Is saving with a little-known bank safe due to FSCS protection?

Competition at the top of the best buy savings tables is rife and rates are rising almost every day.

Many Brits who set their eyes on the best deals will see a host of smaller banks and building societies that they may not have heard of.

This leads to the question that all savers should ask themselves before depositing money into any account: is this bank safe? To answer that, you need to know your way around the Financial Services Compensation Scheme deposit protection.

Large returns from small banks

The well-known big banks are notable absentees from the best buy tables, and many of them continue to get away with paying rock bottom rates to their loyal customers.

The highest paying easy access deals pay more than 4 percent and include names like Chip, RCI Bank, GB Bank, Oxbury Bank and Cynergy Bank.

The best fixed-rate deals — now paying up to 6 percent — include names like Recognize Bank, SmartSave, Castle Trust, Oaknorth and Charter Savings.

While they offer much better rates compared to many of their much larger counterparts, some Britons may be hesitant to join these small banks that are unknown quantities.

This may be partly out of loyalty to their banking provider. To a brand they know and trust. According to a recent survey by Shawbrook Bank, nearly half of UK savers choose to keep their savings in their bank account.

However, it is also likely that Britons are less likely to entrust their savings to a bank or building society they have never heard of.

And yet all authorized banks and building societies follow the same rules and the same deposit guarantee for depositors to operate in the UK.

This means depositors’ deposits are all protected up to £85,000 at each institution by the Financial Services Compensation Scheme (FSCS) in case a bank fails. In the case of joint accounts, it protects up to £170,000.

Unless Britons plan to hold more than this amount at one particular bank, their money is arguably no less safe if they opt for a smaller, lesser-known provider.

But of course it begs the next question. How safe is the FSCS – UK Deposit Guarantee Scheme?

How can the FSCS compensate savers?

Each year, the FSCS forecasts how much it expects to pay in compensation for each type of claim it covers.

This includes claims for depositors, insurance claims, and life and retirement benefits.

Each year, the FSCS imposes a levy that all companies authorized by the Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA) must pay.

This levy funds the cost of the fee it pays to customers, as well as the cost of performing its service and processing claims.

Does one bank pay more than the other?

All banks, building societies and credit unions contribute to the savings compensation levy.

They each contribute an amount based on the size of their business compared to the overall size of the deposit market.

This means that the amount they pay from the total FSCS requirements is proportional to the size of their depository business.

How fast will the FSCS repay savers?

In the worst case, when a bank, building society or credit union goes bankrupt and the FSCS has to step in, it claims to pay compensation within seven days.

However, some complex claims can take up to three months. For example, if there are claims for temporarily high balances.

FSCS temporarily protects high balances in a bank account, building fund or credit union account of up to £1 million for six months.

These are allowed in certain life events, such as after the sale of someone’s home, personal injury, or an inheritance.

In the worst case, when a bank, building society or credit union goes bankrupt and the FSCS has to step in, it claims to pay compensation within seven days.

Is there a limit to what can be paid out at once?

The FSCS charges companies on a “pay as you go” basis, based on the amount of compensation it expects to pay out.

This means it only asks for what it thinks it needs from them each year.

In total, the rules currently allow FSCS to request £1.5bn from the deposit industry each year.

It then has a credit facility to match this £1.5bn so it can quickly access money to meet the seven-day deadline.

If necessary, it can use the credit facility to pay customers and then impose an additional levy on banks and building societies to repay those funds.

In addition, it can borrow money from HM Treasury – which is exactly what it had to do during the 2008 financial crisis when it paid out a total of £20.9bn. The terms of that loan would be determined by the Treasury.

It is worth noting that after the 2008 crisis, the FSCS recovered £20bn over time from the estates of those bankrupt banks, and the remainder plus interest was paid back through the savings levy, so the industry eventually financed the compensation after all.

During a financial crisis, it’s easy to imagine a situation where the FSCS could be swamped with compensation claims and unable to pay out to everyone. But it proved in 2008 that it could handle it.

How will the FSCS pay you?

If you have a balance of less than £500 you will be given a letter to get cash from the Post Office counter.

To receive payment, you must take the letter to a post office counter, with personal identification, as described in the letter.

If you have a balance of more than £500 you will receive a check. In either case, the FSCS will contact you by mail in an unmarked envelope.

When was the last time the FSCS had to help?

The last failed deposit last year was the Birmingham Inner Circle Community Credit Union.

On 26 September 2022, Birmingham Inner Circle Community Credit Union Ltd went into receivership and ceased trading.

The Financial Services Compensation Schedule declared it failed (defaulted) on that same day.

The FSCS handled seven bankruptcies of credit unions, paying a total of around £6.7 million to their members.