By Tony Booth

Keeping large sums of cash in a savings account was always considered a safe method of maintaining the value of an investment pot, but the Northern Rock event has changed how people perceive the 'safety' of UK banks and building societies.

So where and how do you deposit sums to avoid exposure to troubled financial institutions in the light of the ongoing credit crunch crisis?

Until the credit-crunch crisis hit our shores, there was only one financial institution that offered one hundred per cent safety for UK savers and that was the state-owned National Savings & Investments (NS&I).

Most people recognise NS&I as the home of premium bonds, which it is, but of course the institution also has a range of other saving account options as well, including an index-linked product and various ISA's. However, while any amount of money deposited in NS&I is fully protected by the government, the rates of return are not competitive with other providers.

In an ironic twist of fate, when Northern Rock was nationalised, it was transformed from being just about the most insecure financial institution to the safest one in the UK.

Wary

It in fact became only the second bank to have all its customers' funds completely backed by government. Unfortunately and despite the above fact, many people are still wary of putting money into Northern Rock.

Although it may offer complete security and be offering reasonable rates of return compared with other saving account providers, it must be remembered that its current nationalised status is probably only temporary.

Northern Rock is certainly the safest provider of a single savings account for funds in excess of £35,000 (see its Tracker online and Silver Savings Online accounts), but better rates can be obtained elsewhere, if you are prepared to divide large funds into smaller portions and spread them around different providers.

Until the credit-crunch crisis and the disastrous Northern Rock event, most people - including some of the country's most renowned financial advisers - believed it was unthinkable that a UK bank or building society could collapse, resulting in the loss of customers' funds. Now, 'unthinkable' has been exchanged for 'unlikely', which is a hell of shift and a direct result of the recent financial turmoil both in the UK and across the pond.

The disaster has spread outwards, striking virtually all countries across the globe and even the once considered omnipotent institutions like the Bank of England and the US Federal Reserve have been struggling to maintain stability.

Security in place

So, if we take NS&I and Northern Rock out of the equation, where are the safest places to put our property investment nest-eggs? The answer lies in understanding some of the security rules for savings, which astonishingly are rarely publicised and consequently little known, even amongst some of the most experienced and seasoned of investors.

And there's a point worth making before we go down that particular route ... part of Northern Rock's troubles were caused by mass hysteria, when the infection of media hype instilled fear into its customer-base.

What began as a fairly small and probably manageable problem at the outset was disastrously exacerbated by people withdrawing a huge volume of funds all at the same time, causing severe cash-flow difficulties for the bank's management team.

It quickly became financially crippled, because its business model had failed and it needed Bank of England support to continue trading competitively.

This was an injury it partially inflicted on itself by publicly admitting to a cash-flow problem (the rules at the time prevented it from doing otherwise).

The government decided to prevent such an occurrence repeating itself and, in October 2007, proposed legislation to allow banks and building societies to 'conceal' minor problems from the public's gaze.

Mass hysteria

In short, it has prevented rumours from creating mass hysteria - but at the same time it has made it slightly more difficult to assess which banks might be facing problems.

Thankfully, there are enough specialist journalists keeping a close eye on this, at least for the time being, so we should all learn of any impending difficulties faced by a financial institution long before it actually becomes disastrous.

Of course, once this 'hot-topic' cools off in the media, we might have to rely on self-protection methods rather than count on other people switching on the red warning lights for us.

Investors with large pots of money have the greatest difficulty in fully protecting their funds, because to do so involves spreading it around several institutions.

The maximum level of protection currently stands at £35,000 worth of savings per financial institution (subject to meeting the conditions on which this protection relies).

£100,000 max?

Government had made rumbles about extending this maximum to £100,000 - but it has since gone extremely quiet over this proposal, probably realising the cost implications should another bank or building society go pear-shaped in the current climate.

What this means is that if you have savings of £35,000 or less in a UK bank or building society account (but not all banks or building societies - see below), it is probably fully underwritten and protected, even if the institution goes belly-up.

The protection is afforded through the Financial Services Compensation Scheme (FSCS), which is an independent fund set-up by UK financial organisations and regulated by the Financial Services Authority (FSA).

The shield only applies to FSA regulated institutions and to funds and accounts designated as 'savings' (including cash-ISAs); so risk-based 'investment products', such as managed share and portfolio accounts and the portion of share sums in any newly introduced mixed cash and share ISAs, are not generally afforded the benefit of FSCS protection.

