General View of a Northern Rock. Photo: PA

Why I've stopped using banks to save (and you might want to, too)

In this age of blanket guarantees, I have changed the way I think about saving
September 12, 2017

What happens when people stop believing their savings are safe? We glimpsed the answer in 2007, when evening news bulletins led with the sight of savers queuing outside branches of Northern Rock to withdraw their money. They were scared the Rock was bust, although the Bank of England immediately stepped in with about £27bn of emergency support, so there was no danger that they would actually see their deposits evaporate.

The financial crisis had arrived. This epochal convulsion has produced countless legacies among them—thanks in part to the Northern Rock debacle—a much stronger official guarantee that money we entrust to banks is protected against losses.

A couple of weeks after the Bank of England managed to halt the run on Northern Rock, the government moved to reassure all savers their money was safe. The sum guaranteed by deposit insurance increased to £35,000 per account-holder at each banking group where they were a customer. Until then, only the first £2,000 of deposits was guaranteed while the next £33,000 enjoyed 90 per cent coverage.

Lifting the limit to £35,000 sounded reassuring, but in reality it added only £3,300 of deposit protection. A year later in October 2008, as the crisis was entering its darkest phase and world markets plummeted, stronger measures were called for. The deposit guarantee jumped to £50,000, and in 2011 it rose across the European Union to £85,000, the sum that applies today.

A decade on we again take for granted that the money we keep in banks is as safe as houses. According to the Financial Services Compensation Scheme, which administers the deposit guarantee, the £85,000 limit protects 98 per cent of the British public against any loss on their savings from banking failures. One clear effect of the huge extension of deposit insurance over the past decade, therefore, has been to offer much greater protection to wealthy Britons.

Making virtually all bank deposits risk-free assets has important implications. If the government feels it must ensure all but the richest 2 per cent of Britons face no risk of losing any of their savings in a banking collapse, the obvious corollary is that we cannot expect anything more than a minuscule return on that money: removing the last vestiges of risk from bank deposits comes at a price. And with inflation now far higher than the interest rates available on risk-free bank deposits, millions face a steady, year on year erosion in the purchasing power of their savings. The guarantee that makes them feel safe from one source of danger helps to ensure they will be exposed to another—the insidious predation of rising prices.

As a result, I no longer use banks to save. Money I might need quickly goes into premium bonds, where returns are no worse than an instant-access account and a big win is possible, if highly unlikely. My long-term cash is with non-bank finance companies earning significantly higher yields that offer decent compensation for the increased risks.

In this age of blanket guarantees, I have changed the way I think about saving. I need some guaranteed deposits that will not make a meaningful return, and for the rest I want riskier opportunities to earn interest. I think of these as “uninsured deposits.”