WHY YOUR MONEY IS NOT SAFE IN THE BANK

They only have three per cent of your cash at any one time

By Gordon Kerr

WHEN you put money in your bank it is perfectly reasonable to expect that cash to be looked after by the bank and offered back to you on demand whenever you need it. Yes it is not an unreasonable assumption but sadly when it comes to the current banking system, this is incorrect . 

In fact, once you ‘deposit’ your money with a bank you effectively give them carte blanche to do what they like with it, mainly lending it out to individuals and businesses in the form of mortgages and loans, but also playing the international money markets with your hard-earned. 

So much of it is lent out in this way that if all of us demanded our cash back in the same week, we would be lucky to get three per cent of what we put in.

How is this possible? How is this allowed? Well, it has actually been the case for some time.

Lessons not learned from the Financial Crisis

Let’s go back to the Financial Crisis in the late Naughties.

The collapse of the Icelandic banking system in 2005-07 went almost unnoticed by ordinary British people, but it shouldn’t have been. 

Icelandic banks hit the headlines in 2005 when they burst on to the UK financial horizon offering savers spectacular interest rates – 10 per cent per annum when the market rate was five per cent. Understandably they attracted hundreds of millions of deposits, but sadly these banks were owned and managed by a handful of individuals, all of whom ended up on the FBI’s “most wanted” list of international criminals.  

But most ordinary folks barely noticed the ensuing bank bankruptcies because their savings were safe, thanks to government-backed deposit guarantees, which remain and were increased in the wake of the global crash of 2008-09. Today, anyone with £85,000 deposited with a banking institution has no incentive to even think about the financial health of his or her bank, because if the bank collapses, taxpayers guarantee the safety of the funds on deposit.

The reason that we should have all been more concerned about the Icelandic predicament is that these guarantees only apply to consumers, not to local authorities. We all have some form of exposure to local authorities (council tax) and mine, the London Borough of Barnet, had been lured to Kaupthingg and Landsbankki by the high levels of returns promised on deposits, which they never saw again.  

In 2008, the London Borough of Barnet reported losses of £30million of deposits which ultimately has to be paid for by the local residents. Collectively UK local authorities squandered billions. No doubt a consultant or two (never any employee) were fired.

Is your bank as robust as you think it is?

Even experts in forensic accounting would struggle today to assess the financial health of any bank.  

Why? Because the accounts of banks are governed by a system of ‘global’ rules and regulations that would take the ordinary person about 200 years to read, none of which have any realistic bearing on the assessment of bank solvency.  

All of these rules are designed to validate banks as healthy, even though all of our banks are so overleveraged and underprovided with liquid funds (i.e. actual cash) that, if the boot were on the other foot, they would never qualify for loans from each other.   

These rules – the Basel Rules – are basically only two measurements of supposed health. The first deals with leverage, the second with liquidity, i.e. access to cash in emergencies.

Leverage is just a fancy term to describe how far a bank is allowed to stretch itself.  

The Basel leverage rule restricts banks to no more than eight per cent leverage and most central banks have goosed this up to 10 per cent. In other words banks themselves should have ‘savings’ of £10 and should borrow no more than £90 against every £100 of loans which they make

It is like us borrowing for a mortgage where a hopeful first-time buyer will have to put down at least £40,000 if they want to buy a £400,000 house with the help of a 90 per cent, or £400,000 mortgage loan. However banks generally allow 95 per cent mortgages, so this rule appears to present themselves as less risky than you and me. 

But digging a little deeper, experienced critics agree that banks are allowed to mess with the rules and can run their assets through computer models which spit out a lower – much lower – number than the amount actually loaned. So low is the number that Germany’s mighty Deutsche Bank managed to crunch its numbers to the point where it had leveraged itself 98.7 per cent 

Few would consider a bank leveraged at 98.7 per cent debt to equity to be a healthy or reliable deposit taking institution, but that is not unusual in our increasingly creaky global banking system.

What if we all want our cash now?

The second Basel set of rules concerns liquidity – access to funds in an emergency in order to avert the risk of bank runs by concerned customers like us.

This fiendishly detailed rule is supposed to ensure that if a new shock occurs (like the 2008 crash), banks will be able to meet 30 days’ worth of cash outflows (us taking our money out) and thus avert any potential run by customers.

Well, you will not be surprised to find that the details of this rule undermine the whole intent of making things secure for customers. 

In fact, the key number at the root of all bank regulation reform since the crash is three per cent – the level of leverage deemed safe. So this means that banks only need to have three per cent of the actual money they have been given by customers available in any given month. If everyone in your neighbourhood decided in the same week that they wanted to take all their money out of the local bank…well, they simply would not get more than three per cent each – if that.

But today savers have no need to worry, just as Icelandic bank depositors did not in 2005. The magic money printing press will bail you out, just as it has been doing since 2008.

In fact, according to a report by Janus Henderson, global government debt is set to soar to £71trillion this year Link, which shows just how busy that printing press has been in recent years. Let’s just hope that if you and I want to get our hands on our cash at the same time soon that nothing will gum-up the printing mechanism.

Gordon Kerr is the founding partner  of Cobden Partners https://cobdenpartners.co.uk/