SHOW ME THE MONEY!
By Rebecca Atkinson
Tuesday, May 19, 2009.
Editor's note: This article is targeted at readers residing in Britain. Please always seek expert opinions when making financial decisions.
It's now nearly 18 months since savers queued outside Northern Rock branches to get their money out. But September 2007's infamous run on the bank continues to leave an element of doubt in the minds of many savers. The question on many people's lips is: just how safe is our money?
Since then, we've seen Northern Rock nationalised, several Icelandic-owned banks collapse and numerous mergers across the banking sector, including Santander taking over Alliance & Leicester and Bradford & Bingley's savings business, and Lloyds TSB merging with HBOS to form Lloyds Banking Group (LLOY).
In the building society sector, Nationwide has swallowed up several smaller players - most recently Dunfermline, Scotland's largest mutual. Britannia, meanwhile, intends to merge with the Co-Operative.
The Government has announced a host of measures to help stabilise the banking sector - as well as facilitating merger deals, it has bailed out both Royal Bank of Scotland (RBS) and Lloyds Banking Group, and nationalised Northern Rock and the mortgage business of Bradford & Bingley. The Bank of England, meanwhile, has lowered the interest rate to an all-time historical low and launched a quantitative easing scheme.
A lot has happened in a short period of time. To help restore shattered consumer confidence, the Government has compensated savers and upped the official protection depositors receive.
But the Financial Services Compensation Scheme (FSCS) remains complicated - and could actually count for nothing if another bank were to fail.
How does the FSCS work?
Prior to Northern Rock's collapse in 2007, 100% of the first £2,000 of your savings were protected by the FSCS. After this, 90% of the next £33,000 was also protected.
On 1 October 2007, the Government extended the protection limit so that 100% of the first £35,000 was guaranteed per bank, per customer. Since 7 October 2008, this limit has stood at £50,000.
So, if your bank were to fail, technically you would receive 100% of your money back up to £50,000. This protection is per customer, so if you have money in a joint account then you receive a guarantee for up to £100,000 in the account.
There are several "gaps" in the compensation scheme.
The FSCS covers £50,000 per customer per bank. For many people, it is the term "per bank" that causes confusion. This refers not to a bank's brand but to the type of authorisation the institution has with the Financial Services Authority (FSA).
Many banks in the UK are part of the same banking group, and in some cases are regulated by the FSA as one bank. If you have money in several different firms all authorised as the same bank by the FSA, and these all failed, then the FSCS would add up all your balances and only refund money up to £50,000.
You can find out how your bank is authorised by calling its customer services helpline. Alternatively, the FSA can provide you with this information on its helpline (0845 606 1234).
Another flaw in the current rules is that people will only receive their £50,000 back if they don't owe the institution in question (or one of its sister brands if it has single authorisation with the FSA) any money.
So, if you have a mortgage, credit card balance or personal loan plus your savings in the same bank, you could end up with nothing in compensation.
More than £50,000 in cash?
If you have more than £50,000 in cash deposits then the advice is to make sure you spread this among several different institutions (making sure they all have separate FSA authorisation).
This will ensure you receive the maximum protection possible. However, depending on how much money you have, this may seem rather complicated.
Managing several accounts isn't too difficult. But if you have to manage your money across 10 or even more, then you may find yourself wondering whether it is worth it - especially when you consider the added complication of ensuring your money is banked in firms with different FSA authorisation and that you don't have any debt with each institution.
So, is it really worth it? It should be noted that, thus far, the Government has not let a single bank 'go to the wall'. Both Gordon Brown and the chancellor Alistair Darling have repeatedly reiterated the importance of keeping banks operating, even if they end up nationalised or being propped up with taxpayers' money. It has also brokered deals between different institutions and changed competition rules to allow banks and building societies to merge more easily.
Those savers hit by the collapsed of the Icelandic banking system were also compensated with 100% of their money back - even in cases where their balances exceeded £50,000.
This suggests that the Government will not let any saver lose out financially as a result of the banking crisis.
Of course, making the assumption that this will continue to be the case in the future does carry risks. If you would rather not take the chance, then spreading your money across different institutions (making sure each balance is less than £50,000) is your only option.
How safe is your bank?
Without the aid of a crystal ball it's near impossible to know exactly what the future holds for the banking sector. While some people did foresee Northern Rock's problems before the run on the bank in September 2007, it's fair to say that barely anyone predicted exactly how deep the banking crisis would go.
Going forward, it's important to make sure your money is banked with a trusted and secure financial institution.
There are several ways you can assess the safety of a bank. The first is the share price. If the institution is listed then keep an eye on how investors are responding to it. If there's a run on the shares, then the market is aware of some kind of problem with the institution. A run on shares could also force a bank to its knees.
The second method is a trading announcement. Keep your eyes peeled for bad news from the banks.
The third is ratings agencies. Although these are designed for professionals, they can give clues to savers too. The highest rating a firm can receive is AAA - this indicates a strong company. After that comes AA, which is the rating most of the banks have. This is defined as "very high credit quality with expectations of very low credit risk".
A small number of the banks are rated one grade lower, at A. However, even this isn't considered a major risk, and is defined as: "high credit quality".
It's worth looking out for downgrades in ratings. Many have been downgraded in the recent past, such as Lloyds TSB in the aftermath of its bid for HBOS, and Barclays (BARC) after it bought Lehman Brothers' assets. A one-off downgrade from a very high rating to a slightly less high rating may not be cause for concern. However, repeated downgrades should ring alarm bells.
Finally, look at the bank's retail deposits versus its mortgage lending. Ideally, its annual savings income should be larger than its lending outgoings. Also banks and building societies that have diversified into more risky lending practices such as sub-prime mortgages or commercial property could be seen as more risky.
With thanks to Interactive Investors.