BKM209200 - Bank compensation restriction: commencement: examples

The following examples (M, N & O) apply to banking companies which each have a 12 month accounting period from 1 January 2015 to 31 December 2015

This is the most straightforward case, like PPI, where the issue has been ongoing for some years and continues in the year.

Example 1

Bank M has provision of £1bn brought forward. It re-assesses this at quarter end dates as follows:

  • 31 March: £150m is paid out, thinks remaining liability is £850m, no expense recognised (carrying £850m)
  • 30 June: Further £100m paid out, thinks remaining liability now £1bn, so expense of £250m recognised (carrying £1bn)
  • 30 September: Further £250m paid out, thinks remaining liability £1bn, so expense of £250m recognised (carrying £1bn)
  • 31 December: Further £150m paid out, thinks remaining liability £800m, so income of £50m recognised (carrying £800m)

At face value, total expenses in pre-commencement period are £250m; post-commencement £200m. This seems like a reasonable approach.

Example 2

The Financial Conduct Authority (FCA) makes a PPI ruling on 1 September and says that banks have to pay out in regard to a new set of cases. The facts are the same as in Example 1.

Bank N has provision of £1bn brought forward. It re-assesses this as follows:

  • 31 March: £150m paid out, thinks remaining liability is £850m, no expense recognised (carrying £850m)
  • 30 June: Further £100m paid out, thinks remaining liability now £1bn, so expense of £250m recognised (carrying £1bn)
  • 1 September: FCA rules. Bank has paid out further £150m but ruling means it thinks it is now exposed to £2bn further, so recognises expense of £1.15bn expense (carrying £2bn)
  • 30 September: Further £250m paid out, thinks remaining liability £2bn, so expense of £250m recognised (carrying £2bn)
  • 31 December: Further £150m paid out, thinks remaining liability £1.8bn, so income of £50m recognised (carrying £1.8bn)

£250m of the total expenses for the period are pre-commencement and £1.35bn (£1.15bn + £250m - £50m) is post-commencement. Time apportionment would not give a just and reasonable result, as at the commencement date the bank did not have a constructive or legal obligation in respect of the additional claims.

In this example Bank N anticipated having to pay out an additional £1.15bn following the FCA ruling on 1 September.

If instead, Bank N received a claim for £1.15bn in respect of a new conduct issue on 1 September this would be treated in a similar way to the additional claim from the FCA ruling.

Alternatively if Bank N received a new claim in respect of an existing conduct issue on 1 September, the bank does not need to allocate the expense to the date of the claim. Time apportionment will give a just and reasonable result.

Example 3

Bank O discovers at (i) 31 January, (ii) 1 July, (iii) 31 December that it has an issue, and estimates its exposure to be £1bn.

If we follow the principles at BKM209100, then the £1bn estimated at the given date should be allocated to the appropriate period. In the case of (i) and (ii), this amount will be subject to further revisions once at quarter end reporting dates and year end.

In the case of (iii), judgement is required. If the bank discovers the issue because of a ruling or other concrete event, then it seems right that all of the expense is allocated to post-commencement and disallowed. But if the bank discovers the issue in the course of compiling its accounts, and it reflects compensation paid throughout the year, then it seems that time apportionment would deliver a just and reasonable outcome.