There are further complications to what might seem a straightforward safety net ... and important potential benefits that some might be able to claim, if they organise their savings appropriately.

For example, the £35,000 maximum protection is afforded to account holders per institution - not per account - and not even necessarily for what many might believe are different accounts in different banks and building societies.

So spreading your funds through several accounts won't afford any greater protection, it is still only the first £35,000 that is sheltered. More importantly, companies must be individually registered with the FSA for funds to be protected and 'the company' means 'the institution'.

Protection per bank

Things were once very simple. A bank was a bank in its own name, enjoying the autonomy that independence once brought. But some banks and building societies have merged or have been bought out by other institutions over the years, which has made for a far less straightforward picture of who owns and runs what.

And because it is only customers of the 'institution' that are afforded up to £35,000 protection, the differentiation between one company and another and which banks and building societies come under the same umbrella organisation becomes a crucial distinction.

Thus, if you have £35,000 in the Halifax and another £35,000 in Birmingham Midshires, you will actually only have half of your entire nest-egg protected - because both building societies are owned by HBOS (as indeed is the Bank of Scotland).

And even that becomes complicated, because although the Royal Bank of Scotland (RBS) is a conglomerate comprising RBS, Tesco and NatWest, the make-up of this huge financial group means customers with up to £35,000 savings in each one or any in combination would be fully protected ... unless of course you had over £35,000 in RBS and Direct Line together, because they both have the same FSA number.

Confused? I'm not surprised.

How to check

There are a few ways of checking who owns what, but frankly the backdoor method of inspecting the FSA registration number is probably the easiest, not least because all banks and building societies have to display it on their publicity material and letterheads. Providing your maximum fund allowance is held in institutions with different FSA registration numbers, the maximum £35,000 will be covered in each one.

It may be also useful to realise that an account held in joint-names in a savings account with the same financial institution affords the account with double protection benefits (up to £70,000). This arrangement is treated the same as if both individuals had separate accounts, so enjoying up to £35,000 protection each.

And the problem doesn't end there. Investors these days don't just put their money in UK banks. They also scour the globe for the best rates supplied by foreign banks and, often using the Internet, exchange one account provider with another in the blink of an eye.

While this offers investors huge advantages in terms of acquiring the best interest rates, it can be difficult to second-guess just which of these less familiar providers offers a UK equivalent level of financial security.

Many foreign banks operate direct from the UK or are considered authorised and approved UK subsidiaries and are therefore individually FSA registered. Any funds held with these institutions will therefore be awarded the same level of compensation protection as previously described.

But there is an exception to the rule that investors need to be aware of and this involves banks falling under the appropriately titled 'passport scheme'.

While banks outside the European economic area must have full FSCS benefits installed to accept UK orientated and deposited funds, some European institutions operate under the 'passport scheme' whereby their own country's compensation mechanism is triggered before any other. In practice, it is not unusual for funds to be protected by both the foreign and the UK scheme, with the foreign scheme taking precedent.

So, for example, while top-interest payers ICICI and Kaupthing Edge are fully underwritten in the UK by the FSCS, IceSave and ING Direct operate under the passport scheme.

When FSA rules don't apply

It's worth underlining a very important point here. It is possible for a bank to operate in the UK without being FSA registered and without therefore having FSCS in place. In these circumstances, any compensation would have to come from the bank's country of origin - and this may be substantially less than the level afforded through FSA regulated institutions.

There is one bit of bad news that has sprung up recently and is a knee-jerk reaction to the Northern Rock event.

While it is extremely unlikely a UK bank and even less likely that more than one bank will collapse in the near future, causing massive demands on the compensation scheme - the FSCS has installed a clause (from 1 April 2008) that effectively limits the volume of funds that can be collectively claimed under the FSCS per year to £4billion.

The FSCS has stated that in the highly dubious but possible event that its funding measures ever prove insufficient, it would trigger the promised and combined efforts of the government, the FSA and the Bank of England to come up with a remedy.

The credit-crunch crisis continues to cause ripple-effects and government has recently suggested the entire savings market and protection policies offered through the FSCS need a massive overhaul.

There is little doubt that while cash-rich property investors that have sold assets recently might be feeling cushioned and reassured sitting amongst their piles of dosh - juggling where to store it safely has become a bit of nightmare.

The best advice is to spread it around as efficiently as possible, bearing in mind if the safety-deposit door you choose doesn't have an FSA code, you shouldn't even bother trying to open it.