A smarter investor?
December 2008
Jolyon Larkman suggests what charities can do to protect their investments...
At one point in the financial near-meltdown of 6 and 7 October this year, it was possible to buy a share in Royal Bank of Scotland for less than the price of a Mars Bar.
As the banking system is ultimately based upon one thing – confidence – this shows how shaky things had become. Why is confidence so crucial? Well, the key function performed by every bank is the act of ‘intermediation’, and this is at the heart of the crisis.
Intermediation
In financial markets this means acting as a go-between the suppliers and users of capital. Banks are placed at a crossroads, with depositors on one side and borrowers on the other, both of which have different needs. Depositors do not place their funds with banks for very long periods, whereas borrowers often require borrowing over longer periods, particularly where the finance of capital projects is involved.
Banks long ago developed the art of delivering the longer-term finance on the back of shorter-term funding. They have also been able to access a wholesale or inter-bank money market that has grown up largely as a result of their own surplus liquidity.
The key to the successful operation of the inter-bank market was also confidence. Over the last few months, there has been a total erosion of that confidence, resulting in what can only be described as a complete seizure in the money markets.
Over the years, as banks became more trusted, they expanded their services into a range of non-lending activities, of which intermediation is also a key feature. This includes same-day or three-day sterling and foreign currency payments; credit and debit card services; insurance (both broking and underwriting) and electronic commerce. On the lending side, intermediation has expanded from the simple overdraft to term loans, leasing and project finance.
Intermediation effectively lubricates the day-to-day activities of customers, ranging from private individuals to large global corporations. This meant that as confidence slipped and supplies of capital were no longer available, there was a need for swift and decisive government action to prevent a meltdown of the system.
Bank liquidity and regulation
Banks typically borrow many times their capital to finance their business, in particular their lending. It is therefore essential that the bank has sufficient funds available to allow for the repayment of deposits and any of its other day-to-day liabilities. Because of this the taking of deposits has, for a long time, been a regulated activity.
If a bank relies on access to wholesale money markets to meet its liquidity requirements, it is not difficult to see how any doubts over a bank would result in the reduction or even removal of its access to this source of liquid funding. This is one of the root causes of the problems faced by Northern Rock.
The regulation of banks requires them to submit regular returns providing details of their balance sheets, credit risk, the adequacy of their capital and their liquidity positions. Given the current concerns of the regulators, all banks are currently being required to submit liquidity returns to the Financial Services Authority (FSA) on a weekly basis.
Much has been said in recent weeks about the state of banking regulation and in particular the FSA has made it clear that the days of so-called ‘light touch’ regulation are over. Supervision of banking activities is being tightened up. It is hoped that any new regulatory regime will be proportionate to the needs of the situation.[1]
The learnings
So what does this all mean for charities, particularly in the context of managing their funds? It is clear that a significant number of charities have been caught up in the credit crisis, in particular those with exposures to the Icelandic banks (see also Caritas, Issue 12, November 2008, page 3). So what can other charitable organisations learn from this? While further lessons are likely to emerge only once the dust has settled, there are some practical things organisations can do to avoid seeing their reserves becoming stuck in foreign banks.
- Monitor your bank’s performance. It’s not always easy for charity trustees and management teams to gain access to the information they need, but you don’t need to have a hotline to the bank manager to track the ‘health’ of organisations in which you have placed funds. You can keep up to date by reading the financial press – the business and finance sections of the broadsheet press are useful for this, as well as the Financial Times. You can also sign up for email business news bulletins from publications like the Times or read the blogs of key commentators such as the BBC’s business editor Robert Peston.[2] Access to the internet opens up a great vista of information – the problem is sifting it. My recommendation is to do an internet search of the name of any bank with which you have a deposit or fund manager looking after your investments, at least once a month, to see if there is any significant news.
