Insolvency compensation rules for deposit and mortgages

What are the compensation rules when a customer has both deposits (over £85,000) and an outstanding mortgage with the same failed bank (either offset or standalone)? What happened with either B&B or Northern Rock customers in this situation?

I wrote the following letter to both Intelligent Finance and the Financial Services Compensation Scheme but they gave differing responses.

“I have an offset mortgage with Intelligent Finance (part of Lloyds Banking Group).

The offset mortgage is currently £310,000. If I deposit £350,000 in the offset current account would the net balance (current account less the mortgage) be covered up to £85,000?

If the FSCS only covers £85,000 of the £350,000 current account deposits would I still be liable for the £310,000 mortgage.

Please confirm what the situation will be. I called Intelligent Finance earlier and they did not know the rules and referred me to the FSCS. However, I need written confirmation how Intelligent Finance would treat my deposits of more than £85,000.”

Intelligent Finance’s written response:

“The Financial Services Compensation Scheme rules are set by the FSA. They are part of the FSA’s handbook. The scheme itself is administered by the Financial Services Compensation Scheme who are responsible for applying the rules if a claim is made. In terms of bank and building society failure, the scheme is untested and is currently undergoing review. There is no precedent on how the FSA’s rules would be applied in practice.
How the Financial Services Compensation Scheme works.

• HBOS is part of the Financial Services Compensation Scheme. It provides protection to compensate customers if authorised firms cannot meet claims made against them.
• Where a customer has made deposits in a savings or bank account, payments under the scheme are 100% of the first £85,000, subject to a maximum payment to any one depositor of £85,000.
• The amount of any payment under the scheme is worked out on all accounts in the name of a depositor held with the bank or building society concerned, including the depositor’s part share in a joint account.
• Therefore, if two people held money in a joint savings account then each would have a potential claim for up to £85,000.

Please note, the Scheme’s current intention is to take the amount owed by a customer to the relevant bank or building society off the amount he or she had invested in a deposit account with that bank or building society in determining the customer’s overall net claim for compensation.

For example, if a depositor had a mortgage of £200,000 and savings of £175,000 with the same bank, set off would be applied by the Insolvency Practitioner dealing with the bank failure. As a result, the depositor would end up owing the bank £25,000, so there would be no positive balance and no claim. This position is not impacted by offsetting.”

Please note my view of the above “current intention” mean implicit and may not apply if the bank failed.

Financial Services Compensation Scheme’s written response:

“Thank you for your recent enquiry about compensation available from the Financial Services Compensation Scheme (FSCS) for bank and building society deposits in the event of an insolvency.

The FSCS is the UK’s statutory fund of last resort for customers of financial services firms. This means that FSCS can pay compensation to consumers if a financial services firm is unable, or likely to be unable, to pay claims against it. FSCS is an independent body, set up under the Financial Services and Markets Act 2000 (FSMA). We do not charge individual consumers for using our service.

As you are aware, from 31 December 2010, when a bank or building society, authorised by the Financial Services Authority (FSA), is unable to pay back the deposits that have been made, FSCS can pay £85,000 of each depositor’s claim, per authorised institution.

There are two important points to remember about the deposit compensation limit:

1. The limit applies to individuals, not accounts. This means that for joint accounts the limit applies to each named account holder. So, for example, if you have a joint account with your spouse or partner, and no other accounts of your own, you could each receive up to £85,000 under the deposit limit. That means we would protect up to £170,000 of savings in a joint account.
2. The limit applies per authorised firm. This is important because sometimes a firm operates more than one brand under the same authorisation number. This means individuals with accounts held with different brands operating under the same authorisation number will only be entitled to a total of £85,000. You can confirm whether a firm is authorised in its own right by contacting the FSA on 0845 606 1234. Alternatively you may check on line at: http://www.fsa.gov.uk/Pages/consumerinformation/uk_groups/index.shtml

Such protection is also available to depositors not normally resident within the United Kingdom, where the deposit is held within a FSA authorised bank or building society.

A deposit is considered to be money that is placed in a bank or similar institution to earn interest or for safe-keeping. This includes products such as; Savings and Current Accounts, Cash Mini ISA’s and certain types of Saving Bonds. You would need to confirm details of the specific product with the provider concerned (Bank or Building Society).

From 1 January 2011, set off is no longer applied by FSCS. This means that if a depositor owes a bank money, the debt is no longer set off against the positive balance when calculating the amount of the protected deposit. Instead, the Scheme pays compensation as a gross pay-out up to the limit of £85,000.
Removing set off was designed to help speed up payment and ensure that eligible depositors do not lose liquidity in the event of a default.

Negative balances such as overdrafts, credit cards and certain types of “off-set” mortgage accounts (where the savings and loan elements cannot be separated) are now excluded by the FSCS. However, under insolvency law, the remaining deposit balance, anything over £85,000, is automatically set-off against any debts in the liquidation, meaning consumers debts will be reduced by that excess amount.

How are off-set mortgages dealt with?

As in your example, if a deposit account is separate from the mortgage balance, it would be dealt with separately and compensation would be calculated on a gross basis.
If the accounts are separate the FSCS would pay compensation up to the limit, currently £170,000 for a joint account, and the remainder would automatically be set off against the debt (or in this case mortgage) under insolvency law.

Therefore, again using your example, should the deposit taker fail, FSCS would compensate £170,000 and your debt of £300,000 would be set off, by the insolvency practitioner, against your remaining savings. There would be no safeguard for any further deposit monies.

As there are a range of mortgage off-set arrangements, it is recommended, as noted previously, that you confirm the exact arrangement with your product provider.

Please note that the information provided in this reply should be considered a guide based on our understanding of the information currently available and the rules we operate under.

Any personal information you provide us with will be held by the Scheme in accordance with our data protection policy, which is on our website or available on request.

Should you have any further questions please telephone us on 020 7741 4100 or freephone 0800 678 1100.

For further information please visit our website at www.fscs.org.uk”

Overall, from the FSCS response, I am reassured that my deposit account can have a balance of £85,000 (sole) or £170,000 (joint) greater than the outstanding mortgage with the same bank licence irrespective of being offset / tied or standalone accounts . However, Intelligent Finance was not consistent but implied the customer would not be short changed ignoring associated liquidity issues post 1st January 2011.

Ian Holmes

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