Compensation for savers whose bank fails has just gone up to a maximum of £85,000

Big Ben only stopped chiming in the new year a few hours ago but there is already good news for investors: the amount of compensation they can claim for deposits made to a financial services firm that subsequently collapses rose yesterday.

Consumers can now expect to receive up to £85,000 – up from £50,000 – following the rate increase introduced by the Financial Services Compensation Scheme (FSCS), the fund of last resort for customers of authorised firms that are unable to pay claims.

A spokeswoman for the FSCS said the hike was due to new European legislation setting the compensation at the equivalent of €100,000 for consumers with deposits in a UK authorised bank, building society or credit union that fails.

"The increased limit has resulted from the Deposit Guarantee Scheme Directive," she explained. "Having one limit across Europe makes it easier for consumers to understand how much protection they are entitled to."

Such a revision of the directive on Deposit Guarantee Schemes has been long overdue. It was originally set up in 1994 to ensure that all EU member states had a safety net in place for bank account holders in case the institution failed.

However, it has remained untouched for 16 years – despite the financial services industry itself having gone through plenty of changes – and numerous international scandals having dampened the optimism of savers and investors.

The financial crisis in 2008 triggered calls for more to be done to protect savers, with a number of member states deciding that the level of protection should be gradually but quickly increased over the coming months. This resulted in a directive being issued in March 2009 which required compensation levels to rise from a minimum of €20,000 to at least €50,000 by June 2010 and to a uniform figure of €100,000 by the end of the year.

The news has gone down well with industry observers.

Justin Modray, founder of the website Candid Money, branded it "a rare case of EU regulations being welcome", and said the FSCS had a vital role to play in the current climate with people anxious about losing money.

"Without protection many savers would be reluctant to entrust their hard-earned money to a bank and probably stash it under a mattress," he said. "The compensation safety net provides security at a time when the banking system is less than robust."

He also believes the commitment to sorting out the claims and paying people their much-needed cash as quickly as possible will prove to be extremely helpful to everyone concerned."The new EU rules should also ensure that any compensation is paid within four to six weeks – but with a target of one week," he says. "They should also make it simpler to claim when accounts are held in another country."

Dennis Hall, founder of Yellowtail Financial Planning, agrees that it's a significant increase, although he points out that those in the fortunate position of having more than £85,000 to invest must remember to spread it across institutions.

"The most vulnerable members of our society will find the current level is more than sufficient," he says. "There does need to be some level of personal responsibility, which means making sure they do not place too much money in one place."

Financial Services Compensation Scheme: What you need to know

The FSCS is the UK's statutory fund of last resort for customers of financial services firms, and that means it pays compensation to consumers if such a company is unable, or likely to be unable, to pay claims against it.

Having been set up under the Financial Services & Markets Act 2000 (FSMA), it operates totally independently of both the Government and the financial services industry itself – and does not charge individual consumers for its services.

The organisation covers business conducted by firms that have been authorised by the Financial Services Authority (FSA) and protects products such as deposits, insurance policies, insurance broking, investment business and home finance.

As an aside, the FSCS is funded by levies on firms authorised by the FSA. The FSCS's costs are made up of management expenses and compensation payments.

Making a claim: What is covered and who can apply?

The regulations governing Deposit Guarantee Schemes protect all deposits held by individuals and small, medium-sized and large businesses. However, deposits of financial institutions and public authorities are not covered.

The deposits are also covered on a per depositor, per bank basis. This means that the limit of €100,000 – £85,000 in the UK – applies to all the aggregated accounts of one account holder at the same bank, including savings and current accounts.

As far as joint accounts are concerned, each account holder in such an arrangement would be eligible for compensation up to the maximum limit.

Any interest owed to the depositor on the date the bank is declared in default by the FSCS will be paid as part of the compensation amount.

Similarly, notice accounts will be paid as if notice was served on the day the account was frozen with the payment made – including interest – at the end of the notice period. Fixed-term accounts, meanwhile, will be paid at the maturity date with the interest that would have been paid by the bank at maturity date.

Is there any way of getting more money back?

It's worth bearing in mind that £85,000 may not be the absolute maximum that depositors can look forward to getting back if an institution goes to the wall. They may also receive a share of their savings above this limit following any distribution of assets as part of the insolvency process for a failed bank.

The amounts, of course, would be a matter for the insolvency practitioner to determine, and it's worth bearing in mind that it could be a number of months before this process is completed and the money passed on to savers.

Case study: Icesave

'Surprisingly painless: less stressful than dealing with banks'

Karoline Rutrecht, 32

When Karoline was looking to open up an Individual Savings Account she wanted to maximise her returns, so opted for one offered by Icesave, because it was offering the highest interest rate. News of Icesave's collapse reached her through newspaper reports, and she was worried about whether she would get any of her money back.

A number of these articles mentioned the Financial Services Compensation Scheme and that savers who had money tied up with Icesave would be going to the fund in order to get at least some of their money back.

Karoline, who works as an account manager within the public sector, recalls being reassured by the FSCS that it would handle everything; a claim that was backed up by emails outlining the expected timeline when everything would take place. Within two months she had received her money.

''It was surprisingly very painless," she recalls. "The fact that I received an email was enough for me. Money was deposited into my account within the timeframe they had indicated and there were no issues at all. It was actually less stressful than dealing with banks on a day-to-day basis.''

Case study: Square Mile securities

'It was a lifeline ... I can't praise the scheme highly enough'

Rodney Booth, 63

Rodney has every reason to thank the Financial Services Compensation Scheme. He had spent three decades working in the industry for Pearl when he was approached out of the blue by Square Mile Securities – then known as Halewood International Futures Limited.

He decided to invest a small amount of money and remembers being impressed by their confidence and the fact they told him it would be a low-risk investment. In fact, he was so upbeat about the opportunity that he ended up investing more.

Although this confidence was shattered by the collapse of Square Mile, he subsequently received a letter from the FSCS informing him that he was in line to receive compensation and asking him to file a claim, which was paid.

Rodney, who lives in Darlington, describes himself as "much wiser, if poorer", but insists that the amount of compensation he received for his Square Mile savings was "a lifeline" for which he remains very grateful.

"I can't praise it [the FSCS] highly enough," he adds. "I wouldn'tdo anything from an unsolicited call again."

The claiming process

Stage one: The FSCS receives notice of a claim and starts an investigation into the firm in question, finding that they are unable – or likely to be unable – to pay such claims.

Stage two: The firm is declared in default by the FSCS.

Stage three: The FSCS may then try to contact individual depositors with an application form on which to make a claim. At this stage individuals are welcome to make contact themselves.

Stage four: An application for a claim is submitted by the individual to the FSCS.

Stage five: The applicationsubmitted is then reviewed and processed by the FSCS.

Stage six: The individual making the claim is then informed of the decision.