- Beware the ‘best buy’ tables. You should be mindful about what ‘best buy’ recommendations in the financial press and on specialist websites actually mean. Often those listed are offering the best rates available at a given time and no more. There is no allowance made for credit quality or the risk involved in placing funds with a particular institution. Above all remember that these tables are not rating agencies. However…
- Don’t rely on rating agencies. In my experience, there does not seem to be a great deal of difference between the sound of a ratings downgrade and that of a stable door banging in the wind after the horse has bolted. In a way this does not matter as few charities have access to rating agency services, given the cost involved and the relative value to be derived. As part of the general fallout from this extraordinary time, ratings agencies are going to come under greater scrutiny and therefore probably increased regulation. It would be nice to think that one of the outcomes of this could be giving greater access to ratings information to charities, at an affordable price. You could play your own part by encouraging NCVO and acevo to press for this.
- Move to ‘safer’ options. One trend emerging already is that a charity could do worse than to deposit funds with a bank that is, to a greater or lesser extent, owned by the taxpayer (I would include National Savings in this context). There is a parallel here with the old saying related to IT managers when purchasing IT equipment: ‘No-one ever got fired for buying IBM.’ In this context it would probably be safe to assume that no treasurer of a charity or his or her finance director would be criticised for placing money with such a bank.
- Use the best buys to your advantage. Banks are actively pursuing retail deposits right now and charities will not be immune to marketing sweet talk and in particular the offer of attractive rates. There’s nothing wrong in making the most of these offers. But remember what I have already said about best buys. And also remember that those so-called ‘juicy rates’ are used to hook you in, but have a habit of disappearing after a certain period has elapsed. So make sure you diarise to move the funds when your rate is likely to change.
- Spread your risk. If you are eligible for compensation and have more than £50,000 to place in an account, look at the possibility of spreading it around a number of banks or building societies. The only downside is that you will have to deal with a considerable amount of paperwork to meet the anti-money laundering requirements of each bank and building society and keeping a tab on all those accounts will require more work.
The future
To conclude, these have been and indeed remain challenging times for us all. It seems that we are set for a recession, the depth of which appears uncertain at this stage. Looking for the positives however, from a charity’s point of view in relation to managing its cash:
- the nationalisation or part-nationalisation of banks has provided an underpinning for deposits in certain organisations;
- stronger supervision can provide greater assurance regarding the future behaviour of the banks; and
- the increase of the compensation limit to £50,000 is to be welcomed.
Ultimately, while it is easy to be sentimental and feel that savers – both personal and charity – should be protected, risk should not be removed from finance.
However, if savers do not understand that higher returns can involve more risk they will not make informed financial decisions. Perhaps the Government should consider funding the extension of financial education programmes to charities, especially small volunteer-led organisations.
Key points
· Understand what you plan to spend the money on and when. If you have short-term needs or are funding a development project, putting money into the volatile equity market is unlikely to be appropriate.
· If a bank is regularly paying top-ofthe- market rates for deposits ask yourself why. Trust your instinct.
· Ask yourself if your bank is worthy of you. If you need to borrow, you will be asked all sorts of questions. If you lend to the bank, do your own due diligence before you make a decision to deposit your funds there.
· Mix your portfolio so you balance more advantageous but secure returns with secure but mission-led returns, especially if interest rates do start to fall.
- Keep checking the status of your financial institutions – you can get guidance from the Financial Services Authority at www.moneymadeclear.fsa.gov.uk.
[1] The statement from the Treasury on financial support to the banking industry can be found at: www.fsa.gov.uk/pages/ Library/Communication/Statements/ 2008/fin_supp.shtml
[2] www.bbc.co.uk/blogs/ thereporters/robertpeston/
Author: Jolyon Larkman
Jolyon Larkman is chief operating officer at Charity Bank, and has 40 years’ experience in commercial banking. While at Barclays, he specialised in debt workout for less developed countries, chairing three committees: Nigeria, Poland and Romania. He is also chair of the board of Heritage Care and a trustee and chair of the grants committee at the London Chamber of Commerce and Industry Commercial Education Trust.
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