Why big savers may be at risk

The government-backed safety-net for cash deposits has three large holes in it...

The financial crash of 2007/09 showed just how risky investing can be.

After the UK stock market peaked in mid-June 2007, it almost halved. In fact, London's leading stock-market index, the FTSE 100, nose-dived by 48% within 21 months. (Read The scary truth about shares to find out more.)

Also, property values suffered during the credit crunch and economic downturn. At its peak in August 2007, the average UK home cost £199,612, according to the Halifax House Price Index. By April 2009, this had slumped to £154,663, a fall of 23% in 20 months.

Safe, secure savings

During the worst global downturn since the Thirties, almost no assets escaped unscathed. The obvious exception was cash, which rode out the crash in its usual steady-but-dull fashion.

Although savers didn't lose any of their capital during the downturn, the buying power of their cash has been eroded by inflation (the rising cost of living). In the four years to June 2011, the Retail Prices Index (RPI) measure of inflation rose by 13.5%. In other words, it takes £113.50 of today's money to buy goods costing £100 in June 2007.

Thus, unless your savings have grown by 13.5% after tax over the past four years, then they can buy less today than they could in June 2007. Happily, the top savings accounts, especially tax-free cash ISAs have done this, thus maintaining the 'real' value of cash after inflation.

Moral of the story? It really is worth the effort involved in constantly shopping around for the best savings rates.

The savings safety-net

There's one big reason why cash is so safe and secure: UK-registered banks are covered by a government-backed safety-net known as the Financial Services Compensation Scheme (FSCS).

In the event that a UK-registered bank gets into trouble (as Northern Rock did in September 2007), the FSCS guarantees 100% of the first £85,000 per person per institution. For a couple with a joint account, this guarantee is doubled to £170,000 per institution.

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Thus, the existence of the FSCS makes cash deposits safer than property, shares, bonds and other investments. Despite this, saving in cash is not completely risk-free. Alas, there are three gaping holes in the FSCS safety net for savings that big savers in particular need to be aware of.

Here they are:

1. £85,000 limit

The first problem is that FSCS support for savings is not unlimited. As I explained above, this guarantee stops at £85,000 per person per institution. Thus, if you have, say, £100,000 in a single account, then £15,000 of this will not be protected by the FSCS.

The simple solution to this problem is to keep no more than £85,000 in any one account (£170,000 for a couple). Thus, spreading your savings between institutions makes them safer.

2. One licence could cover many banks

The second problem is that the FSCS cover applies per institution, not per bank or building society.

A wave of banking mergers and takeovers in the Noughties created mega-banks such as Lloyds Banking Group, Royal Bank of Scotland and others which operate under a wide range of brands.

For example, Lloyds operates under its own name, as well as the AA, Bank of Scotland, Birmingham Midshires, Cheltenham & Gloucester, Halifax and Intelligent Finance brands. Similarly, RBS has its core brand, plus NatWest, Ulster Bank and Coutts.

Is there a simple way to tell which brands are covered under a wider 'umbrella' FSCS licence, or whether they have their own, separate FSCS licence?

Alas, the answer is no. The only way to tell whether your £85,000 protection applies per brand or per bank is to check each institution's FSCS licence on the FSA website. Here's the full list of linked deposits.

For instance, the UK's biggest building society, Nationwide BS, has one licence covering itself, Cheshire BS, Derbyshire BS and Dunfermline BS. Thus, if you have more than £85,000 of savings spread across these four building societies, then some of your savings aren't covered by the FSCS.

3. There's no claims pot

Although the FSCS is backed and managed by the government, there is no multi-billion-pound pot at the heart of the scheme, awaiting the next batch of claims. Instead, the FSCS is funded by the financial services industry on a pay-as-you-go basis.

Each year, the FSCS charges a levy to FSA-registered firms based on its estimates of the compensation it expects to pay out. If this levy is too low, say, when a massive wave of claims comes in, then the FSCS can borrow to meet its promises to the public.

In short, the FSCS is only as strong as the government backing it. Right now, the UK is AAA-rated, which is the highest credit rating available. However, as our nation's finances weaken (which they have dramatically since 2007), then the protection provided by the FSCS will become gradually weaker.

Trouble abroad

Despite these shortcomings in the safety-net for UK savers, things could be worse.

I'd much prefer to have money on deposit with UK banks than, say, those in bailed-out countries such as Ireland and Greece. Ultimately, a banking system is only as strong as the state supporting it, so Irish and Greek banks look far too risky for my liking.

Similarly, I wouldn't keep even a single penny in offshore bank accounts, such as those on offer in the Channel Islands, Isle of Man and other overseas tax havens. These accounts are not covered by the FSCS, so they rely on the lesser protection offered by foreign states. Not for me, thanks very much!

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