This article has been penned for us by Stuart Langridge and whilst we hope that it will not come true, understanding how to prepare seems to be very appropriate.
March 2008 - Just a few years ago, the notion of a banking collapse, credit crunch or liquidity crisis was laughable to almost everyone. Yet here we are in early 2008 with the problems of Northern Rock in the UK, Bear Stearns in the US and a crisis of confidence between everyone else. This financial crisis has made it easy for speculators to trade on this fear - as the wild swings in UK banking stocks have recently demonstrated.
As the continues to drag down the rest of the housing market and economy, it looks like it is just a matter of time before a big bank with millions of customers goes down.
Just last week the UK's largest buy-to-let lender (a very significant piece of the mortgage market), Paragon Mortgages, announced redundancies because it has been unable to write any new business of late. If rumours are to be believed, an American lender - Thornburg - is on the verge of collapse.
Clearly, this isn't a good place to be!
The last thing that this mini-report is meant to do is frighten people into irrational action. However, there is an obvious need for families to carry out some clear headed thinking and planning. We should all be asking, "What if things really do get bad and impact me?"
There are several simple steps which virtually any family should be able to take to help them ride through a storm of a bank run.
Firstly though, lets take a peek at what may happen...
The first real issue will be panic. If a major bank collapses, customers will be in a state of shock. Never mind that they have been reading about this in their daily newspaper for months, it will still be a shock.
In our modern world, we are actually very disconnected to the things upon which we survive. Very few of us grow our own food or would know how to. Most of us have less than one week of food in the kitchen cupboard, which means that if there is a sudden lack of money, people will instantly descend on supermarkets to panic buy. But with what? If banks go under, will credit and debit cards still work?
In mid 2007 I was at the family home in Gloucestershire, England, when heavy rains and flooding hit. Luckily, we were not flooded - but the local water pumping station was. With barely any notice, the taps ran dry. As may be imagined, supermarkets were packed with people trying to buy mineral water. But oddly, they were panic buying all sorts of other products.
Gloucestershire had run out of Evian, but people were buying dozens of loaves of bread, milk in huge quantities, fruit and veg and other short life products. To me, it all seemed rather odd. There was no milk shortage, but the panic buying very nearly caused one!
Just think what might happen if there was a banking collapse and money shortage. Any spare cash would be spent on anything a family may need in the coming days and weeks. That means bare shelves in every shop in every town and city.
There would almost certainly be people without food. Most likely, these people would be city based where the constant availability of goods means that they do not plan far in advance. There would also be people who are unable to travel. A petrol shortage would be guaranteed as people filled their tanks to ensure that they can get to and from their place of work. But for those that did not or could not 'fill up'? Many staff would not be able to get to or from their place of work and business would be hampered.
In the most extreme of circumstances, this may all lead to looting and violence. The aged will be very vulnerable and will need extra help from families and neighbours.
In the short-term, governments will not be able to cope with the massive requirements they face. As days pass, supplies will be more orderly and the situation will stabilise. During previous disasters, governments have been able to focus resources and man-power to help communities. Could they do this for an entire nation?
For the majority of us, money in the bank is actually insured. The bank will have insurance plans in place and most governments guarantee deposits. However, these guarantees usually have an upper limit. This is important if the majority of your net worth is held in one account. It might be a wise idea to spread a little of it around to other banks and accounts in amounts that will be guaranteed.
The problem with banking guarantees is that it can take some time to rescue deposits from a collapsed institution. In real terms, this would mean that whilst the money itself might be 'safe' you may not have access to it for some time - and it will almost certainly not be earning any interest after a collapse.
From the perspective of stock investments - since that is what this site is about - most fund based products should be safe. Even funds invested through a bank owned fund manager are usually held by a separate company, called a custodian, to protect against this eventuality. Of course the underlying value of the assets would almost certainly be hit, and probably hit hard.
Selling assets at a time like this would be bordering on the ridiculous. In the midst of a panic, prices offered for stocks in the market will be dismal at best. If an individual is forced out of the market by a sudden panic and cash shortage as is being described here, it is hard to believe that they should have been investing at all!
The only sale that might be justified would be in the specific bank that is collapsing - though the prices will probably be in free-fall.
It is also worth pointing out that any sales made now would need to be transacted through a bank account. This would probably mean a delay in accessing the money, which would not really help in a cash crunch situation.
However, for those with access to cash on deposit, the midst of a panic can be a great time to pick up a bargain or two. For those bottom fishers or value investors looking to the long term, a banking crisis would be a fabulous opportunity to create future riches.
It is probably redundant to say this, but this would not be a time to purchase banking assets. Instead, it would be a great time to find other companies whose price has been slashed in the market chaos for no real reason.
To read the second part to this article, please visit:
Since this article was written, there was, of course, a banking crisis. While most normal depositors are not impacted when an investment bank crashes, Lehman Brothers made a huge dent in the financial system.
In Europe, the financial crisis helped the eurozone crisis to move into a higher gear, which lead to bank instability and rescues in Spain, Greece, Cyprus and Italy. While the impact was mostly contained at the time, the impact on the financial health of the continent of Europe will last for decades.
Both businesses and individuals in Cyprus faced a sobering lesson when all account balances above 100,000 euros were effectively confiscated. It ought to be added though, that there were signs that Cyprus was in deep trouble many months before the actual events took place.
In fact, the bailout Cyprus received was essentially postponed until after a general election campaign. For those watching, the warning signs were in place and there was an opportunity to make other arrangements over a period of several months.
It was for this reason that it took several weeks after the bailout before the true scale of the problem was known. While news reports and politicians were discussing the island as a haven for dirty Russian money, the reality was that whatever dirty Russian money there may have been had had chance to be moved to somewhere safer. Thus, the banks actually held far less capital than they realised.
It pays to keep a watchful eye on the location of your money and should you need to make alternative arrangements, do not hesitate to do so. Banking is a business built on confidence and should it be lost, it is very difficult to rebuild.
Please click here to return to the financial writers section.