When savings banks aren’t safe after all

The world as we knew it shook a little bit more last week, as euro zone finance ministers took the unexpected and controversial move of imposing a levy on deposits of Cypriot savers as part of a bail-out package.

While the levy was ultimately restricted to savers with in excess of € 100,000 on deposit, the expressed intention to overturn the European-wide €100,000 deposit guarantee has shocked savers.

“It’s an unprecedented move,” says financial advisor Simon Shirley, adding that up until now, deposits had been seen as “sacrosanct”.

“Savers took comfort that it was a line in the sand that policy makers wouldn’t cross,” says Vincent Digby of Impartial financial advisers, adding that while Cyprus’s situation is an “extreme example”, it nonetheless has the potential to undermine people’s confidence in the €100,000 guarantee.

Indeed, the events of the past few weeks do show evidence of a paradigm shift in how policy makers view savers.

'Shift in the mindset'
First, we had the removal of the Eligible Liabilities Guarantee (ELG) scheme which protected deposits over €100,000 in covered institutions, and then we had the liquidation of the Irish Bank Resolution Corp (IBRC).

While some 394 depositors of the bank who were covered by the €100,000 guarantee have, to date, received compensation totalling €9.03 million, others, such as credit unions, stand to lose some of their deposits.

“There appears to be a shift in the mindset of policy makers and IBRC might be a small indicator of that. It’s [a case of] ‘we’re not here to be the nanny state and fully protect everyone’,” notes Digby.

So in light of the risks, what should savers do? The bad news is that there is no easy answer.

“There is no such thing as a risk-free guaranteed investment,” says Shirley. “There is no magic bullet, there is no such thing as a cast-iron guaranteed investment and there never was.”

For Digby, individuals need to take responsibility for their savings themselves.

“My advice to people is to research it, get help with it, consider the risks, consider the options and make a plan. Even if you decide to do nothing, at least that’s an informed decision,” he says.

Firstly, it’s worth familiarising yourself with the terms of the permanent guarantee scheme, which protects deposits of up to € 100,000 “in the event that a bank, building society or credit union is declared insolvent or a liquidator declares that it cannot repay its deposits”.

Remember that, although EBS was merged into AIB, from a guarantee perspective deposits are covered separately, which means that you can have €100,000 protected in both institutions, or €200,000 in total.

The deposit guarantee scheme is operated by the Central Bank, and covers Irish-based institutions that are regulated here. Institutions covered by the scheme must contribute 0.2 per cent of deposits into this fund, and according to the Central Bank, it currently stands at about €388 million. But is this enough?

Germany asks its banks to set aside a higher proportion of deposits, at 0.6 per cent, but again it raises the question of whether or not the funds are available to cover an insolvency?

External options
As such, the advice is to choose carefully where you put your money, although this is easier said than done. Of the "World's 50 Safest Banks", as ranked by Global Finance magazine, just one, Rabobank, accepts retail deposits in Ireland, and this has recently lost its cherished AAA rating.

It might help to remember that when you place money on deposit with a bank, you are lending that institution money. So can you trust them to pay you back your loan?

Recent events have also raised the question of whether or not the euro zone sovereign debt crisis, which has been largely quiet since European Central Bank president Mario Draghi pledged to do “whatever it takes” to save the euro, is likely to rear its ugly head again.

“I would say it has sparked fears again,” says Shirley. “We’re in completely unchartered territory”.

Digby agrees. “Risks are potentially ratcheting up again, and the needle is inching more towards the red for concern,” he says.

For savers, this may mean considering external options once more. Indeed, at the moment, the closest thing to a risk-free investment is probably German bunds.

From an investment perspective, investing in government bonds has never been the most attractive option, given that you pay tax on your interest at your marginal rate.

In addition, yields on short-term German bunds have edged into negative territory, which means that together with inflation, this option results in you losing money.

“You have to pay the German government for the privilege of lending it money,” as Shirley puts it.

Nonetheless, if you’re looking for capital preservation, bunds are hard to beat.

Spread of investments
Another option is a bank account in a stronger economy that has strong banks, with Digby noting that Deutsche Bank in Germany pays interest of 0.4 per cent on 12-month deposits.

Moving your money outside of the euro zone, means taking on currency risks. If a currency moves against you, it could destroy your capital.

While the Cyprus example has shown us that even if you had substantial deposits spread across different banks, it wouldn’t have protected you from Europe’s planned haircut on deposits, advisers still say spreading your savings minimises risks.

Shirley’s advice for savers is to have a spread of investments, with different providers covered by different guarantees.

This means opting to put some of your money into a bank such as Investec or Nationwide Building Society, which come under the UK’s Financial Services Compensation Scheme, offering cover up to €100,000 (£85,000); Rabodirect, which is covered by the Dutch scheme (€100,000); and Danske Bank, which offers protection under the Danish scheme (€100,000).

A further option posited by Shirley is to consider a money market or cash fund.

“If you look at large corporates, they don’t use single deposits – they use money market funds,” he says.

Popular with retail investors in the US, money market funds never quite caught on on this side of the Atlantic, but they could be an additional option for savers looking for a low-risk route to diversification.

The money in such a fund is invested in a range of short-term liquid assets, such as floating rate instruments, certificates of deposits, commercial paper, asset-backed securities, and government and corporate bonds, and as such, is very different to putting €100,000 into a single bank.

The downside is that returns tend to be less than stellar, at under 1 per cent, while typical fees of about 0.5 per cent per annum can wipe away any returns thus re-introducing inflation risk.

In 2012, for example, State Street’s EUR Liquidity Fund returned just 0.34 per cent, beating a benchmark return of just 0.05 per cent.

In this regard, “it’s purely a capital preservation play”, notes Shirley.