For all the resilience the UK economy has shown, there is no doubt that this year's ISA season is set against a backdrop of uncertainty. Whatever the pros and cons, Brexit, and a lack of clarity on what our future economic relationship with the EU will look like, has left us at a crossroads.
What is the Financial Services Compensation Scheme?
You often hear the Financial Services Compensation Scheme (FSCS) mentioned within the realm of UK personal finance. Indeed, in the peer-to-peer lending sector, platforms are at pains to remind consumers that any losses on capital are not covered by the FSCS. Yet, what exactly is this scheme, and what are the rules pertaining to it? That’s what this guide seeks to clarify for you.
An overview of the FSCS
The Financial Services Compensation Scheme is a statutory fund of last resort for customers of specific firms authorised and regulated by the Prudential Regulation Authority and the Financial Conduct Authority. If a relevant firm is unable, or likely to be unable, to pay claims against it, the FSCS – a non-profit, independent body – then steps in. The scheme covers deposits, insurance policies, insurance brokering, selected investments, mortgages and mortgage arrangement, and was created back in 2001 under the Financial Services and Markets Act 2000.
A levy is placed on member firms, thus making the FSCS free to consumers. In the past 16 years, nearly 5 million people have been paid out for a collective total of roughly £30 billion. Between 2006 and 2011 (during the years of the financial crisis), the fund paid out nearly £26 billion alone.
Compensation rules and limits for the scheme were last changed in 2010 so as to bring them into line with the EU (and EEA) deposit guarantee requirements under the European Union directive 94/19/E. Limits are thus linked to those set by the European Commission – currently €100,000.
The following table outlines the limits and percentages of a claim to which an individual is entitled to as at August 2017 (Note: these limits apply per person per firm, and per claim category):
A refund of an individual’s savings is triggered automatically when a member firm goes bust, and payouts on savings are usually made within seven working days thereafter. With regard to general insurance, it is likely that a settlement will be paid out within 14 days of agreement of the claim. For all other categories, compensation is usually made within six months.
Authorised firms to which the above is applicable are usually banks, building societies and credit unions, and, since 2012, it has been a requirement for these institutions to display information about the FSCS both in branch and on their website, while also presenting customers and depositors with this information too.
The FCA and PRA Handbook explains all rules pertaining to eligibility and limits, but the key points are as follows:
- Compensation is paid only when an authorised firm is declared in default
- The scheme only pays out for financial loss, and is designed to protect consumers from losses in the event of a firm holding their money going bust, rather than losses from bad investments
- Consumers are eligible, but the eligibility of other entities such as businesses and charities is subject to certain criteria
- The FSCS applies to firms in the UK, except those in the Channel Islands and Isle of Man (bar a few exceptions)
Peer-to-peer lending and the FSCS
As is the case with losses on other investments such as stocks and shares, losses on peer-to-peer (P2P) loans are not covered by the FSCS, and capital is thus not guaranteed should a borrower default. It is therefore important that all prospective lenders appreciate that there is risk involved with this particular asset class. However, it should also be remembered that it is very much in the interest of P2P platforms to take measures to mitigate this risk, as customer trust and retention is key to long-term success.
Central to this is protecting against borrower default, but, at Lending Works, we go a step further. In the unlikely event of platform failure, we have an agreement in place with an independent third party, who will wind down the loan book and ensure that all loans remain collectable, and are repaid by borrowers as usual. You can therefore rest assured that, even in the worst-case scenario, there are measures in place to help keep your investment safe.
Final thoughts on the FSCS
At a time of political and economic instability, the merits of the FSCS are clear, and the fund has been an important source of reassurance for customers, and even provided a boost to consumer confidence given that depositors can sleep peacefully knowing their savings are guaranteed. The limits of the FSCS should be borne in mind, as should the fact that derisory, sub-inflation savings rates mean that even FSCS-covered money is, in effect, losing value in real terms. However, the FSCS has nonetheless been a force for good, and one of the pillars upon which a more consumer-friendly financial services landscape in the UK can be built.
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