santa Clara, California, U.S. March 13, 2023. REUTERS/Brittany Hosea-Small
Customers waited for hours outside of the Silicon Valley Bank headquarters in California to get their money. Photo: Brittany Hosea-Small/Reuters (Brittany Hosea-Small / reuters)

The sudden failure of SVB with assets valued at $212bn, which primarily lent to tech startups, rattled investors. The failed bank was reportedly without a risk management officer for months before it collapsed.

A bank run occurs when customers lose faith in an institution’s ability to look after their money, and large numbers withdraw their deposits all at once.

As more people withdraw their funds, the likelihood of the bank being able to cover the withdrawals falls, leading more customers to pile in and demand the return of their money.

Customers withdrew $42bn in a single day from SVB, leaving the bank with $1bn in negative cash balance, the company said in a regulatory filing.

HSBC Holdings eventually purchased Silicon Valley Bank’s UK business for £1 to contain the fallout and protect the lender’s clients.

The US Federal Deposit Insurance Corp guarantees deposits up to $250,000.

“The American people and American businesses can have confidence that their bank deposits will be there when they need them,” president Joe Biden said in a statement in the wake of the SVB collapse.

The US has already announced a review of its deposit insurance system, something Bailey said could be a problem for smaller UK banks as they "find it harder to issue marketable long-term debt securities that can count as 'eligible liabilities'".

Government to look at levels of protection

UK chancellor Jeremy Hunt said:"We need to look at deposit insurance and keep that under review. If there is a decision [from regulators] that we should increase [the £85,000 limit], it will come across my desk as to how we finance that increase."

Hunt said that raising the limit would require an immediate call on public money as there were currently no reserves to pay depositors quickly like there was in the US.

Read more: UK inflation is 'bad luck', says Bank of England's chief economist

The chancellor said he would defer to Bailey and the Prudential Regulation Authority to decide exactly what the correct limit should be.

“The thing that was most noticeable about Silicon Valley Bank was the speed at which deposits were transferred,” Hunt said.

“Word gets round on social media. And so we need to make sure we are constantly updating our stress testing to deal with situations that might occur.”

A BoE spokesperson declined to comment on the report.

Watch: Banking sector doesn't have a contagion problem: Rubenstein

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