Should the true costs of insuring deposits of up to £75,000 be made clearer?

Andrew Hewitt.

Deposit insurance schemes guard against bank runs by reducing or removing individual depositors’ incentives to withdraw their funds if they believe their bank to be in trouble. They help protect depositors but they risk also protecting risky bank business models by removing depositors’ incentives to avoid riskier banks. What can be done about this? In the past the answer was sometimes to make small depositors bear part of the risk through “co-insurance”. This was proven not to be credible. In this blog I consider some of the options available, including the risk-based levies currently being introduced in the EU and elsewhere, and increased transparency, drawing on recent literature on the saliency of tax in consumer choices.

The global financial crisis that began in the late 2000s prompted authorities across the world to increase deposit insurance limits. This was to maintain and restore public confidence in the banks and avoid bank runs. In the US, the limit jumped from $100,000 to $250,000 (bringing it back to roughly five times per capita income). The EU made a threshold of €100,000 (or its national currency equivalent) mandatory for its then 27 members, five times the previous minimum requirement of €20,000, and about four times GDP per person across the EU (just over three times GDP per person in the UK). In this way, policymakers relearnt the lessons of 1930s America, when deposit insurance coverage of around nine times GDP was introduced to restore confidence during a calamitous banking crisis in which more than 10,000 banks had failed. This is shown in the chart below.

Sources: Financial Services Compensation Scheme, Financial Services Authority, Office of National Statistics, Bureau of Economic Analysis, Federal Deposit Insurance Corporation, author’s calculations.

As well as increasing coverage levels, authorities across the world removed “co-insurance”. Until 1 October 2007 the first £2,000 of each UK deposit was fully protected, but the depositor would stand to lose 10% of everything above that amount, up to the threshold of £35,000 – the co-insurance element. The idea was supposedly to give even small depositors an incentive to assess the credit-worthiness of banks. But UK authorities found out the hard way that this is not realistic, and such schemes defeat their own purpose because they don’t change incentives for depositors to withdraw their funds at the first sign that a bank may be in difficulties. That’s why on that day in the autumn of 2007, when faced with the real prospect of a run on Northern Rock by its depositors, the FSA did away with co-insurance, with immediate effect. Co-insurance is now no longer a feature of any G20 or EU system.

But who is paying for all of this? In almost all jurisdictions, deposit insurance is paid for collectively by some combination of the shareholders, creditors, employees, and customers of banks in the system through levies imposed upon the banks themselves. But amongst the biggest direct beneficiaries are those fortunate enough to have deposits now covered by the higher limits. As banks’ levies are based on the amount of insured deposits they take, they could pass increased insurance costs directly on to those insured depositor beneficiaries, by reducing interest rates. But it is questionable if this happens in practice: there is a great deal of cross-subsidisation in the UK retail bank account market, and a glance at the “best buy” tables suggests banks tend not to differentiate between insured and uninsured deposits in the interest rates that they offer.

This raises a number of problems. First of all, there is a big distributional problem. Only about 15% of UK households have more than £13,500 in savings accounts; less than 5% have more than the new £75,000 limit that has applied since 1 January 2016 (to maintain equivalence with €100,000). The proud owner of a high-spec luxury sports car worth £75,000 would be surprised if he didn’t have to pay to insure his new toy against theft just because he had found what he considered to be a reasonably secure garage in which to park it.

But it gets worse. It is widely recognised, including by deposit insurers themselves and with empirical evidence in support, that unpriced deposit insurance of this type can cause significant “moral hazard.

This is because, with deposit insurance, especially with no co-insurance, insured customer depositors have no need to balance risk and reward as there is no risk to their funds whichever bank they choose. So they would demand no “risk premium” for depositing funds with banks with riskier business models. This can encourage risky lending. The fact that deposits were covered by deposit insurance (or, at least, the perception that they were covered) helped the Icelandic banks, for example, to raise deposits at home and in other European countries to fund a risky and ultimately unsuccessful business model.

A way to realign risk and reward is through risk-based levies (RBLs), which require riskier banks to pay higher levies than safer banks. They have been in place in the US since the 1990s and are now mandatory across the EU, except where other existing measures (such as the UK bank levy) are in place. A risk-based system has number of advantages. In particular it should, if passed on to insured depositors, remove the risk premium they may otherwise demand if their deposits were uninsured

But it is very hard to ensure that RBLs reflect the actual risk posed by each bank to the deposit insurer, particularly where target levels for the aggregate size of the deposit insurance fund are not themselves risk-based. And even if levies were accurate, cross-subsidisation could mean that costs are not passed on to depositors.

