I have written recently why I am opposed to deposit insurance, and what, over the longer term, should be done instead. However, as I said in that article, my alternative scheme (electronic payments account insurance combined with gilt aggregator account insurance) could not be introduced immediately. So what could be done instead, if not following the Continental route of blanket 100% deposit insurance?
Here is what I propose. The government should issue gilts to set up a deposit access fund. The amount would need to be fairly large to be credible - I suggest £50bn as the initial amount, though a rather larger fund would be needed eventually. In the event of a bank failure, the government should allow the company to be liquidated - no more nationalisations, and no subsidies for private takeovers. It is highly implausible that a bank failure would lead to such extensive losses that any depositor would lose money - given the ordering of claims on assets during liquidation, this would imply a degree of insolvency that would suggest British regulators had been negligent on a literally unimaginable scale. The problem with liquidation, from the depositors' point of view, is not that they risk losing their money; it is that they risk losing access to their money - potentially for years. To resolve the problem of access, the deposit access fund would allow depositors to withdraw up to some percentage of their funds at will - say, 100% up to £50,000; 90% of funds up to £200,000; 60% of funds above that. The fund would pay depositors interest at the gilt rate. There would not be insurance - in the highly unlikely event that liquidation led to deposits lost, then if a sum greater than the deposits to be repaid had already been withdrawn from the deposit access fund, those monies would be owed to the taxpayer by the depositor. Monies withdrawn from the deposit access fund would be replaced in the fund by the proceeds of the liquidation.
For the government to establish such a fund, with much fanfare, would, I suggest, provide confidence to the public that depositors would be able to gain rapid access to their money and would empower the government, politically, to permit banking failures. This would be a far preferable route to the vain attempt to recapitalize all the UK's banks - a scheme that, if it were to be done on a scale that might work, would cost unimaginable sums beyond the reach of most governments, and would probably throw good money (that we would need later in the recession) after bad.
