What is wrong with the way some banks work nowadays? It seems to me you can run a poor show, and when things go badly wrong the central banks will bail you out, and then off you and your highly paid colleagues can go again to mismanage your way to the next catastrophe.
The one thing I explain to people time and time again is that when you deposit any of your hard- earned cash in a bank, the bank has it is on ‘their’ balance sheets. They can then use that to go off and lend money or invest in assets where they can make more money. So effectively, they are using your money to make themselves money. The problem is that a lot of what they do may need a long timeline to work, so if people start demanding their money in large numbers (known as a run on the bank), they may not actually be able to meet those requirements, hence they close the doors to withdrawals.
Years ago a run on a bank would take time, with people literally queuing around the block looking to withdraw their money from the person behind the counter. The trouble nowadays is that a run on the bank is so much easier to implement, with all of us having apps on our phones and laptops that mean we can ask for our money in an instant. That was one of the biggest issues contributing to the failure of Silicon Valley Bank in America a couple of weeks ago, and the start of this whole process of fear beginning again. Due to the frenzy of concerns about that bank being whipped up on social media, thousands of clients started to try and withdraw their deposits all at the same time. To say the run on the bank happened quickly would be an understatement.
It is interesting to see what happened by looking more closely at what went wrong there. The bank had a huge amount of funds on deposit, and although they were large lenders, they had a lot of excess cash doing nothing for them. They needed that to be making money for them so, in their view wisely, they bought a large amount of 10 year government bonds. They did this because government bonds are traditionally seen as safe and would earn a small return.
Then the Fed started raising interest rates in a bid to stem inflation. Of course, this then meant the value of the government bonds became more and more stressed the higher the rates went. Effectively the clients’ money was now in the wrong place and couldn’t easily be unwound. In simple terms, a pretty basic error which you would hope someone looking after your money should have been aware of.
As I write, the contagion this whole issue has caused in the banks is causing share prices to tumble again. It’s so frustrating when this sort of thing happens, as very often it’s the baby being thrown out with the bathwater, but unfortunately this is how the stock markets tend to be. Anyway, it never seems to change and the fact that the Fed raising interest rates has led to the banks ´´crumbling´´ is somewhat bizarre in my humble opinion, when they seem to think they know what they are doing!
I speak a great deal with clients about using ‘insurance’ based products to house their investments. The reasons and advantages are many but the most relevant point I like to make, and relevant to what I’ve been talking about, is when you invest your money in these companies it is physically off their balance sheet and held for your benefit only. That’s the polar opposite to leaving your money in the bank. Of course, the risk is then what you do with your money, but it’s a massive point that is regularly overlooked and gives people a high level of comfort.
This article was kindly provided by Jeremy Ferguson from The Spectrum IFA Group and originally posted at: https://spectrum-ifa.com/the-banking-industry/
The above contents and comments are entirely the views and words of the author. FEIFA is not responsible for any action taken, or inaction, by anyone or any entity, because of reading this article. It is for guidance only and relevant professional advice should always be taken before investing in any assets or undertaking any financial planning.