Brussels launches plan to avert future bank runs

Northern Rock Picnik.jpg

The European Commission will today (12 July) propose a series of measures to protect savers from the risk of failure in a move aimed at restoring confidence in the banking system and preventing public panic during financial storms.

Michel Barnier, the EU's internal market commissioner, is planning to review legislation governing bank deposit guarantees and the protection of retail investors, according to a Commission note obtained by EURACTIV.

He is also embarking on a more ambitious venture to introduce guarantees against the failure of insurance firms with a "minimum set of common requirements" across Europe.

Preventing bank runs

When the US sub-prime mortgage crisis hit Europe, anxious savers in the UK rushed to their banks and moved their deposits to British branches of Irish banks, which were protected by an unlimited deposit guarantee scheme from the Irish government.

As a result, British banks, even those which had only been marginally affected by the crisis, suddenly found themselves in a liquidity trap.

The European Commission reacted by increasing an EU-wide deposit guarantee scheme to up to 50,000 euro by June 2010, with the possibility of raising the ceiling to 100,000 euro by the end of the year.

With the proposal to be announced later today, the Commission intends to confirm the 100,000 euro deposit guarantee ceiling. This means that in the event of bank failure, consumers will be able to get their money back throughout the EU, up to the value of 100,000 euro. 

Barnier is also proposing to slash the pay-out period to seven days from the present maximum of 42 days. In an earlier plan, the Commission proposed a three-day payout period, but EU member states and the European Parliament pushed for this to be prolonged.

Banks will be required to protect savings by setting up deposit guarantee schemes to be funded regularly on the basis of the financial risks they take on. Should these schemes prove insufficient to cover losses, a system of inter-bank borrowing would come to banks' aid.

Consumers may be at risk of paying for these stronger guarantees themselves via higher banking fees or reduced interest rates on their deposits. However, the Commission calculates that possible drawbacks would amount to extra fees of 7-12 euro per year per account or a 0.1% cut to savings accounts interest rates.

Avoiding another Madoff scandal

In the midst of the 2008 financial crisis, global investors found that major financial fraud had hit a number of investment companies, directly affecting their own investments.

Behind the scandal was former Nasdaq Stock Exchange Chairman Bernard Madoff, who perpetrated the biggest financial fraud ever – worth some 50 billion US dollars – via his hedge fund.

Madoff was exploiting legislation – also in place in Europe – which does not protect investors when their assets are managed by third parties.

The Commission will today propose changes to the current rules in order to extend investors' coverage to cases such as the one exposed by the Madoff scandal.

Moreover, Brussels is proposing faster payouts and more compensation for lost investment of up to 50,000 euro, rather than 20,000 euro as currently foreseen.

The new measures would cover losses due to fraud, mismanagement and negligence, but not investment risks, which will still be borne by investors themselves.

Insuring against insurance failures

The boldest proposal concerns insurance guarantee schemes, which are meant to protect policy holders from the potential failure of their insurance firm.

So far, only 11 of the EU's 27 member states have such schemes in place. Most of the countries do not foresee any protection for consumers in the event of failure by an insurance firm. According to the Commission, this means that roughly "one third" of the entire EU insurance market "lacks any kind of coverage in the event that an insurance company has to close down".

Consumers in most EU countries could therefore lose all their savings entrusted in life insurance policies or other insurance undertakings.

No rules currently exist at EU level to offer consumers protection here. Barnier is thus launching a debate on the need for a guarantee system, which would be applied homogenously across all EU countries.

However, national legal divergences make it difficult to establish a common EU system. "For the moment therefore, the most realistic approach is to establish relevant schemes at national level, which ensure that all member states are in a position to ensure comprehensive and even levels of protection of policy holders and beneficiaries in the event of an insurer's insolvency," reads a Commission note to be published today.

Brussels calculates that the size of an insurance guarantee scheme should be set "at 1.2% of gross written premiums per year".

Financial markets across the globe went into a tailspin following the US sub-prime mortgage crisis in early August 2007, forcing central banks to make massive cash injections to keep the system rolling and fend off a possible liquidity crisis. 

The crisis stormed into mainland Europe at the end of September 2008, forcing governments to rush to salvage a number of financial institutions, among which giants such as Fortis and ING.

EU institutions approved a number of measures to restore confidence in financial markets. Guarantees on bank deposits were raised (EURACTIV 19/12/08) and a review of rules protecting investors was announced (EURACTIV 21/01/09).

  • 30 Nov. 2010: End of consultation period on insurance guarantee schemes.
  • 2012-2013: Likely entry into force of saver and investor protection measures.

Subscribe to our newsletters