Insolvency rules to protect bank savers

Retreat from plans to raise compensation levels likely in Banking System Bill

Reforms of banking regulation designed to protect depositors caught up in Northern Rock-style collapses are now almost certain to focus on changes to insolvency regulations, rather than a further rise in compensation levels.

Yesterday's Queen's Speech revealed that the Government intends to bring forward a Banking System Bill early in the new year following a consultation period that ends on 5 December. However, early suggestions from the Treasury that the compensation available to depositors who lose money when a bank or building society goes bust could be raised to as much as £100,000 have now fallen from favour.

Instead, ministers are likely to maintain the maximum compensation figure at the £35,000 to which it was raised in the immediate aftermath of the Northern Rock collapse. In addition, Treasury insiders say a shift to the sort of insolvency regime that protects depositors in the US is now favoured by ministers. In particular, depositors could be given preferential status as creditors in the event of a bank going under.

A retreat from the £100,000 figure initially mooted by the Chancellor of the Exchequer, Alistair Darling, would represent a victory for Britain's banks, which are keen to head off any reforms to the deposit protection scheme that would require a substantial increase in the cost of funding the system, which is met by the industry.

The British Bankers' Association will argue in its response to the government consultation that at £35,000 the scheme already covers 95 per cent of depositors in full and that is the third most generous compensation fund in Europe.

"Reform of the deposit scheme should be considered in conjunction with broader issues," said Peter Tyler, a director of the BBA. "Solutions must not be rushed and proper consultation must have taken place before legislation is put through; rushed solutions raise the risk of unintended consequences."

The banking sector has also enlisted the help of the CBI, the business group, in warding off costly reforms. Yesterday, its deputy director-general, John Cridland, said: "Businesses will be pleased to see the inclusion of measures to increase confidence in the British banking system, particularly the provisions to safeguard investors' deposits. The Government must be careful not to dampen innovation in the UK's successful financial services sector however."

One potential problem for the banks, however, is that the Government has promised to look closely at the report of the Treasury Select Committee into the Northern Rock affair before finalising its proposed legislation. The committee, led by the influential Labour MP John McFall, may be more aggressive in its proposals on reforms than Mr Darling would like.

The Treasury could also face a backlash from consumer groups, which have called for an overhaul of the deposit protection scheme. "While it sounds a simple system, it is still far too complicated and confusing," said Martin Lewis, of Moneysavingexpert.com. "In a year when we've had the first run on a UK bank in living memory, this just isn't good enough."

One loophole worrying consumer groups is that the deposit protection scheme does not always fully cover savers who have several accounts with a single financial institution. At banks such as HBOS, which has only one banking licence, savers with accounts at different parts of the group, such as Halifax and Bank of Scotland, for example, would be able to claim only one pay-out in the event of a failure. At groups such as Royal Bank of Scotland, which maintains separate licences for each of its subsidiaries, savers would be covered in full.

There is also concern that an over-generous lifeboat fund could encourage banks to take more risks. Julia Goldsworthy, the Liberal Democrats Treasury spokeswoman, said: "Without better regulation, this legislation will act as a carte blanche for banks to engage in ever more high-risk strategies, knowing that they will not be held responsible for the consequences of their actions."