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Money, money, money: protecting against bank failures

Author: ICAEW Insights

Published: 23 May 2023

If recent bank failures are making you twitchy, what can you do to mitigate the risk of losing your hard-earned business deposits?

We talk about bank runs and the collapse of banks, but how about the depositors? What can UK-based burgeoning start-ups and flourishing SMEs do to protect their hard-earned cash?

It is worth remembering that money held in a current or savings account is, in effect, a liability for a commercial bank and, like all debtors, there is always a risk – albeit small – that you will not recover it. 

Cash conundrums

Currently in the UK, up to £85,000 of savings in your business name per financial institution is automatically protected by the Financial Services Compensation Scheme (FSCS), although some businesses are excluded

In principle, you could split your cash across several banks to maximise FSCS coverage and minimise losses in the event of a collapse. In reality, this approach is often impractical. If you’ve completed a successful capital raise, you’ll be sitting on a huge pile of cash and there are unlikely to be enough FSCS-protected baskets to protect all your eggs. 

At the same time, most SME and corporate accounts charge fixed monthly transaction fees, so the pursuit of multiple baskets could be an expensive endeavour. The administrative burden of running accounts across several banks that don’t talk to each other, each with their own approval and multi-factor authentication processes, is onerous to say the least, particularly when you’re operating a lean start-up that requires instant access to that cash to pay your staff and fund R&D and overheads. 

Start-ups often have poor control environments as resource restraints coupled with the pursuit of growth push risk management down the list of priorities. While that’s clearly not always the case, having multiple bank accounts undoubtedly increases oversight burden for management. Managing numerous bank accounts is likely to exacerbate the potential risk of fraud and/or error in an environment where resources are already stretched. 

As an SME, pooling your money to establish a strong relationship with your banking partner has the potential benefit of giving you access to more preferential rates and lines of credit. The bank is able to do this as it can see all of your transactions and can better monitor your credit risk. 

The reality is, though, that you may not have a huge amount of choice in banks. Silicon Valley Bank (SVB) was popular among tech start-ups, thanks largely to its reputation as being amenable to the banking requirements of start-ups, ie, quick and easy access to credit in the early stages where there is not much collateral. There are few other banks catering to this demographic. 

This in turn leads to concentration risk for banks; when a bank is overly exposed to one particular sector, it can quickly act as a point of failure when things go wrong. Again, SVB’s reliance on tech start-ups is a case in point: a concentration of hyperconnected tetchy tech bros contributed to a bank run materialising in record time. For that reason, ideally you would want to bank with a financial institution with a well-diversified portfolio of counterparties. 

Finding the one (or two, or three) 

You may think you’ve found the perfect banking candidate but, rather like Tinder, you need the other party to swipe right as well. The reality is, banks that tick a lot of boxes can afford to be picky and may not want to work with SMEs that they view as higher risk. 

Before you settle for the first banking partner you match with, you should do your due diligence to assess whether the pairing is conducive to a long-term relationship. To protect your money, it is important to examine the reasons behind why certain banks are more amenable to being paired up by asking yourself the following questions: 

  • Is it a smaller bank keen to win new business and increase its market share? 
  • What risks does this create to the bank and has it managed these risks adequately? Could the bank be taking on too much risk in pursuit of growth? 
  • What happens to your banking facilities if the bank gets into difficulties? Not just in a bank run, what happens if you’re not able to access your cash due to systems operational downtime – planned or otherwise? 
  • Does the bank operate internationally? How is it doing in other countries? In today’s interconnected banking market, an issue in a continent far away quickly translates into issues at home. 

Your answers will give you a good indication of where the risks with your money lie and whether you should go exclusively with one bank or spread your money across several. 

Other developments to help the cause

Open banking is promising to open up the market by allowing your business to bank with multiple partners easily and facilitating access to other non-traditional lines of credit, so that you are not at the mercy of any one bank. However, open banking is still at a relatively early stage and has only been rolled out to current accounts in the UK, which limits its utility at this point in time. Recommendations for the next phase of open banking in the UK were recently published in April, so watch this space. 

There are no straightforward answers to the conundrum of keeping your money safe. But the good news is the regulatory framework around banks in the UK is generally stronger than the US. In the UK, the regulator does not distinguish between size – if you’re a bank, it doesn’t matter if you’re big or small; bar approaches to calculating capital, you will be subject to more or less the same banking regulations (note this is likely to change somewhat with the incoming ‘Strong and Simple’ framework).

This should in theory mean smaller banks in the UK are more resilient than those in the US, where a multi-tiered system operates and banks holding below $250bn of assets are currently subject to less regulatory scrutiny. Perhaps not surprisingly, SVB and the US regional banks that recently collapsed fell into this cohort.

It is also worth noting that the UK deposit protection threshold of £85,000 is actually much lower than the US equivalent of $250,000. Bank of England Governor Andrew Bailey has indicated that the UK might need to increase its limit in light of the recent banking failures. Regulators are also considering increasing the amount insured for small businesses who need consistent access to their funds to pay suppliers and staff – for many, the current level of protection is too low to make a difference. 

Something that became apparent in the recent bank runs was how much more quickly customers in the US were able to regain access to their cash due to much higher levels of pre-funding (pre-funding is the money banks stump up initially to contribute to bank deposit insurance). The UK is looking at increasing levels of pre-funding to close the gap. It will be interesting to see what potential revised threshold for deposit protection and pre-funding is set in the UK and how the regulator negotiates the tightrope between increasing its effectiveness at preventing bank runs versus the cost to lenders. 

Short of hiding your money under a mattress – impractical, even in higher denominations, for a business – no one can stave off a bank failure. But by banking in a country with robust banking regulations and taking on some of the measures described above, you can take comfort that your money is protected as well as it can be. 

Further reading

 

Author: Polly Tsang - Financial Services Faculty 

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