Although they may seem monolithic and indestructible, history has taught us that even the largest financial institutions are vulnerable to collapse.
Savers can therefore be forgiven for wondering if their savings are protected in a bank or building society.
Here we outline the logistics of the Financial Services Compensation Scheme (FSCS), which savers and investors can rely on should a financial firm go bust.
What is the Financial Services Compensation Scheme?
The FSCS is the fund of ‘last resort’ for investors if a financial firm goes bust. Funded by the financial services industry, the FSCS will pay out compensation if UK-registered providers go out of business.
What does it cover?
Generally speaking, the FSCS covers savings deposits, insurance policies, and investments. It’s important to note that it only covers firms that are regulated by the Financial Conduct Authority (FCA). Consumers can find out whether a firm is a member of the FCA by checking its register.
The scheme also covers loss of interest as part of the compensation amount.
Since 30 January 2017, the FSCS has covered up to £85,000 of savings. For joint accounts the limit is £170,000.
Investments are also covered by the FSCS, but only up to £50,000 of investments in a firm that has gone into default. This applies to both fund managers and brokers. Peer-to-peer platforms are not covered by the rules.
Although the FSCS was primarily set up to help consumers, small qualifying businesses are also covered – although they typically will have to have a small turnover to qualify.
‘Investments’ covers stocks and shares, unit trusts, futures and options, and other long-term investments. The FSCS will only be triggered when an investment product provider goes bust, or for a loss arising from bad advice; rather than for the demise of an underlying investment. So if you buy shares in a company that subsequently goes belly-up, you’re on your own, as sadly that’s the nature of investment.
As investment trusts and exchange traded funds are considered as shares in a company, these are not covered by the FSCS either unless there is case for bad advice rather than poor stock market performance.
Investments in a Sipp are typically ring-fenced away from the provider, so funds shouldn’t be affected if the Sipp provider goes bust. This also applies if you bought shares or funds through an online broker. The money is not held with the provider, so your money should be safe.
Peer-to-peer (P2P) platforms are not covered by the rules, which makes picking your platform very important. You will lose all of your cash if the platform itself goes bust.
The savings compensation limit is for one financial banking group or credit union, rather than each separate bank and building society, so it could be the case that the limit is stretched across several institutions.
Many banks and building societies have been merged together in recent years, so if you’re unsure which come under the same umbrella, check with the individual provider.
Cash savings held in a self-invested personal pension (Sipp) are also covered, separately to any investments held within the wrapper.
However, if you do hold money above the compensation limit in just one institution that goes bust, you may still be compensated as part of the insolvency process – it all depends on how much can be retrieved by the administrator.
The FSCS also now offers compensation for temporary high balances of up to £1 million for money held for under six months, and pertaining to specific life events such as a redundancy payout, insurance payout, divorce, or several other circumstances.
What about overseas banks?
All EU countries have a compensation limit of €100,000. While many overseas banks market savings and investments to UK consumers, not all of the banks are regulated by the FCA and so operate under a different compensation scheme in the institution’s home country.
The safety of overseas deposits was put to the test when Icelandic bank Icesave famously went under in 2008. More than 300,000 UK savers had to wait around eight weeks to get compensation from the local deposit guarantee scheme in Iceland.
In addition, any money held offshore – in the Channel Islands, the Isle of Man and outside of the European Economic Area – isn’t covered.
What isn’t covered?
Pre-paid currency cards and savings schemes are not covered by the FSCS. Likewise, money held in PayPal, the eBay subsidiary, is not covered.
Structured savings deposits are a murky area. Structured deposit-style accounts, which are often mistaken for fixed-rate savings bonds, are usually covered by the FSCS.
They are also known as ‘guaranteed equity bonds’, and index-linked bonds with National Savings & Investments are one example of these. But, an ‘investment-style’ structured product – where the return of the investment is dependent on stock market performance – is not covered by the FSCS as it then counts as an investment.
What if I have debts with the defaulted bank?
If you have a mortgage, a loan or a credit card with a bank that has gone into default, these will be treated separately to savings and investments. So, the money will be compensated by the FSCS but debt will still apply and be owed to the bank.
What if the firm is still trading?
The FSCS only looks at firms that have gone into default, while the Financial Ombudsman Service deals with complaints about authorised financial firms that are still trading. Visit www.financial-ombudsman.org.uk for more information.
How long will the compensation take?
All claims will differ, but the FSCS aims to pay out compensation for cash deposits within seven days of a bank or building society defaulting. For investments, claims should be paid within six months of the firm going bust.
To be completely safe, try to keep below the limit to allow a small margin for interest or dividend payments. Even if you aren’t in danger of touching the saving or investment limit, the golden rule of investing, diversity, still applies. By spreading money across several banks or investment firms, if one does fail, you’ll still have access to your cash should you need it.
Lastly, it’s the responsibility of the provider to inform you whether your investment is covered by the FSCS, but if you’re unsure, just ask.
We make every effort to ensure our beginner's guides are kept up-to-date. However, in the constantly shifting environment of investment and financial services, occasions may arise where elements of a guide become out-of-date. Please double-check the facts before taking any important financial decisions.
This story was originally written for our sister magazine, Money Observer.