When you put your money into a bank or building society account, you could be forgiven for thinking it sits there waiting for the time when you want to go back in and take it out. But the reality is very different.
In fact, when you give your money, you are in effect giving the provider the right to use that money in a variety of ways some of which might surprise you.
Most common uses include providing loans to customers who want to borrow money, so in effect, your current or savings account cash could actually be sitting with Mrs Miggins as part of her mortgage. The interest charged on loans is generally higher than the amount paid in savings interest, which is one way the banks make money from your money. Others would include investing in assets to generate returns – which can lead some depositors to question the ethics of the institution if, for example, those assets include oil, arms or gambling - or dealing in currency exchanges.
If you want to find out how the providers use your money and what they are investing in, you can simply ask the bank itself and they should be able to give you an answer. It is not necessarily something the staff at your local branch will be able to help you with immediately, but a question from them to the right department should elicit the answer for you.
Some providers will have details on their websites about how they use your money, especially smaller building societies and those that use this as a marketing opportunity. Ethical banks, for example, will make a statement about how and where they will invest or lend funds deposited with them. So, if you have an aversion to oil and prefer clean energy production or you would not want your money to be invested in arms, gambling, alcohol or tobacco products, then it might be worth looking at a bank with a stated ethical policy that resonates with you.
Of course, the fact that providers use your money in this way does not mean you cannot get that money out of your account when you want to. So, how can both things be happening at once?
The bank ‘pools’ all of the client assets it has within its accounts at any time, so if you want to take your money out of your account, then your withdrawal will be taken from that overall pool of money and your account balance reflects the amount of money within that pool that you are then entitled to. But remember, the bank’s own money has to be kept separate from client money, the two are never mixed and this is monitored by the regulatory authorities.
As the banks are constantly using client money to generate their own returns, which are passed on to you in interest, they never have as much as the combined value of the money from all their depositors sitting in the bank at any one time. This may sound worrying, but it is only an issue if all savers and current account holders wanted to take their money out of their account at the same time. In this case, it would be hard for the bank to survive.
The most recent case of this happening in the UK was when customers of Northern Rock queued outside branches in a desperate bid to get their money at the start of the credit crunch, forcing the Government to step in and nationalise Northern Rock in 2008. It was the first time in around 150 years there had been what is known as a ‘run on a bank’.
As a result of the Government’s need to bail out the banks in the credit crunch, the banks themselves are now required to hold more of a financial buffer so they can cope with tough economic times and these levels are stress-tested each year by the regulators, including the Bank of England.
But even if the worst should happen and a bank fails, you still have your deposits protected up to £85,000 with each institution covered by the Financial Services Compensation Scheme (FSCS). So, it is worth ensuring you have your accounts spread sufficiently to provide the highest amount of protection under the FSCS possible.
At Savings Champion, we can advise on the appropriate action to take to spread funds over different providers to reduce risk and ensure full FSCS protection. For more information please look at our FSCS Guide or call one of our savings experts on 0800 011 9705