by Simon Black, Sovereign Man:
A few weeks ago, one of our Europe-based Total Access members reached out to ask us about a bank account he was considering for his new business.
This is important stuff.
As I’ve written before, most people spend more time thinking about what they’re going to have for dinner than even considering whether or not their bank is safe.
In finance there’s hardly anything more critical.
Never forget that the moment you deposit your savings at a bank, it’s no longer your money.
From a legal perspective that savings becomes the bank’s money; as a depositor, you have nothing more than an unsecured claim against the bank.
They don’t actually have to give you back your deposit.
Under current regulations, banks have countless ways to freeze your account in their sole discretion, or to deny your request to withdraw money.
(If you don’t believe me, try to withdraw $25,000 in cash and see what happens.)
In many ways banks are lifelong, silent financial partners.
And given their incredible power over our finances, it certainly makes sense to spend a few minutes considering our options.
In the case of our Total Access member, he was thinking about establishing an account at a mid-size European bank and wanted our opinion about its safety.
I’ll briefly explain to you a bit about how we performed our analysis so that you can do the same with your own bank.
Just about every reasonably-sized bank in the world publishes annual financial statements.
If your bank doesn’t do this, or they don’t share the financial statements with you, take your money and run away. Immediately.
Banking implies a sacred obligation of transparency.
And if they’re not willing to be candid about what they’re doing with your savings, then they shouldn’t have your business.
This particular European bank has its annual financial statements available online.
We flipped to the balance sheet and looked for some key numbers.
Under the “assets” column, we saw immediately that the bank had “cash and cash equivalents” of 126 million euros.
Typically “cash equivalents” are stable, extremely liquid assets like short-term government bonds, reserve balances at the central bank, and even physical cash they hold in their vaults.
Next we looked in the “liabilities” column at another important number: Total Customer Deposits.
This bank’s total deposits were 8.5 billion euros.
Looking at the cash equivalents again, it means that the bank was holding about 1.4% of its customer deposits in extremely liquid, stable, short-term assets.
I call this a bank’s liquidity ratio. And 1.4% is extremely low.
It means that if more than 1.4% of this bank’s customers want to withdraw their savings or move their money abroad, the bank won’t have enough liquid funds.
Sure, 1.4% might be sufficient in good times when the financial system is stable.
But if there are ever any problems in the system like we saw in 2008, a liquidity ratio as low as 1.4% means that the bank could easily fold.
Without sufficient liquidity to honor its customers’ withdrawal requests, a bank must resort to selling other assets in order to raise the cash that it needs.
After all, if a bank only holds 1.4% of its customers’ deposits in cash equivalents, then it should have at least 98.6% of customer deposits invested elsewhere.
In this particular example, the European bank had made about 5.6 billion euros in “loans”, and several billion more in “other investments”.
This is where things become very challenging for distressed banks.
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