It won’t affect UK retail savers but the collapse of the US Lender Silicon Valley Bank (SVB) reminds us all about the importance of the Financial Services Compensation Scheme (FSCS).
As the name of the bank suggests, SVB specialised in lending to technology companies and the bank was shut down by US regulators last week (Friday 10th March) - the biggest collapse of a bank since the financial crisis in 2008.
So what happened to see the 16th largest bank in the US go bankrupt in 48 hours?
Head of Investments at The Private Office, Daniel Douglas-Wright, explains “In a nutshell, during the Covid-19 pandemic the US Government issued massive stimulus measures which saw technology companies record significant increases in revenue and profit which subsequently, saw increased deposits into SVB.
SVB then invested these increased deposits into U.S. Treasury Bonds because Government Bonds are generally considered to be lower risk investments. The risk of default is considered to be low and liquidity - the ability to buy and sell an asset without an impairment of its price - is high or perceived to be high. Therefore, it is not uncommon practice for a bank to invest deposits into these types of securities.
However, the subsequent economic issues caused by the pandemic and later the Russian invasion of Ukraine saw a big increase in inflation, which was more embedded than previously forecasted. The subsequent rise in interest rates to combat inflation and falling consumer demand created, saw costs for many companies rising, but revenue and profit falling.
As a result, many companies became under more and more pressure to meet their own funding requirements but, according to a Treasury spokesman, “tech sector companies are often not cashflow positive as they grow and they rely on cash deposits to cover their day-to-day costs”. Whether that be to pay salaries or to pay suppliers, companies needed cash from their bank – as times were getting harder.
But with higher deposit requests and falling asset prices and liquidity both occurring at the same time, both exacerbating one another, ultimately this led to SVB unable to meet client deposit requests.
So, SVB attempted to sell down its holdings in U.S. Treasuries, to raise enough cash to pay the withdrawal requests that its customers were asking for.
However, things have changed a great deal since SVB was buying those US Government Bonds. Interest rates were 0.25% - 0.50% when they purchased the bonds. They are now 4% - 4.5% and the problem is that when interest rates go up, the price of a bond goes down.
So, if the money was invested in, say a 30 year Government Bond which was purchased two years ago at $100, what happens if it’s now worth $85?
Ordinarily this wouldn’t be a problem - it's not ideal, but it's not a material issue. However, in times of panic, when multiple people are trying to do the same thing - withdraw their money from the bank - this creates a problem.
It was your quintessential “run on the bank”, driven by panic, and panic begets more panic. It's a well trodden path in markets. SVB will go down as one of the largest bank runs in history, but the cause is no different to what has happened before.
History is littered with these examples – I bet everyone remembers the run on Northern Rock in September 2007, but ultimately what we know at this moment in time, is there has been no nefarious activity, no corruption, no fraud, no Ponzi schemes, no esoteric black box leveraged investments. It was a failure in finance. A failure to hedge liabilities.
And that is how a bank goes bust in 48 hours.”
While this is still an ongoing situation in the USA, SVB does also have a UK arm which according to The Sunday Telegraph is a ‘pivotal lender’ to the tech industry. The good news for the UK tech firms caught up in the debacle is that HSBC has swooped in to buy the UK arm of SVB – paying just £1 – but bringing relief for those companies that were worried that they could go bust themselves. They will now be able to access their cash as normal.
But, if the bank were to have become insolvent, those companies with deposits held at SVB would have only been able to have access to the £85,000 that is protected by the FSCS.
What is the FSCS and what does it cover?
The Financial Services Compensation Scheme (FSCS) is in place to protect savers and compensate them if their chosen bank or building society ceases trading and is unable to return their funds. It is funded by the financial services industry in the form of a levy, paid by each UK authorised financial services firm.
Any savings provider that is authorised by the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA) is covered by the FSCS.
The FSCS currently covers up to £85,000 per person, per banking licence – so those with joint accounts would be protected up to £170,000.
And all companies that deposit funds into an FSCS protected savings provider will also enjoy the protection of £85,000.
Interestingly, the protection limit is actually at its highest level since its introduction. Before 2007, the maximum FSCS pay-out for depositors was just £31,700 per person, made up of 100% of the first £2,000 and then 90% of the next £33,000.
Since then, recognising that this was not enough to reassure savers, in October 2007 the limit was raised to £35,000 and a year later, raised again to £50,000. It was first increased to its current limit of £85,000 from 30 January 2017.
Temporary High Balances
The FSCS can also protect certain deposits above £85,000 that are held by individuals. So if you have received a large lump sum as a result of one of a number of specified major life events, temporary high balance (THB) cover may apply. This was introduced in 2015 and provides protection on up to £1m per person, per banking licence for a period of six months. This means that you would have time to carefully consider what to do with these funds, rather than making any hasty decisions.
So, although it would be terrible to see any UK retail bank or building society go bust, at least we have the comfort of knowing that in the worst case scenario, at least our cash would not be lost, as long as we keep to within the FSCS limit.
Of course, it’s important to remember that some providers share a banking licence. For example Santander and Cahoot – so if you hold £85,000 with both of these brands, only half of the money would be protected. To check if your provider has a shared licence, take a look at our FSCS Licence information Guide.
If you are in receipt of a large lump sum and would like to discuss what you could do with that money in both the short and the long term why not give us a call on 0333 323 9065 to see if we can help.
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