Cabinet Office
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Consumer of financial products well protected in the UK

The third Scotland analysis paper highlights the benefits of UK consumer protection measures for savers and pensioners in Scotland.

The analysis prepared by Treasury officials will explain how schemes such as the Financial Services Compensation Scheme (FSCS) and the Pension Protection Fund (PPF) - funded by UK-wide levies on the sector – provide safeguards for deposits in UK banks and UK pension schemes.

The paper will show that the UK has well-funded arrangements which can afford to compensate savers if banks get into difficulties, such as in 2008 where the UK Government stepped in to guarantee deposits.

It also explains that the large number of defined benefit pension schemes in the UK makes it easier to fund the UK-wide Pension Protection Fund (PPF) by spreading the risks across a much larger number of levy paying schemes.

The paper will also highlight the fact that UK consumer protection measures ensure there is a fair and consistent standard of protection for financial customers in all parts of the UK. Someone mis-sold Payment Protection Insurance in Newtonmore has the exact same protection as someone in Newcastle.

However the analysis also concludes that the arrangements that protect UK savers from financial shocks could be difficult and expensive to maintain in an independent Scotland.

An independent Scotland could have ‘significant difficulties’, says the paper, providing standalone Scottish protection to match schemes such as the UK’s Financial Services Compensation Scheme (FSCS) which protect deposits in UK banks up to £85,000. The retail deposit market in a separate Scotland would be dominated by only two large banks (RBS and BoS) and, if one of these were to fail, the costs for compensating the depositors would fall almost entirely on the one remaining bank.

The paper also makes clear that under EU law an independent Scotland would be required to establish its own Deposit Guarantee Scheme rather than share such schemes with the UK.

The paper also points to the extensive range of UK consumer protection and advice bodies which it would be costly and complicated to duplicate in an independent Scotland. These include the Financial Conduct Authority, the Financial Ombudsman Service and the Money Advice Service. Re-creating these bodies in an independent Scotland would be costly, and these costs are ultimately likely to be borne by individuals (either as tax payers or customers).

Key extracts from the Scotland Analysis paper on UK Consumer Protection include:

Overall strength of UK Consumer Protection measures:

‘The financial sector provides essential credit and financial services to households and businesses, from the role of banks lending money to business, to independent financial advisors who help individuals save for retirement. The current UK-wide market creates a number of benefits for households and businesses as consumers of financial services. The UK has well-functioning arrangements for protecting consumers of financial services that ensures there are consistent standards across the whole UK.

‘There are three distinct advantages that arise from the existing UK framework as a whole. First, it means that there are consistent standards of consumer protection across the UK market. Second, the consumer protection bodies are large, well-funded organisations, able to take a consistent approach across the UK market, creating efficiencies. Finally, the compensation bodies (the FSCS and the PPF) are able to pool risk across a large and diverse market.’

Financial Services Compensation Scheme (FSCS):

‘The UK’s arrangements for compensating consumers of financial services are funded by levies on a large and diverse financial sector, and the UK Government has the fiscal capacity to provide the necessary liquidity to ensure that schemes can always pay out to eligible consumers. If Scotland were to become independent, the Scottish sector would be much smaller and less diverse; and unless it restructured itself dramatically, it would be highly concentrated. This would create significant difficulties for the risk pooling and management schemes.

‘The Financial Services Compensation Scheme (FSCS) is the UK’s deposit guarantee scheme. It pays compensation up to £85,000 where a financial services firm is unable to meet claims against it. This discussion focuses on the deposit taking class. However, the issues raised also apply to the other classes of financial services covered by the scheme.

‘Payouts under the scheme and the operational costs of running it must be funded entirely by levies on industry, although the Government may lend money to the DGS in order to help fund large compensation payouts. The UK Government lent around £20 billion to the FSCS during the recent financial crisis. Under European law an independent Scottish state would not be able to “share” the UK’s deposit guarantee scheme, such that it covered firms authorised in both Scotland and the continuing UK.

‘In the UK at present there are a number of large deposit takers, meaning that the risk if one of them fails is spread over the remaining firms. In an independent Scottish state, by contrast the deposit taking sector would be very highly concentrated (assuming no change to the current profile of the sector).

‘The principal benefit of the UK in this area is risk-pooling. When one deposit-taker fails, the others are liable to contribute to the cost of compensating eligible depositors.

‘The UK retail deposit taking sector is fairly concentrated: the largest six firms have around 73 per cent of the market share. Lloyds Banking Group, the largest has, just over 25 per cent of retail deposits; but within this there are a number of deposit takers that are separate legal entities (Lloyds TSB Scotland PLC, Bank of Scotland PLC and Lloyds TSB PLC). By comparison, the Scottish retail deposit market is far more concentrated: it would be dominated by two large banks – Bank of Scotland, and Royal Bank of Scotland. If one of these were to fail, almost all of the costs for compensating the depositors would fall on the remaining large firm.

‘If Scotland were to be become independent, it could create particular difficulties for the Financial Services Compensation Scheme (FSCS). In an independent Scottish state, FSCS-eligible deposits held by Scottish firms (and which would therefore be covered by the Scottish compensation scheme) would be over 100 per cent of Scotland’s GDP, representing a significant contingent liability of the state – and a much more significant proportion than in the UK as a whole, as can be seen in Chart 4C. As was clear from the 2008 financial crisis, where there are doubts about the ability of the sector to meet claims through the compensation scheme, it can be necessary for governments to step in to guarantee deposits in order to prevent deposit flight.

Pension Protection Fund (PPF):

‘The Pension Protection Fund (PPF) protects millions of people throughout the UK who are members of eligible defined benefit pension schemes. If the sponsoring employer has a qualifying insolvency event and there are insufficient assets in the scheme to cover benefits at the same level as PPF compensation, the scheme will enter the PPF, which will pay compensation to members. The PPF is currently paying 360,000 individuals. The PPF is funded by a pension protection levy, the remaining assets of schemes transferring to it, funds recovered from insolvent employers and investment returns.

‘If Scotland became independent, members of defined benefit schemes in Scotland would not be covered by the PPF. If Scotland succeeded in obtaining EU membership it would be required to protect the member benefits in defined benefit occupational pensions.15 The most obvious method would be through the creation of a guarantee fund analogous to the PPF.

‘It would be difficult for an independent Scotland to maintain an effective standalone scheme. The UK has a large number of defined benefit schemes, meaning that the risk is spread. In an independent Scottish state there would be a much smaller number of providers (a rough estimate, based on the number of providers whose billing address is in Scotland, puts the figure at around seven per cent of the total number of schemes).

Duplication costs:

‘The consumer protection bodies discussed in this Chapter are funded through levies on one of the largest and most diverse financial services industries in Europe. They are large, well-resourced organisations that cover the whole financial services industry, UK‑wide. The existing system is therefore relatively cost effective. If Scotland were to become independent, it would need to make a number of decisions about what structures to put in place to provide consumer protection. In some cases it might wish to duplicate the UK’s arrangements or establish equivalent bodies. In other cases, it might wish to put in more limited or more extensive provisions.

‘For an independent Scotland and the continuing UK to set up duplicate or parallel bodies would be less efficient and cost effective overall than the current position in which there is a single set of bodies serving all consumers. In other words, should Scotland become independent, it would be more expensive to achieve a level of consumer protection equivalent to that which currently exists.’

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