03 February 2009

Building Societies Turn Against the FSCS

Building Societies seem to be increasingly unhappy about the functioning of the Financial Services Compensation Scheme.

This is one of the reasons, amongst others I've given in recent posts, that I think depositor guarantees are a bad idea. If you make everybody in a market share the risks created by the other participants' decisions, you encourage reckless risk taking. Depositors see guaranteed safety and head for the highest interest rate, irrespective of how risky the lending which generates that interest is. The more cautious institutions end up finding it hard to compete and also lose the longer term advantage they should have when their profits are eaten away by the losses of failed higher risk institutions.

The building societies seem to favour a move to a system where payments into the scheme are determined by risk, rather than based on the total value of deposits. I think that would be excessively vague and difficult to calculate and in any case, I don't think anything other than the total abolition of the scheme will resolve all the problems it creates.

In the absence of the FSCS, the building societies, if they wished, could set up their own arrangement to guarantee each other's deposits, which would enable them to avoid the risks taken by banks. It would also allow the customer to choose from a building society within the scheme, where the risks would be shared, but greater risk taking is likely to result, or a building society outside the scheme.

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