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Financial Services Compensation Scheme

Volume 715: debated on Thursday 19 November 2009

Statement

My honourable friend the Economic Secretary (Ian Pearson) has made the following Written Ministerial Statement.

The Government are correcting an omission in Section 214B of the Financial Services and Markets Act 2000 (FSMA), inserted by Section 171 of the Banking Act 2009, relating to the calculation of the contribution of the Financial Services Compensation Scheme (FSCS) to special resolution regime (SRR) costs. The necessary amendments are included in the Financial Services Bill but new regulations made under the revised power will have retrospective effect so they will take effect from today.

In the event of a bank or building society (an institution's) insolvency the FSCS provides statutory compensation to eligible depositors, up to a prescribed limit currently set (in rules made by the Financial Services Authority (FSA)) at £50,000. On paying the compensation, the FSCS takes over the depositors' claims against the estate of the insolvent institution. The FSCS is funded by levies on industry.

The SRR, established by Part 1 of the Banking Act 2009, enables the authorities to resolve a failing institution, rather than allowing it to become insolvent. Under regulations made under Section 214B FSMA, the FSCS may be required to contribute to the costs of the SRR, up to the net cost that the FSCS would have had to incur in a counterfactual scenario where the institution had instead gone into insolvency.

The change will mean that the Government can include the interest costs incurred in a resolution in the calculation of costs to which the FSCS may be required to contribute. It will also mean that the maximum contribution the FSCS can be required to make will include interest costs which the FSCS would have borne in the hypothetical scenario where the institution had gone into insolvency.

This will be achieved through the keeping of two separate accounts which record all costs (including interest), recoveries, and any interim contributions to SRR costs which the FSCS is required to make. The interest will be calculated by applying interest rates prescribed by the Treasury to the net balance in the relevant account at that time.

First, a real account will be kept which records all actual resolution outlays the authorities incur and all associated inflows (ie the proceeds of the disposal of the assets of the failed institution and any interim contributions to SRR costs). Interest will be calculated periodically (on the net balance on the account) and added to the outlays.

Secondly, a hypothetical account will be kept based on the counterfactual scenario using data from the FSCS as to how much compensation would have been paid and when. Interest will be added to reflect the cost of the borrowing the FSCS would have needed to fund compensation payments. The timed recoveries that would have been received from the insolvent estate are to be determined by an independent valuer and will be included in the account and will reduce the balance on which interest is calculated. Any interim contributions the FSCS is required to make to the SRR and any compensation the FSCS has actually paid to depositors will also be included to reduce the balance on which interest is calculated.

When all recoveries have been made the real account will show the net cost of the resolution including interest incurred by that date; the hypothetical account will show the net cost of compensating depositors were the institution allowed to fail, including interest up to that date. After independent verification, the FSCS may be required to contribute up to the lower of the two accounts. Payment may be requested before all recoveries have been made based on an estimate of the payment required which, if included in the lower of the two accounts, would bring the balance when all recoveries had been made to zero. If, after all recoveries had been made, this turned out to be too large a contribution, the Treasury would make a balancing payment to the FSCS.

Since this power is to have retrospective effect from today, this interest cost will be included in the two accounts kept in relation to Dunfermline Building Society from the date of this announcement. As announced on 30 March 2009, the FSCS will be required to pay a contribution to resolution costs at the end of the Dunfermline Building Society resolution; no interim contributions to SRR costs will be required.

The interest rate to be used on the two accounts in relation to Dunfermline Building Society is 4.50 per cent. This rate reflects the rate of interest the FSCS would have had to pay were the institution to become insolvent and funds were borrowed in order to make compensation payments to depositors, with recoveries made over an estimated five-year period.