Among the litany of EU absurdities that Brexiters and Eurosceptics have long liked to trumpet, some are apocryphal — excessively curved bananas, pint measures at risk from litres, etc.
The silly rule governing deposit guarantees is quite real, though. The EU directive on Deposit Guarantee Schemes (1994/19/EC), enhanced in 2008, dictates that customers of deposit-taking institutions will have their money safeguarded up to a €100,000 limit.
It sounds helpful and reassuring. Previous schemes were far less generous and factored in “haircuts” — taking a slice of deposits in the event a bank collapsed. Back in 2007, the UK scheme offered a 100 per cent guarantee for the first £2,000. The next £30,000 was also guaranteed but only to the tune of 90 per cent. This was one reason why customers panicked when Northern Rock got into trouble, frantically queueing to withdraw their savings.
As policymakers around the world tried to calm nerves in response to the 2007-8 crisis, they understandably introduced more generous guarantees. In the US, a $100,000 limit covered by the Federal Deposit Insurance Corporation became $250,000. Across the EU, a €100,000 threshold was established. Such moves played an important role in stabilising the system.
But the EU deposit guarantee mechanism is flawed — both in practice, and in principle.
The practical drawback is a distortion on a par with the diktat on maximum banana curvature. Because the legislation was drafted with a euro-denomination guarantee, the threshold in EU states outside the eurozone fluctuates. What began in the UK as an £85,000 limit in 2010 was bizarrely cut to £75,000 in 2015. The exchange rate trend has gone into reverse amid the referendum on Britain’s membership of the EU. As Financial Times columnist and BBC Money Box presenter Paul Lewis has argued, logic would suggest that the limit should now be raised again, to at least £85,000. The Treasury disagrees, telling the FT it does not intend to ask the European Commission to change the limit, as the law allows.
The whole idea prompted Andrew Tyrie, the influential chairman of the UK’s Treasury select committee, to vent. A fluctuating guarantee threshold, he says, is crazy. “Each change carries a cost. Stability, on the other hand, entrenches public confidence in depositor protection.”
Uncoupling the UK from the EU scheme may solve the problem. Or it may not. It is unclear to what extent Britain will promise to retain EU financial services regulation in an effort to preserve the City’s prized ability to “passport” into the single market.
The broader question of principle is whether deposit guarantees — whether in Europe or anywhere else — are a good thing in themselves. To purists they are another example of compromise capitalism, comparable with the state’s involvement as a go-between in the US mortgage market. The guarantees are typically funded by a levy on all banks in the market, rather than from taxpayer funds. All the same, there is a whiff of socialism about the concept that hardly befits Wall Street or the City of London.
At a time of crisis it was crucial to club together to protect the system and stem panic, whether in the form of taxpayer bailouts or mutualised deposit guarantees. But that crisis phase, some policymakers argue, is over. In particular, the danger of big banks, deemed “too big to fail”, has been solved, according to top international policymakers, such as Mark Carney, who heads the Bank of England and the global umbrella regulator, the Financial Stability Board. Systemic risk has been defused by a combination of bigger equity cushions and schemes to “bail in” bondholders, rather than tap taxpayers, if banks get into trouble.
If that is right, deposit guarantees start to look like an expensive, distortive and unnecessary anachronism.
Doing away with them would require thorough preparation. Without deposit guarantees, customers would have to choose their bank on the basis of financial solidity, not just headline interest rates or service quality. But it should be perfectly feasible to come up with a consumer-friendly metric to reflect a bank’s capital strength and credit rating. In a market where stiffer regulation has led to increased commoditisation of products and services, that would be a refreshing initiative to promote proper competition. It would be a big change, but a healthy one.
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