Maybe introducing a direct, risk-based “deposit tax” payable by insured depositors would help. But this would be politically difficult, and costly to administer. Instead, deposit insurance levies expressed as percentage of covered deposits could be framed as a notional tax on deposits. Banks, not depositors, would still have to pay the levies. But if banks were required to prominently to display in marketing material and on bank statements the interest rate reduction caused by the deposit insurance levy, depositors might be nudged into better choices by making the levy more “salient”. Evidence from an economics laboratory experiment suggests that consumers spend 30% less on a given product when the sales tax element of the price is made transparent. Another study, this time in the real world of a US grocery store, found that tax transparency reduces demand by about 8%.

Such transparency would allow depositors to see at glance how much it is costing them to keep their money at a particular bank. If levies were risk based, it could prompt them to switch to a less risky bank. This would be good for competition. Firms with the least ability to absorb losses, and so least ability to avoid calling on the deposit insurance arrangements if they fail, might struggle as a result. They might react in the short-term by increasing deposit rates in a bid to keep depositors or attract new ones, as weak firms often do. This underscores the importance of having an effective resolution regime in place, allowing for orderly exit with minimal impact on customers.

But insensitivity to deposit interest rates would likely mean that any change would be gradual. In 2013 there was at least £145bn of deposits in accounts with more than £5,000 that paid a rate of interest equal to or less than the BoE base rate, despite better deals being available.

However, even if levies are not risk-based and some depositors are not sensitive to interest rates, increased transparency could still have a positive effect over time. It could help and encourage banks to pass on levies directly to their wealthier insured depositors. It could make savers more conscious of the existence of deposit insurance, and – if they don’t require an insured safe haven – that they could avoid paying the “tax” by moving funds out of banks and directly into capital markets. All of these things could have downsides. But increasing transparency in this area is worth further consideration.

This post was written whilst Andrew Hewitt was working in the Bank’s Resolution Policy Division.

If you want to get in touch, please email us at You are also welcome to leave a comment below. Comments are moderated and will not appear until they have been approved.

Bank Underground is a blog for Bank of England staff to share views that challenge – or support – prevailing policy orthodoxies. The views expressed here are those of the authors, and are not necessarily those of the Bank of England, or its policy committees.

6 thoughts on “Should the true costs of insuring deposits of up to £75,000 be made clearer?

  1. It’s an anomaly that if you lend to non-bank corporations X,& & Z i.e. buy their bonds, there’s no government organized protection for you, but if you lend to a bank (i.e. make a deposit at a bank) which itself lends to corporations X,Y & Z, and it all goes belly up, government rescues you.

    There is of course a very simple solution to the latter anomaly, and indeed to the quagmire dealt with in the above article. The solution is based on a very simple and widely accepted principle, which is that anyone engaging in COMMERCIAL activity (e.g. who asks a bank to lend on their money), is on their own. I.e. there is no government organised protection for them. Full reserve banking incorporates that principle.

  2. Expecting Consumers – ON THEIR OWN – to be able to assess Bank Risks invisible in 2008 to Bank Execs & apparently unquantifiable / Incalculable does not appear appear a very sensible proposiiton. I would far rather subscribe to a Non-Lending Banking Entity ( Aggregator ) with an account with the BoE ( even if I had to pay ) rather than take a risk with potentially future-risky Private Banks. Can we have such a provider soon?

  3. The problem with risk rating is that the schemes pretend the various risks are uncorrelated, but at the moment you become worried about the risks, suddenly they are all correlated.

    Deposit insurance only subsidizes risky behaviour if you allow the bank to operate finance business outside of its expected deposit customer base. All these other finance businesses if left to broker-dealers, investment banks, funds, whatever, would then present no risk to deposit insurance.

  4. Its a good subject but the real question is not so much the insurance, The question is under systemic event or events, which is very possible in this market of financial bubbles, financial engineering, break in the transmission, interconnected financial system, and etc. the deposit insurance will be overwhelmed and would not be sufficient.

    Bottom line, the amount of insurance/reserves is not sufficient to protect all the depositors. But there are sound financial ways a depositor and large depositor can protect their funds.

    Ps: If you are a regular reader of Bank Underground, you will note my Bearish views and comments. Yes, I am a Bear on MKTS and the abilities of the system to respond in the next major crisis/event, many tools and reserves have already been used.

  5. Excellent piece. Glad to see that the Bank is on the case even if the politicians are fast asleep.

  6. You say “But it is very hard to ensure that RBLs reflect the actual risk posed by each bank to the deposit insurer” but don’t really address this problem.

Comments are closed.