FSCS’ Funding Re-Visited

You may well have assumed that the publication of FSA’s review of FSCS funding in March marked the last word.  Not so:  FSCS will shortly publish two important documents on how the new arrangements will work in practice.

Both will be drafts, so let me whet your appetite – and I hope encourage you to read those documents – by giving you a brief preview.

The first document answers some common questions about FSCS’ approach to raising levies and to borrowing.  FSCS committed to its publication as part of the recent funding review.

I’m often asked about borrowing in particular.  Why doesn’t FSCS use its borrowing facilities to spread compensation costs over time?

The straightforward answer to that is that FSCS is primarily funded through the levy and will first have recourse to the levy to meet compensation costs which fall within the affordability thresholds set by PRA & FCA.

We may borrow commercially to meet short-term cash flow needs: for example, to ensure a seven day pay-out of deposits in a failed bank, building society or credit union.  But our commercial borrowing facility is itself conditional on re-payment through the levy and can’t be used for longer-term borrowing.

So the only circumstances in which FSCS borrows long-term – and spreads costs over time – arises when compensation costs exceed what the industry can afford – the thresholds again.  In those circumstances, FSCS would look to HM Treasury, as we did in 2008 in order to fund compensation costs arising from the bank failures.

You’ll find a more detailed explanation of our funding  arrangements in our paper.

The second paper seeks your views on a new approach to raising levies which FSCS would like to introduce from 2014-15.

The key proposal here is that FSCS may be able to reduce the volatility and unpredictability of our levies by looking at expected compensation costs over a 36 month period.   We would then levy annually one third of that amount unless we had grounds for thinking that the costs in the year ahead would be greater.

So how would we arrive at our assessment of compensation costs over the next 36 months?

Well, given the unavoidable uncertainty of FSCS workload, we think that the best guide is likely to be the rolling average of compensation costs over the previous three years adjusted to reflect any exceptional factors or established trends. 

We’ve looked at other ways of doing this – for example, by looking at macro-economic trends or even credit default swap indicators – but none correlates strongly with expectations of future compensation costs.

At any event, we would welcome your views when you have a chance to read the paper itself.

I emphasise that we want to avoid levying the industry for money we do not need to meet compensation costs.  But we also want to give the industry more certainty to the extent we can within an inherently uncertain environment.

The question is: does the approach on which we’re consulting achieve those twin objectives?