With everything going on in the banking sector at present - and the press reveling in the drama as usual - I thought it might be useful to provide a level-headed explanation of the situation, and how it may impact your personal finances. Is this a repeat of the infamous banking crisis of 2008, or something different, and what can you do to ensure your savings are protected?
Please note this bulletin is for general information purposes only and should not be considered personal financial advice. Investments carry risk and you may get back less than you invest. Past performance is not a guide to future performance and the value of investments may fall as well as rise.
So, what exactly has happened?
On 10th of March, SVB, a specialist US bank that predominantly served small tech businesses, collapsed into insolvency. This marked the single biggest failure of a US bank since the infamous global financial crisis of 2008.
In turn, this led to the failure of two more small US banks. Signature Bank was shut down last week, while First Republic was propped up by emergency lending from a conglomerate other banking institutions.
Then today came the news that on Sunday, the Swiss Bank, Credit Suisse, was acquired in an emergency deal with former competitor UBS. Not only was this more significant, as Credit Suisse was the second biggest bank in Switzerland, it was also a paradigm shift for the Swiss, whose world-renowned banking sector had been a source of national pride for decades.
How can a bank just suddenly fail?
In a note sent to me yesterday by our investment partners Tatton, they quoted Ernest Hemingway, who said that bankruptcy happens “gradually, then suddenly”.
Weaknesses in a company often build over time, like small cracks in the wall of a dam. Wider economic circumstances add pressure and the cracks spread. They can sometimes be spotted early if someone happens to be looking in the right place, at the right time. However in most cases, the full extent of a business’s - or a bank's - weaknesses, are only revealed when the dam reaches breaking point. Or worse, when the water bursts through.
The nature of banks means the financial system is more vulnerable than other sectors. Often the first bank failures in a downturn don’t precipitate a crisis, but they do reduce the system’s overall willingness to tolerate risk. When the next set of bad news gets out, confidence falls further and financial problems mount. We saw this a decade and a half ago with Bear Stearns and later Lehman Brothers. Cracks emerge slowly, but the shattering happened all at once.
You might have seen or heard the term, 'bank run', or 'a run on banks'. So, what does this mean then? Well, basically it's when deposit holders panic and all try to withdraw their money at the same time, for fear of the bank failing.
Remember the scenes from 2007, at the beginning of the credit crisis, when people were queuing around the block at Northern Rock to get their money out? A perfect example. Ironically, as is often the case in investments and finance, it is this panic behaviour that leads to the event that everyone is fearful of. On a smaller and less significant scale, rather like everyone fearing there being no toilet paper during Covid, panic buying all the toilet paper, resulting in there being no toilet paper.
So, a bank ruin is when a wave of scared deposit holders demand their money all at once. The bank must pay them out, which it does from it's free cash reserves (a.k.a. it's 'liquidity'). But when the run continues, if the bank’s liquidity has been all used up, what next? They have to start selling investments. If this is during a time when those investments have fallen in value, this can cause a major problem.
Selling all your investments after a market drop is the worst thing any investor can do. How to make a small fortune? Invest a large one and then pull your money out during a market dip... You just converted a temporary paper loss, into the permanent destruction of capital.
In the case of the banks they're smart enough not to do this by choice. But, when their liquidity dries up, and they must keep paying their deposits holders out, they're forced to start selling investments. In this case, many of those investments were bonds and gilts, which saw a sharp decline in value last year. So, in this way, the temporary losses on paper of banks like SVM, quickly became permanent real ones on their balance sheets. And suddenly, just like that, the bank is insolvent. 'It started gradually, then suddenly'…
So, is this the start of another banking crisis like 2008?
Whilst we cannot predict the future, it seems unlikely that we are seeing another crisis like we saw in 2008. Whilst this is a serious matter, banks have stronger balance sheets than they did during the ‘credit crunch’, due in part to intervention of regulators, who wanted to prevent a reoccurrence of the global banking crisis. Fix the roof whilst the sun is shining, as George Osborne used to say. Words to live by.
