Savings Guarantee Falls Short

New compensation for savers announced today fails to hit the mark.

In the wake of the Northern Rock debacle, consumer confidence in the UK banking system has been understandably shaken. In an attempt to restore faith, the Chancellor, Alistair Darling, recently floated proposals to radically improve protection for depositors. But the new rules unveiled today are less generous.

Following today's announcement, the Financial Services Compensation Scheme (FSCS) guarantees the first £35,000 you hold on deposit will now be 100% protected. From today, if a Financial Services Authority (FSA) authorised firm is no longer trading or has become insolvent and unable to meet claims made against it, you can turn to the FSCS to safeguard £35,000 of your savings with that firm.

The level of protection available has been marginally stepped up with the previous rules entitling depositors to maximum compensation of 100% of the first £2,000 followed by 90% of the next £33,000.

As a summary I've outlined six key points you should know about the FSCS following today's announcement:

1. The new rules guarantee the first £35,000 of your savings in full per financial institution. The scheme applies to cash ISAs as well as ordinary deposit accounts.
2. 'Per financial institution' doesn't necessarily mean the same as `per account'. Be careful not to choose more than one subsidiary in a group as you may only be covered once by the FSCS. That depends on how each individual company within the group is authorised by the FSA. You can check with the FSA whether an individual company is authorised in its own right or through the parent company.
3. To obtain the highest level of protection don't hold more than £35,000 in one account. This was difficult to achieve when 100% protection was capped at the first £2,000 but it's much more feasible with the new, higher guarantee. Spread the default risk by choosing different accounts with a number of firms to maximise the protection. But keep an eye out for competitive interest rates and don't sacrifice return for security. Why not compare accounts at The Fool's savings centre?
4. Joint accounts holders are covered separately by the scheme and therefore could be eligible for maximum combined compensation of up to £70,000 per institution.
5. The new higher limits don't apply to any financial institution that defaulted before 1 October 2007.
6. The FSCS is your last port of call when you haven't been able to recoup your lost savings by any other means.

So the new rules are certainly an improvement and they may go some way to appeasing savers. But the rules fall seriously short of earlier indications of an American-style system of protection. Alistair Darling had previously floated the idea of a scheme that would involve ring-fencing savers' money in the event of a bank collapse, with a generous guarantee offered by the UK scheme of 100% of the first £100,000.

But the £100,000 guarantee has failed to materialise which seems a little unwise since touting such a dramatic upgrade only to back track on it shortly afterwards may damage depositors' confidence further. That said, the new rules are apparently just the first step towards building an altogether more robust compensation scheme. The Treasury has hinted at a possible extension to the guarantee but only after a consultation period.

Such a scheme is likely to be funded by the banks but this, in itself, is contentious. If the banks are left to foot the bill, who will ultimately pay the price? Yes, you guessed it. It's savers like you and me who could lose out if our interest rates are cut back to cover the cost of providing more generous guarantees. The FSCS is already funded by levies on firms authorised by the FSA, but greater protection will no doubt lead to larger levies with the costs presumably passed on to savers.

In that case do we want or even need such far-reaching protection?

According to the Association of British Insurers (ABI) a guarantee capped at £30,000 would be adequate to protect 98% of savers. And the probability that anyone saving in a well-known bank or building society would need to call on the FSCS to recoup their savings is pretty minimal (although not impossible). After all, depositors with Northern Rock never got anywhere near approaching the scheme for recompense with the Government stepping in to guarantee all savings with the bank.

Personally, I would rather not sacrifice a decent rate of return on my savings to pay for a compensation scheme I almost certainly won't ever use. I'd be happy to stick with today's rules, it's just a shame that Mr Darling spoke about a more generous scheme before today's announcement.

More: £100,000 Savings Guarantee.