Drop the guarantee on bank deposits to boost competition in finance

Katie Evans
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Northern Rock depositors rushed to withdraw money as they feared the bank would fail

AS NORTHERN Rock began to crumble in the autumn of 2007, then chancellor Alistair Darling stepped in to stave off a bank run by guaranteeing all existing deposits. To some extent, it worked: queues outside Northern Rock branches soon dissipated. But deposit insurance has since been raised dramatically for authorised banks and building societies, and now covers up to £85,000 of a customer’s deposits per institution in normal circumstances. There are proposals to protect some deposits of up to £1m.

To many, this will seem fair – why should consumers pay for the reckless behaviour of bankers? But deposit insurance is contributing to a sense of apathy around financial services. A new SMF/Populus survey of 2,000 British adults found that 71 per cent think it is the government’s job, and not their role as consumers, to ensure financial services firms behave well. The increase in deposit insurance has led to a delegation of consumer responsibility. This has arguably made financial services more risky, as savers have little incentive to punish badly-behaving banks by removing deposits.

Of course, financial services are highly complex. How are consumers meant to evaluate accountability mechanisms, whistle-blower protection, incentive schemes and risk controls, when the industry’s experienced regulators sometimes struggle to do so? To make the consumer’s task easier, we propose the implementation of a Good Culture Kitemark and rating scheme. This should be overseen by an umbrella body, bringing together regulators, consumers and the industry, to monitor firms and provide information about their behaviour to consumers in a way that is easy to access and understand. But like the energy efficiency ratings on electrical appliances, this will be most effective if consumers know they will feel a benefit in the bill they face at the end of the day.

A measure of deposit insurance can support financial stability in times of trouble, reducing the chance of a widespread loss of consumer confidence. But the average financial wealth of a UK household is just £8,000, according to the ONS. We may want people to save more than this, but a gradual reduction of deposit insurance to a level of around £30,000 would still cover a year’s post-tax income for the median household, and is the amount of cash required to pay a 10 per cent deposit on a house of median value.

This level of deposit insurance would still cover the vast majority of the UK’s savers, but the reduction would provide a signal that consumers have a key role to play in monitoring the behaviour of their financial services providers. Otherwise, financial services firms will simply be able to compete for customers on the basis of returns, encouraging them to take risks without considering the potential costs.

Together, these two signals could hit financial institutions where it really hurts – their market share – creating competition around behaviours and a marketplace where good behaviour pays off. Two-thirds of consumers told us they were willing to switch from a badly-behaved bank to a more ethical provider. It’s time to give them the tools they need to distinguish and make their preferences count.