UK & Irish banking crisis: An insurance scheme

Savers in stampede to safety

Lenihan told Darling that the decision to safeguard all deposits at six banks had not been planned, but had been an emergency move to prevent the collapse of one Irish bank leading to the failure of another.

The Treasury said last night that the chancellor had been given a sympathetic hearing. Darling made two calls in response to signs that savers were rushing to open accounts at Irish-backed banks, including the UK Post Office, whose accounts are provided by Bank of Ireland.

Under pressure from furious high street banks, the chancellor urged Lenihan to make the scheme open to British banks operating in the republic. (Guardian)

Guaranteeing deposits sounds all very fine and dandy, but imagine what that means for the banks! They can spend, spend, spend, do what they like, go hog wild, because no matter what they gamble and lose, or how much they pay themselves, it doesn't matter - the government will pay the depositors. That can't be right, surely? I mean, if I had any savings I'd want them guaranteed, but...how is that going to work?

Am I the only one who thought that money in banks was safe before? How naive, apparently. I thought there were regulations and that the money you kept in a bank was owed to you and backed by some sort of insurance or whatever. But nada.

That is the solution to the problem of safeguarding deposits, then: insurance. The banks must pay insurance premiums into an insurance fund and when one of them goes bust, they must cease trading forthwith - like any bankrupt business, not carry on trading while insolvent, which is illegal for ordinary businesses. The more risk there is in their line of business, the higher their premiums would be set. That should stop them from taking undue risks with people's money.

Then the government backs only the insurance scheme, which creates a commercial buffer zone and guarantees efficiency as far as practicable. No direct "guarantee", but a quid pro quo in return for insurance premiums paid to a state or European central insurance system. To work, it must be made compulsory for all banks.

The same advice goes to the US legislators: make your system a free-standing state-backed insurance agency. Don't pour money into a failed system, because it will flow out through the same holes that are the problem, and you'll be down $700 billion, more indebted and still have the same problem you started with.

Zoz