By Ian Pollock
Personal finance reporter, BBC News
Better compensation might reassure some customers
The sight of long queues outside some Northern Rock branches this week has prompted a re-think at the Financial Services Authority (FSA).
Specifically, it will look at whether or not to raise the compensation levels for savers when a bank or building society goes bust.
It became obvious very quickly that the Financial Services Compensation Scheme (FSCS) - which offers protection up to £35,000 of savers' money - did not engender enough confidence among Northern Rock customers.
"We need to give consideration to why consumer confidence in Northern Rock was clearly eroded," said Hector Sants, chief executive of the FSA, earlier this week.
"Investors are clearly aware of the limitations of the scheme and in the light of events it would be right to look at it again."
His view was supported by the Governor of the Bank of England, Professor Mervyn King.
Addressing MPs, he said: "Our system for dealing with the insolvency of banks and deposit insurance is markedly inferior to other countries."
In fact the FSCS was reviewed by the FSA earlier this year and, subject to consultation, plans are already afoot to tweak it in 2008.
But those impending changes are not intended to raise the levels of compensation on offer. That may change.
"Clearly it is the case that the existing industry-backed scheme does have limitations, particularly with regard to large deposits," said Mr Sants.
"It does seem reasonable to conclude that that may well have been a contributing factor to the loss of confidence seen with Northern Rock depositors."
The FSA decided only last year that there should be no change to the current FSCS limits.
Its main reason was that most claims were well below the maximum limits.
It added that: "There is no evidence that consumer behaviour and market confidence are being significantly affected by current limits."
That assumption has now been challenged.
The FSCS started in 2001, taking over from various predecessor schemes in the financial services industry.
SAVERS' COMPENSATION LIMITS
USA - $100,000 (100%)
France - 70,000 euros (100%)
Germany - 20,000 euros (90%)
Ireland - 20,000 euros (90%)
Italy -103,291 euros (100%)
It is a straightforward insurance scheme, under which companies in various sectors of the financial services industry pay annual levies.
That gives the FSCS a pot of money into which it can dip to compensate customers if their bank (or other financial firm) goes bust.
Currently the scheme's limits for bank and building society savers stands at £31,700 per person, made up of 100% of the first £2,000 and then 90% of their next £33,000.
Since the FSCS started though, no bank in the UK has actually been asked to pay an annual levy at all - which could have been as much as 0.3% of their depositors' money.
That is because the money the FSCS inherited from the Deposit Protection Board was reckoned to be enough for the time being.
Currently there is about £4.4m in the pot for banks and other deposit takers.
If more was actually needed though, the scheme could impose an emergency levy and even borrow money if it was running short.
"The scheme works on a pay-as-you-go basis," said a spokeswoman.
"We can raise money when we need to," she added.
In recent times bank failures have been rare.
The most recent was the collapse of the small London Trust bank in 2000 which saw the then Deposit Protection Board pay out about £30,000.
Before that the spectacular closure of the fraudulent BCCI bank in 1991 eventually led to customers being repaid £78m.
Compared with other European countries the FSCS is generous.
A European directive of 1994 said all EU countries must protect depositors money up to 90% of the first 20,000 euros.
"The UK has the most comprehensive scheme in the financial services sector in Europe," said Leonie Bell, of the economics consultants Oxera, which wrote a report for the FSA on the topic earlier this year.
That is because it covers not only bank and building society savers but also investment firms, mortgage advisers, and life and general insurance firms.
Remember though that it is a scheme that exists to provide compensation when a company goes bust.
So it does not cover normal investment losses, or claims for the return of money or assets due to fraud or mis-selling, where the company is still solvent.
Interestingly, the compensation limits for some of these other categories of business are much higher than for bank, building society or credit union savers.
For instance, customers of investment firms or mortgage brokers can reclaim up to £48,000 per person (100% of the first £30,000 and then 90% of the next £20,000) if a company collapses.
And people who have lost money to bust pension or life insurance brokers or providers can claim 100% of the first £2,000 plus 90% of the remainder of their claim.
It seems the authorities may now look at the possibility of copying the way things are done in the USA.
Backed by the US government, the Federal Deposit Insurance Corporation (FDIC) repays at least the first $100,000 (roughly £50,000) of savers' money.
To pay for this, banks and other institutions pay insurance premiums to the scheme, which is backed by US government bonds currently amounting to $51.2bn, roughly £25bn.
Would higher limits have made any Northern Rock customers feel any happier - and stay at home instead of trying to get their money out?
In the USA, bank collapses have been common - 1,600 went under between 1986 and 1992.
Thus many people are aware of the FDIC and how it operates.
Its typical plan is to quietly line up a buyer which takes over the insolvent bank over a weekend - lock, stock and barrel.
What if that fails?
"We close it on a Friday and send out cheques on the Monday to depositors, if we cannot find a buyer," said FDIC spokesman David Barr.
"They see the smooth, seamless way the troubled bank is handled, so it's been a while since we have had a run on a bank in the USA," he added.