This weekend saw the Irish Government open the doors to a bailout (sorry “programme”) from a Trio of the IMF, EU and ECB.
It is unclear as to how much of a “programme” we need and also why exactly we need it. I would hazard a guess we will get approved for more than we need which will probably be more than €100billion and I would also suggest that the reason we need it is that even though this crisis is now in its 3rd year we still have not got a handle on how much money the banks are going to need to keep them afloat.
Basically when the Irish government guaranteed all deposits in the Irish Banks international money flooded in. The international investors knew that if an Irish Bank defaulted it was effectively a default of the Irish Government.
Europe won’t allow us to do this because it brings the whole stability of Europe into question. So they are giving us money to invest in our banks. But why not give it to the banks? For two reasons firstly because the ECB can only give the banks a limited amount of money and it is based on the amount of cash that bank holds but secondly and most importantly if they give it to the government to give to the banks the government owes it back, not the banks.
So the trio (ECB, EU &IMF) don’t trust our banks enough to give them a wad of cash so should you with your cash. Right now probably yes, because right now the Irish government guarantee that all deposit cash is guaranteed by the state. This is due to expire at the end of this year at which point we most likely will revert to the old scheme of the state guarantee of €100,000 per individual.
We have witnessed huge withdrawals of cash from our banks in particular I believe AIB was hit fairly badly in the last week. I will say that the government guarantee scheme is useless if everyone wants their money back on the same day. A bit like in Mary Poppins when there was a run on the banks.
Neither the banks nor the government would have the reserves to pay everyone on the same day if they had to. Why not?
The reason is a matter of logistics. When you deposit your money with a bank they do several things with it. Firstly they usually invest in, but secondly they usually use their investment as security for a loan. A bank can borrow from the ECB and other banks a multiple of the money they have on deposit. When they do they usually give it out to other customers in the form of a loan (see previous article “how banks work” http://prosperous.ie/?m=200911)
If everyone wants their money back at the same time it would be difficult to unwind all the investments but more importantly it would be difficult to call in all the loans on that day. So confidence is key, right now you have the bank, the Irish government, the EU/IMF/ECB supporting your cash so it is reasonable to expect that it’s safe.
But talking to people over the weekend that is not enough, they want more security. If you move away from the banks where can you put your money? There is the credit union and there is no reason to think this isn’t a bad option. Be careful though not all credit unions partake in the government deposit guarantee scheme. But remember credit Union work on a similar basis to banks in that they are in the business of lending out your deposits to other customers in order to make a profit. They are under more stringent rules and have to hold large cash reserves to ensure the safety of customer’s money but they would also be in the same position of having to call in loans if everyone were to look for their money back today.
Life companies however work on a different basis. Life companies are the like of New Ireland, Zurich, Irish Life, Canada Life, and Aviva and so on. Some of these are owned by banks but that doesn’t matter because the life business has to be completely ring fenced from the rest of your businesses i.e. it can’t share its cash with the other businesses within a group.
Unlike a bank when a life company takes your cash off you it actually invests it on your behalf. In most cases it physically goes out and buys shares in companies on your behalf or puts it on deposit, (in many cases with international banks). Not only this, but the life company also has to hold significant cash reserves in addition to the investments it holds on your behalf.
This does effectively mean that if everyone wanted their money back it could be organised within a reasonable amount of time because all the life company would have to do is unwind the investments. There would be no need to chase down loans and in fact they already have a lump of cash sitting on the sidelines in addition to the amount you have invested.
In my mind right now if you are exceptionally worried about the banks you should consider some of the exceptionally safe investment strategies available from the life companies. You can invest with them with no investment risk and safe in the knowledge that there is significant financial strength behind them.
Note: Minimum investment with a life company is typically €5000. Investment may go up as well as down. Get good independent advice.
About the Author
Eoin McGee is the owner of Prosperous Financial Services, an independent firm regulated by the financial regulator as a multi agency intermediary and mortgage intermediary. He has over 10 years experience giving advice to both individuals and companies in relation to their finances, he can be contacted on firstname.lastname@example.org, 045 841 738 or 087 6 44 55 33.