Why safeguarding can be safer than deposit guarantee programmes

Safeguarding can actually offer a more reliable alternative to traditional bank deposit insurance. Unlike bank deposit insurance, which has limits and conditions, and relies on spending government funds, safeguarding ensures comprehensive protection without the uncertainties of banking systems.

Let us explore a complete comparison in this article.

So, what is safeguarding?

Its definition and purpose

Safeguarding refers to a method of protecting funds beyond traditional bank deposit insurance. It aims to provide an additional layer of security for clients' assets. The primary purpose of safeguarding is to ensure financial security for clients. This strategy builds trust between clients and financial institutions. It applies primarily to Electronic Money Institutions (EMIs) and Payment Institutions (PIs), like Paycury.

How it protects funds

Safeguarding mechanisms offer immediate access to funds during emergencies. Clients can retrieve their money without delays. These mechanisms protect against various financial risks that bank insurance does not cover, like holding funds over the insured limit. Proactive measures are taken in safeguarding to prevent unauthorized access to funds. This includes regular audits and strict access controls.

Regulatory measures

Stringent regulations govern safeguarding practices. Financial institutions must comply with specific legal requirements to ensure effective safeguarding. These regulations mandate the separation of client funds from institutional assets. Regulatory bodies oversee these practices to guarantee client protection. They conduct regular checks to ensure compliance and effectiveness.

What about deposit insurance?

Basic overview

Deposit insurance schemes vary by country, offering protection to depositors in the event of a bank failure. In the United Kingdom, the Financial Services Compensation Scheme (FSCS) provides coverage up to £85,000 per person, per authorized bank or building society. The Federal Deposit Insurance Corporation (FDIC) in the United States offers coverage up to $250,000 per depositor, per insured bank. In the European Union, there is a harmonized deposit insurance scheme that provides protection of up to 100,000 EUR per depositor, per bank. Each scheme has its own regulations and limits, but they all aim to safeguard depositors' funds and maintain confidence in the banking system.

Coverage limitations

Bank deposit insurance has specific limits on coverage. The standard deposit insurance coverage limit is $250,000 per depositor, per insured bank in the United States. This limit applies to each account ownership category. In cases of large deposits, clients may find themselves underinsured.

Certain scenarios reveal the shortcomings of deposit insurance. For example, if a bank fails and a depositor exceeds the coverage limit, they face potential losses. Deposit insurance does not cover investment losses or fraud. Such gaps highlight the importance of additional protection layers.

Risks and shortcomings

Relying solely on bank deposit insurance carries inherent risks. Depositors may assume their funds are completely secure without understanding coverage limits. This assumption can lead to financial surprises during crises.

Bank practices may also fall short in protecting client interests. Some banks may prioritize profits over safeguarding client assets. This reality necessitates vigilance among clients regarding their financial institutions' practices.

Government intervention

Government intervention plays a critical role in safeguarding client funds during crises. Actions taken by governments can enhance the effectiveness of safeguarding measures. For instance, during the 2008 financial crisis, government support helped stabilize failing banks.

Instances of government support have proven crucial in protecting client assets. Programs like the Federal Deposit Insurance Corporation (FDIC) provide reassurance to depositors. This reassurance is essential for maintaining public confidence in the banking system.

Government actions often create additional layers of protection for clients. By understanding these interventions, clients can better navigate financial uncertainties.

How are they different?

Fund segregation benefits

Fund segregation enhances the safety of client assets. It involves keeping client funds separate from institutional funds. This separation provides a clear distinction between what belongs to clients and what belongs to the institution.

Keeping funds separate protects clients in the event of institutional failure. If an institution faces bankruptcy, segregated funds remain unaffected. Clients can access their assets even when the institution struggles financially.

Risk exposure levels

Risk exposure varies across financial products. Safeguarding often presents lower risk compared to bank deposit insurance because of its unlimited nature and the fact that safeguarding accounts don’t go onto the balance sheet of the safeguarding credit institution

Understanding risk exposure helps clients make informed decisions about financial protection options. Safeguarding reduces the likelihood of significant losses during market fluctuations. Clients should assess their risk tolerance before choosing their financial products.

Priority in claims

Safeguarding establishes a clear priority in claims during financial distress. In times of crisis, clients with safeguarded assets have a defined claim structure. This clarity allows clients to understand their position relative to other creditors.

Having a structured claim priority is advantageous for clients. It ensures that they receive their funds promptly if an institution fails. Clients benefit from knowing they are prioritized over unsecured creditors during financial turmoil.

Advantages of safeguarding and why it might be better

More transparency, less lending

Transparency is vital in safeguarding practices. Clear communication about how funds are managed builds trust between clients and financial institutions. Clients appreciate knowing the specific processes involved in safeguarding their assets.

Transparent operations lead to stronger relationships between clients and their financial institutions. Institutions that openly share information foster a sense of reliability. This openness enhances the effectiveness of safeguarding by ensuring clients feel informed and engaged.

EMIs/PIs are prohibited from taking funds from the safeguarding account for any purposes like lending or investments. This restriction makes sure that client funds remain secure and untouched, minimizing the risk of misuse or loss. By not allowing EMIs/PIs to lend out or invest client funds, a higher level of safety is maintained within the financial institution, even compared with banks that do sometimes make risky decisions with client funds.

Less financial risks

Safeguarding significantly reduces financial risks for clients compared to bank deposit insurance. Traditional bank deposit insurance often only protects against specific types of losses. In contrast, safeguarding encompasses a broader range of protective measures.

Proactive measures in safeguarding minimize potential losses effectively. Regular risk assessments help identify vulnerabilities before they become issues. This foresight allows institutions to act swiftly, protecting client assets from unforeseen events.

Clients benefit from long-term financial stability through safeguarding practices. The combination of enhanced protection and transparency creates a safer environment for investments. As a result, clients can focus on growth without the constant worry of potential losses.

Safeguarding has its risks too

Mismanagement concerns

Mismanagement of funds is a significant concern in traditional banking. Funds can be mishandled due to poor oversight or lack of transparency. For example, an EMI can hold client funds in its operational account for longer than the legal limit, which is until the end of the first business day after funds were received. In this case, the money is not properly protected. This risk is heightened when institutions do not prioritize proper management protocols.

Regulatory safeguards

Regulatory safeguards exist to protect client funds through safeguarding mechanisms. Authorities impose strict regulations on how financial institutions manage client assets.

Continuous monitoring and evaluation processes are vital components of safeguarding. Regulators regularly assess compliance with established standards. They identify weaknesses and implement corrective actions as needed. This ongoing scrutiny helps maintain the integrity of financial systems.

Regulatory safeguards build client confidence in these systems. Clients feel more secure knowing that their funds are protected by stringent rules and oversight. Trust is essential in financial transactions, and regulatory frameworks foster this trust.