As part of its work creating a safer and sounder financial system, preventing a future crisis and restoring consumer confidence, the European Commission has proposed changes to existing European rules to further improve protection for bank account holders and retail investors. Furthermore, the Commission has launched a public consultation on options to improve protection for insurance policy holders, including the possibility of setting up Insurance Guarantee Schemes in all Member States.
Protecting your savings
The recent financial crisis illustrated once more how banks are susceptible to the risk of "bank runs" – i.e. when bank account holders believe that their savings are not safe and try to withdraw them all at the same time. Since 1994, a Directive (94/19/EC) ensures that all Member States have in place a safety net for bank account holders. If a bank is closed down, national Deposit Guarantee Schemes are to reimburse account holders of the bank up to a certain coverage level.
When the financial crisis hit in 2008, some quick-fix amendments were made, notably to increase the coverage level to € 100 000 (in two steps) and to abandon the possibility to have co-insurance in place (i.e. that bank account holders are not fully repaid, but are to bear a certain percentage of their lost sum – even when the lost amount would be lower than the coverage limit). However, as other shortcomings were detected in existing schemes, the Commission now comes forward with a proposal to fully amend the 1994 Directive and ensure that all lessons are learned from the crisis.
The key elements of the proposal are as follows:
Better Coverage: the upgrade to € 100 000 by the end of this year means that 95% of all bank account holders in the EU will get all their savings back if their bank fails. Coverage now includes small, medium and large companies as well as all currencies. Excluded are all deposits of financial institutions and public authorities, structured investment products and debt certificates.
Faster payouts: bank account holders will be reimbursed within seven days. This will be a major improvement as today many account holders wait weeks, even months, before getting their money back. In order to facilitate such a short payout, managers of Deposit Guarantee Schemes will have to be informed early about problems at banks by supervisory authorities. Banks will have to specify in their books whether deposits are protected or not.
Less red tape: for example, if you live in Portugal and have your account at a bank in Sweden, the Portuguese scheme would repay you on its own initiative and act as your contact point. The Swedish scheme would then reimburse the Portuguese scheme. This would be a strong improvement over the current situation, where all correspondence has to be done via the scheme of the country where the bank's headquarters are located. The new approach will mean less bureaucracy and faster payouts.
Better information: bank account holders will be better informed on the coverage and functioning of their scheme by a new easy to understand standard template and on their account statements.
Long-term and responsible financing: concerns have been expressed that existing Deposit Guarantee Schemes are not well funded. The proposals will ensure that they are now more soundly financed following a four-step approach. First, solid ex-ante financing provides for a solid reserve. Second, if necessary, this can be supplemented by additional ex-post contributions. Third, if this is still insufficient, schemes can borrow a limited amount from other schemes ("mutual borrowing"). Fourth, as the last resort, other funding arrangements would have to be made as a contingency. Contributions will, as is currently the case, be borne by banks. However, they will be calculated in a fairer way since they will be adjusted to the risks posed by individual banks.
Not only will Europeans have better protection for their savings, but they can now also choose the best savings product in any EU country without worrying about differences in protection. Banks will benefit from the proposal since they could offer competitive products throughout the EU without being hampered by such differences. Moreover, taxpayers benefit from a better financing of schemes – rendering state intervention much less likely. Most improvements could already come in effect by 2012 and 2013 and would apply in all EU Member States as well as in Norway, Iceland and Liechtenstein, once incorporated in the European Economic Area Agreement.
Protecting your investments
Since 1997, the Investor Compensation Scheme Directive (97/9/EC) has protected investors who use investment services in Europe by providing compensation in cases where an investment firm is unable to return assets belonging to an investor. This might occur for example where there is fraud or negligence at a firm or where there are errors or problems in the firm's systems. It is not a protection against investment risks at such. There are now 39 investor compensation schemes in place in the EU's 27 Member States.
The proposal is intended to ensure that the rules on investor protection are more efficient, that there is a level playing field concerning the type of financial instruments that are protected and that there is appropriate funding and the necessary arrangements to make sure that investors are compensated.
The key elements of the proposal are as follows:
Better coverage: the current minimum level of compensation for investors is € 20 000. Under the Commission's proposal, this will be increased to € 50 000 per investor.
Faster payouts: under the current legislation, it can sometimes take up to several years for investors to receive any compensation. This is to change under the Commission's proposal, where investors will receive compensation at the latest 9 months after the investment firm's failure. Such a timeframe is however necessary in order to allow competent authorities to investigate the case and determine the positions of individual investors.
Improved information: investors are to receive clearer and more extensive information about the extent to which their assets are covered. For example: investment risk – an investment losing value due to a declining stock market or bankruptcy of an issuer – is not covered under the Directive.
Long-term and responsible financing: since 1997, there have been a number of cases in Member States where schemes have had inadequate funding to compensate lost assets of investors. Under the Commission's proposal, a minimum target fund level will be introduced which needs to be fully pre-funded. If necessary, schemes can borrow a limited amount from other schemes and other funding arrangements as a last resort ("mutual borrowing"). Contributions are to be borne by investment firms.
Wider protection: currently, investors are not necessarily protected if the investment firm uses a third party custodian to hold the client's assets and the third party defaults without returning the invested assets. Similarly, unit holders in investment funds can suffer loss if there is a failure of a depositary or a sub-custodian of the fund. The Madoff investment fraud case in 2008 is a recent example. The Commission now proposes to also cover such situations.
Most improvements could already come in effect by end 2012 and would apply to all EU Member States as well as Norway, Iceland and Liechtenstein, once incorporated in the European Economic Area Agreement.
Improving protection for insurance policy holders
Insurance Guarantee Schemes (IGS) provide last-resort protection to consumers when insurers are unable to fulfill their contract commitment, offering protection against the risk that claims will not be met if an insurance company is closed down.
IGS can offer protection by paying compensation to consumers, or by securing the continuation of their insurance contract through, for example, facilitating the transfer of policies to a solvent insurer or the guarantee scheme itself. There is no European legislation on guarantee schemes in the insurance sector today. Currently, 12 Member States operate one or more IGS which cover life and/or non-life insurance policies. They not only vary in terms of protection and eligibility, but also on when they are to intervene or how they are to be funded for example.
In the White Paper that was adopted today, the Commission sets out different options to ensure a fair and comprehensive level of consumer protection in the EU as well as to guard against the need for taxpayers to foot the bill in case an insurance company is to collapse. In particular, it proposes introducing a directive to ensure insurance guarantee schemes exist in all Member States and comply with a minimum set of requirements. The White Paper on Insurance Guarantee Schemes is up for consultation and all interested parties are invited to submit their comments and further input by 30 November 2010.