Today, it is a common perception that the safest place to deposit money is in a bank account. But do you know how deposits in accounts actually work and what would happen if all customers wanted to withdraw their deposits?
What is a bank deposit?
When you deposit your money with a bank, you have actually made a loan to the bank. The remuneration for this form of a loan is called interest, although thanks to the reduction in interest rates, this interest has been very low in recent years, in some places even negative. Yes, the bank was essentially penalising its customers for depositing money with it.
Interest rates may be rising now, but inflation is rising along with them, erasing any interest you may have earned. Inflation can not only wipe out your profit, but even wipe out some of your saved money if it is higher than the interest rate on your account.
Current estimates of inflation are around 7 – 10%. How does your fixed deposit/savings account earn interest?
What happenes during a crisis?
Banks lend out far more money than they have deposits. In the event of a crisis, if more people suddenly decide to withdraw their money from their accounts, there may be a situation where the bank simply doesn’t have the funds.
This has happened in Cyprus, for example, where banks have been forced to limit withdrawals to a relatively small fixed amount.
This was because the banks were using your money for other purposes. So your money doesn’t just stay in the bank, as it used to in the early days of banking, where you deposited gold with a goldsmith and it was just safely stored there until you withdrew it again against a receipt. These receipts, by the way, later became what we consider money today. But that’s not how modern banking system is now working.
Banks use the money from your deposits for lending to other clients at a much higher interest rate than you have in your account. Therefore, banks only have a fraction of what their customers have deposited with them. It is called fractional reserve banking and it is how banks operate nowadays.
Cyprus and debt crisis
In 2013, Cyprus was hit by a huge debt crisis. The classic picture from that time was of closed banks and long queues at ATMs, with people wanting to get at least some of their savings out of the banks before a total collapse. However, they had limited withdrawals – just €100 per person per day.
Bank Laiki was also in trouble. People who had more than 100,000 euros (about 2.6 million crowns) deposited in the bank lost up to 80% of the value of their assets.
In the end, the EU helped Cyprus stabilize the situation, but it was ordinary people who paid the most.
Bail-in law and Deposit Insurance Fund
As such a situation could be repeated anywhere else in the EU, a so-called Bail-in law was passed throughout the EU. The Bail-in law introduced the so-called Financial Market Guarantee System, under which the existing Czech Deposit Insurance Fund was incporporated. Contributions to the Deposit Insurance Fund (DIF) are collected so that by the end of 2024 it will be filled to 1% of the volume of insured deposits. Currently there is over CZK 35 billion in the fund.
To give an idea, one medium-sized bank services deposits of approximately CZK 50 billion.
Little-known piece of information is that this insurance does not cover bills and securities – bonds, shares, units and even pension and retirement savings, life insurance (investment and capital).
So while it looks at first glance that deposits are insured and nothing can happen, you need to realize the following:
Banks do not have enough funds to pay out all their clients’ deposits at once. Not even the Deposit Insurance Fund, which is not yet sufficient to cover the deposits of the clients of a medium-sized bank, can save the day. Moreover, deposit insurance does not cover all deposits in a bank. Last but not least, in the event of a crisis, you will get your money slowly and gradually.
So is there any other option?
Fortunately, there are other ways to keep your money safe and protected from crises and inflation. Plus, you can safely earn more on your deposit than on any banking product. These options include modern digital currencies. If you want to learn more, contact us.
Sources: https://www.garancnisystem.cz/o-pojisteni-vkladu, https://cs.wikipedia.org/wiki/Bailout, https://www.penize.cz/bezne-ucty/420507-pojisteni-vkladu-kde-se-berou-penize-ktere-jisti-vase-uspory, https://www.idnes.cz/ekonomika/zahranicni/bakovni-krize-na-kypru-a-skrty-v-bance-laiki.A130327_110306_eko_euro_spi, https://www.investopedia.com/terms/f/fractionalreservebanking.asp