People rely on banks in their daily lives, whether it’s for looking after their money, paying for things and receiving wages.
Not surprisingly, then, if banks stopped working, the entire economy would grind to a halt. It’s the Bank of England’s job to make sure that the banking system continues to work in a safe and sound way.
As part of this, we put a lot of effort into reducing the chances of a bank getting into financial difficulty in the first place.
But it is not possible to prevent all banks from ever failing.
Just like any other type of business, it is important that a bank that doesn’t make a profit is able to fail.
Who pays the price when a bank goes bust?
If a bank goes bust you would want to know what happens next and who foots the bill. Back in 14th Century Barcelona, if a bank failed, the owners of the bank would be publicly condemned by the town crier and forced to live on bread and water until they repaid people they owed money to.
Fast forward to the global financial crisis that ignited in 2007, when a number of UK banks and building societies got into trouble. In the end the government had to step in using tax payers’ money to bail out failing banks.
Things have changed since then. The Bank of England has a new set of tools that allow it to step in quickly where needed.
A bank failure today would play out in an orderly way with far less disruption to the rest of the financial system than before. And crucially, under the new set up, the cost would fall on the shareholders and creditors of the failed bank, not on tax payers.
What did we learn from the 2007-08 financial crisis?
The crisis that broke out in 2007 was one of the worst ever seen.
We learnt two important lessons about how to deal with a failing bank:
Who deals with bank failures?
At the time of the crisis, no single authority was formally responsible for dealing with failing banks.
Who pays for bank failures?
During the crisis, public funds were used to bail out a number of UK banks and building societies.
The bailouts came at a huge cost to taxpayers. They were necessary, though, to stop very serious disruption to the UK’s banking system. If that had happened, people wouldn’t have been able to pay for things or have their wages paid in the normal way.
What happens when a bank fails today?
Things are very different today.
We have been given new powers to step in if a bank fails. We also work with banks to create ‘living wills’ to show how they could be dealt with if they suffered a catastrophic shock.
So if a large commercial bank did go bust today, it could now do so in an orderly and safe way. The losses would fall on the bank’s investors, not taxpayers. And if your bank failed, you could claim back up to £85,000 of your money through the Financial Services Compensation Scheme.
The new rules are designed so that even the biggest, most complex banks can fail if they become unprofitable – but they can do this without the need for taxpayer support and without causing disruption to the financial system or wider economy.