UK Treasury exempts banks from prefunding deposit assurance scheme

After the failure of Silicon Valley Bank UK’s UK branch in March, British banks were spared the cost of prefunding an insurance scheme for multi-billion pound deposits.

In a Consultation document released on Thursday, the UK Treasury detailed “modest reforms” to strengthen the regime to protect smaller banks from failure and improve resilience in banking.

After the crisis top lenders were preparing for the demands of paying large sums to the deposit guarantee scheme. These funds would be used in the future to reimburse customers if a bank fails.

The Treasury announced a set of measures on Thursday that would “address issues raised in March” without “imposing additional upfront financial costs to banks”.

One of the key proposals was to use the Financial Services Compensation Scheme (FSCS) to fund a failing smaller bank by recapitalising and covering their operational costs.

Treasury stated that the costs “would be funded subsequently through a levied on the banking industry”.

These measures reduce the risk of a run by allowing a bank to continue to operate normally despite its difficulties. Depositors can access their funds as usual, rather than having to wait to receive payment from the guarantee scheme.

The Treasury stated that “this proposal would introduce modest and sensible enhancements to resolution regime, giving the BoE greater flexibility to manage the collapse of a small banking without significant changes to regime itself and avoid new upfront costs for companies.”

When SVB’s parent company, the SVB Financial Group , collapsed Bank of England regulators warned UK depositors of wait times of at least seven days to receive their government-guaranteed deposits, capped at £85,000.
Fears were raised by companies that used their accounts for salaries and bills. The crisis was averted when the government-brokered deal to sell SVB’s UK division for £1 to HSBC was completed.

The larger banks have already access to debt and equity that they can use in the event of failure to recapitalise, making them less vulnerable to deposits rushing to withdraw their money.

Treasury stated that the measures “would reinforce the UK’s robust regulation regime and ensure continued protection for financial stability, public funds and customers when banks fail”.

The Treasury stated that the Prudential Regulation Authority of the BoE, which is the BoE’s regulatory body, will be conducting its annual review of the deposit protection limit in 2025.

The £85,000 limit is in place since 2010. It is similar to the €100,000. However, it is far below the US $250,000 which regulators have suggested increasing.

Some regulators argue that pre-funding a deposit scheme is fairer, as it requires lenders who fail to pay their share of the costs during a healthy period to pay for the system.

The Treasury stated that “the government is open to feedback on alternative funding methods which could help achieve the policy objectives in the long-term. For example, a prefunded approach.”

The BoE welcomed the consultation which will run until 7 March and supported measures that continue to improve the UK bank resolution regime.

Simon Hills, director for prudential policies at the banking lobby group UK Finance said that “the financial system demonstrated its resilience in 2023.” The introduction of a resolution power allowing FSCS recapitalisation financing to a small banks is a practical measure that could boost the system’s resilience.