Britain considers copying U.S. and German deposit insurance

Bank Shares Rally After Chancellor Steps In

By Peter Thal Larsen, Chris Giles,
and George Parker
Financial Times, London
Tuesday, September 18, 2007

http://www.ft.com/cms/s/0/cc10b29c-655e-11dc-bf89-0000779fd2ac.html

Bank shares rallied on Tuesday after the government moved to guarantee the deposits of Northern Rock customers in an attempt to quell the growing crisis of confidence in the sector.

In lunchtime trading, shares in Northern Rock were up 11 percent while Alliance & Leicester -- which on Monday denied that it had called on the Bank of England for support -- rallied 25 percent, recouping most of its sharp fall on Monday.

The market was also soothed after the Bank of England said it would inject L4.4 billion into the system at its benchmark rate of 5.75 percent in a two-day "exceptional" tender. That brought overnight lending rates, which on Monday had surged to their highest levels in nearly six years, back down to 6.14 percent.

"This action, which is additional to the injection in last Thursday’s weekly open market operation, is being taken to help offset the disturbance to conditions in the short term money markets following the announcement of lender of last resort assistance to Northern Rock," the bank said.

Alistair Darling, chancellor of the exchequer, said in a statement on Monday that the government was stepping in to guarantee all of Northern Rock's deposits. The Treasury said similar assurances would be available to customers of any other lender that ran into difficulty in the current turmoil.

The Financial Times has also learnt that the Treasury, the Bank of England, and the Financial Services Authority have concluded that the current system for protecting savers, which guarantees deposits only up to L35,000, is inadequate. They have already begun a review of the system and are minded to opt for a US-style alternative, ringfencing depositors' money in the event of a bank's failure.

Hector Sants, FSA chief executive, said on Tuesday that it "would be right" to review current arrangements. Speaking on BBC Radio 4, Mr Sants said: "Clearly it is the case that the existing industry-backed scheme does have limitations, particularly with regard to large deposits. It does seem reasonable to conclude that that may well have been a contributing factor to the loss of confidence seen with Northern Rock depositors."

Mr Darling's intervention on Monday came after it became clear that the run on the Northern Rock, the first mass public bank run since the 1860s, was not abating as a third day saw thousands queuing outside branches to withdraw their cash.

He said that the government, along with the Bank of England, would "if necessary" guarantee all the existing deposits in Northern Rock. The bank has lost more than L2 billion -- at least 8 per cent of its deposits -- since it turned to the Bank of England for emergency support on Friday.

"This means people can continue to take their money out of Northern Rock. But if they choose to leave their money in Northern Rock, it will be guaranteed safe and secure," Mr Darling said.

The bank said on Monday night that the government guarantee should remove any remaining doubt among customers. "Consequently anybody who is in a queue outside a branch, or who is trying to access an online account can be fully reassured that there is no cause for concern whatsoever," it said.

Northern Rock took out full-page advertisements in British newspapers on Tuesday in an effort to reinforce the message. People close to the bank said customers had last night started calling to cancel withdrawals after hearing the chancellor's statement.

The bank also offered to refund penalties charged to savers who had withdrawn funds if they reinvest before October 5.

The chancellor's move is a belated recognition that last week's rescue of Northern Rock by the bank has failed. In spite of repeated assurances from the chancellor and the FSA, customers rushed to withdraw their savings amid concerns that the bank would collapse.

But Mr Darling faced criticism on Monday from George Osborne, his Conservative counterpart, who, while supporting the move, added: "Alistair Darling has gone in the space of a week from attacking the lending practices of the banks to providing this emergency guarantee."

Mervyn King, governor of the Bank of England, is also likely to face difficult questions when he appears before MPs on Thursday. Gordon Brown's spokesman said on Tuesday that "the prime minister has full confidence in the governor ... and thinks he's done a very good job." The spokesman rejected suggestions that Mr King would be punished for the Northern Rock crisis by not having his five-year contract renewed.

Regulators believe it is unsatisfactory there is no special protection for customers of banks that become insolvent. They are known to be impressed by the systems in the US and Germany, where regulators have the authority to transfer customers’ deposits to other lenders if a bank is about to fail.

Northern Rock said on Monday that it was not in takeover talks, but added that it was "actively considering all options in the interests of shareholders, customers, and other stakeholders."

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