The government is considering increasing the amount of savers' money that is protected should a bank go bust. It says the move will increase consumer confidence in the UK banking system - but do we have a reason to worry?

The run on Northern Rock last year put a question mark over how safe our savings really are. Although the government is quick to point out that not a single person has lost any money as a result of a British bank failing, it is currently considering whether to raise the deposit protection guarantee from £35,000 to £50,000.

The proposals also include measures that will see banks provide compensation upfront into a pre-paid fund. This would mean that, if a bank or building society collapsed, savers would receive their money back - up to £50,000 - within seven days.

The new rules are expected to come into force early in 2009, but critics say raising the guarantee by £15,000 doesn’t offer any additional benefit or protection to consumers as the government is extremely unlikey to allow a bank to fail.

So why are the measures being considered? And to what extend are our savings protected?

The current rules

Prior to Northern Rock’s collapse year, 100% of the first £2,000 of your savings were protected by the Financial Services Compensation Scheme (FSCS). After this, 90% of the next £33,000 was also protected.

On 1 October, the government extended the protection limit so that 100% of the first £35,000 was guaranteed per bank, per customer.

Currently, it takes about one month for the FSCS to pay out compensation, but the government wants to make the process speedier so that people potentially receive at least some of their money back within seven days.

To achieve this, banks and building societies may be required to create a pre-paid compensation fund.

If a bank were to fail, and you had more than £35,000 in an account or with a specific bank or building society, then you would not be able to claim a refund for all money over the threshold.

Savers with more than £35,000 are, therefore, recommended to spread this across as many different organisations as needed.

What about joint accounts?

The current rules, and those being proposed, cover people with joint bank accounts. This means that, should your provider fail, you would each be covered for up to £35,000, giving you a joint protection guarantee of up to £70,000 in the account.

Under the new rules, couples with joint accounts will be able to have up to £100,000 protected per bank.

Any money over this amount would not be protected.

Are deposits with foreign banks protected?

In recent years a number of foreign banks have created UK operations offering savings accounts Brits. The presence has not gone unnoticed, especially as several have dominated the best-buy tables for saving products with attractive headline rates.

For example, two prominent Icelandic banks - Landsbanki and Kaupthing Bank - are known for their regularly offering competitive ranges of saving products.

Landsbanki launched a savings account provider called Icesave into the UK in 2006. It currently has around £5 billion in saver deposits.

Kaupthing Bank, Iceland’s largest bank, has been in the UK since 2005 but only launched a savings account earlier this year through its Kaupthing Edge brand.

In order to operate in the UK, these banks must be registered with the Financial Services Authority (FSA). Once they are registered, they are automatically enrolled in the FSCS compensation scheme – which means your money is as safe with an FSA-regulated foreign bank as it is with a British player.

However, some of these banks are covered by the FSCS and compensation schemes in their own country.

For example, Icesave is not fully FSA-regulated, so it is required to be part of the European passport scheme. This means that approximately the first £16,000 is covered by a similar compensation service in Iceland and savers would have to claim their money from there.

Once this money had been received, any outstanding compensation up to £35,000 (minus the £16,000) could be claimed back from the FSCS.

Dutch firm ING bank is similarly part of the passport scheme. However, Kaupthing Edge is fully FSA-regulated so 100% of your lost money (up to £35,000) could be claimed back directly from the FSCS.

More than one account with a bank?

The current – and proposed – compensation scheme applies per person, per bank. So, if you have two accounts with a bank, then you would still only be able to claim back the first £35,000. Any money over this amount would be lost.

The problem is, many banks are owned by the same parents and are authorised by the FSA under their group name. For example, Intelligent Finance, Birmingham Midshires, Halifax and Bank of Scotland are all part of the HBOS group.

Because the banks are authorised by the FSA under their parent group, they effectively count as one when it comes to compensation. So, if you had £35,000 with Halifax and a further £35,000 in a Birmingham Midshires account, you would only be able to claim the first £35,000.

However, other groups of banks have separate authorisation – such as the Royal Bank of Scotland and NatWest, which are both part of the RBS group.

So, if you had £35,000 with NatWest and another £35,000 with Royal Bank of Scotland, then all your money will be covered by the compensation scheme.

To see whether your bank is part of a group, and to find out if it is regulated as an individual firm or not, visit the FSA’s website of authorised firms or contact the FSA consumer helpline on 0845 606 1234.

More on:

• savings
• FSCS