Governments are also wiser and better equipped to deal with crises such as these after the harsh lessons of '08. In the case of SVM, the US government wasted little time in stepping in to reassure deposit holders that their money would be safe, with Biden himself speaking conclusively on the matter.
In the UK, our government moved quickly to facilitate the emergency acquisition of SVM's UK banking arm by HSBC, to maintain order in the system, ensure deposits holders' money was safe and avoid the need for them to intervene directly. HSBC weren't doing this out of the goodness of their heart of course. They bought SVM UK for the princely sum of £1 (not a typo), so no doubt in time will covert this into a handsome profit further down the line.
However, the announcement on Sunday of Credit Suisse's failure, shows that the current issues are not limited only to smaller challenger banks. Credit Suisse were acquired by UBS in another emergency deal that hit the headlines. Credit Suisse had been struggling for some time, but I don’t think anyone expected them to fail to this degree, so it's a troublesome development.
For now, whilst I’m currently on annual leave, I'm keeping a close eye on the situation as it evolves. (I've written this in the sunshine, so not feeling too sorry for myself).
In the meantime, perhaps the most important question is:
What can I do to keep my money safe?
It seems highly unlikely the banking system, or world governments, would allow banks to completely fail in today's world, without bailing out deposit holders in some way. However, nothing is impossible, and it is still advisable to take precautions. I'm not taking about stuffing cash under the mattress or buying gold bullion. If you want to ensure full protection, then make sure you keep your deposits within the limits of the 'Financial Services Compensation Scheme ('FSCS'). The FSCS covers up to £85,000 per person, per banking institution, in the event of a bank going bust.
I know this is unlikely to be news to you, as we talk about it often during annual reviews, but it's worth doing a fresh audit of your savings, to check if you're exposed.
Be mindful of the 'per banking institution' part, as it's not always clear which banks form part of which groups. Got money on deposit with First Direct and HSBC? Part of the same banking group, so you only have £85,000 protected. Yorkshire Bank and Virgin Money? Both part of Clydesdale so the same applies.
Fortunately, consumer group Which have a useful online tool, that'll help you check your deposit accounts, to see if any are with the same banking group. You can access the tool by clicking here.
By setting up a few accounts with different banks and keeping within the £85,000 limit, for many people, it's not that hard to keep everything safe and sound, especially if you're partnered or married. However, for those of you with higher levels of savings, especially those into seven figures, it gets a bit trickier, especially if you are single. You can soon end up with deposits all over the place, a multitude of banking apps on your phone, and an administrative headache.
This is where NS&I comes in. Yes, I know I'm always banging on about NS&I (I should be on the payroll by now), but it really is the bank of security and simplicity. The NS&I Direct Saver allows you to deposit up to £2m per person, on an instant access basis. The best part is that ALL your money is protected, not just the first £85,000, as NS&I is the government's bank. This avoids the need to have accounts all over the place, if you're holding large amounts of capital on deposit.
Yes, the interest rate isn't quite as sharp as some of the banks and building societies, but I'd take security on larger sums over a bit of interest rate premium all day long, and it's still paying 2.85%, so not too shabby for instant access. Accounts can be set up easily online via their website, so if you have a substantial sum in a single bank or building society, that is far beyond the FSCS limit, you might want to consider an NS&I Direct Saver, if you want to copper-bottom the security of your savings.
The same applies if you're looking at an imminent business sale, or major capital event. Even if the deal is yet to complete, you can set up an NS&I account ahead of time, so you have somewhere to deposit the funds when the transaction completes. You can then take your time thinking about what comes next, knowing that the proceeds are in a safe place. Of course, in the case of especially large capital events, issues can remain if you've fully used your NS&I entitlements. However, between that and splitting the remainder between different banks, you're taking steps to keep your money safe from a banking failure.
