Time to fix the plumbing: Improving the UK framework following the collapse of Northern Rock

Abstract

The crisis surrounding Northern Rock plc raised a number of issues and revealed major failings surrounding the financial safety net and the state of depositor protection. In response, the UK Authorities issued a Consultation Paper entitled ‘Financial stability and depositor protection: strengthening the framework’. It contained recommendations to enhance depositor protection arrangements but it was only the first step in what will be a long process of needed reforms. This paper proposes that the mandate of the Financial Services Compensation Scheme Limited (FSCS) be revamped in two very important areas. It is recommended that the FSCS become an independent agency with a risk-minimiser mandate, backed by the government, with the authority to assess and collect tax-deductible premiums based on the risk profiles of its members. The restructured FSCS would report to Parliament through the Chancellor of the Exchequer and it would have the mandate and the powers to promote the stability of the financial system through the provision of effective depositor protection. It would also have access to all regulatory and supervisory information, would have the authority to act independently of the Financial Services Authority to effect bank resolutions, and would be accountable for its actions. Supplying the FSCS with the recommended mandate will provide a needed ‘check and balance’ in the UK financial system safety net. In particular, the exposure of taxpayers will be greatly reduced because the FSCS would be mandated to find least-cost resolutions in a manner that contributes and promotes the stability of the financial system. To improve the public's understanding of the benefits and limitations of deposit protection, it is proposed that the FSCS be further mandated to develop and implement a public awareness programme. The objectives of the programme would be clearly set out and would be consistent with the stated public policy objectives of the UK Government. Since considerable guidance in this area has been provided by the International Association of Deposit Insurers (IADI), it is recommended that the Authorities also undertake an evaluation of the system of deposit protection through an assessment using all of the 21 IADI Core Principles.