What a bank run looks like: UK

More on the banks. And your money.

As you may know, enough people worried about BMO on Monday to drive the stock down 3% in one session. The options market flooded with about 25,000 orders to sell shares short. The puts beat the calls by a margin of 13.

Some people, believing the web-based rumours that I told you to ignore, took their money out of the bank and stuck it in others. Only Beemo knows how much cash moved.

If anything, this should remind us that banks are financial intermediaries. They do not take your cash and put it in a safe room with a honking big lock and then pay you interest. Instead they accept your money and give it to other people in the form of mortgages, loans, lines and a host of other products. The bankers make money on the spreads.

That means a run on a bank in which 95% of the deposits have been turned into loans, is a recipe for disaster.  This should surprise nobody. But it does. Which always surprises me. (Take a look at the picture above, when this happened a few months ago to Britain’s Northern Rock Bank.)

Some visitors to this blog asked about deposit insurance and what protection Canadians have in the event of a bank collapse or, for that matter, the insolvency of an investment dealer holding your investment funds or a mutual fund company with your retirement nestegg. So, let’s take a minute and review that. Then a couple of comments. First, this:

So much for blog terror: BMO profits jump
5,500,000 shares trade - up 6.8%

Regarding your bank accounts.

CDIC will only insure deposits in Canadian funds, payable in Canada and for term deposits of five years or less. Your limit is $100,000 and it covers money in savings or chequing accounts, GICs, money orders, traveller’s cheques, bank drafts or accounts which hold funds for property taxes or mortgages.

Of course, you can exceed the hundred grand in a number of ways. For example, an account in your name is insured, plus one in your spouse’s name, and a third one held jointly. Or money in a trust account for your kid has its own insurance, as does an RRSP or a RRIF – to a max of $100,000.

But not insured: Mutual funds, stocks, marketable bonds, T-bills or any debentures or debt issued by governments or corporations. Also SOL is anything in US dollars or other currencies.

So, what happens with your investment portfolio? After all, the big banks all own brokerages – like BMO Nesbitt Burns – so it’s logical to believe trouble with one might mean grief with the other. Here’s where CIPF comes in, an insurance scheme set up by the investment industry.

This is intended to cover securities that you might lose, plus cash balances, if a broker or dealer, discount brokerage or other accredited company goes paws-up. You have 180 days to make a claim, which can be for a million bucks.

As with deposit insurance, you can goose that coverage fairly easily. For example, a general account can be insured for $1 million, and then a separate account can cover retirement savings for another million (on a combined basis). Joint accounts are also covered, but the percentage proportion is added to each person’s general coverage.

And as of four years ago, there’s another plan run by the mutual fund business. The MFDA-IPC gives investors some recourse if a fund company kicks. Like the CIPF, you can claim a million for a general account and still have an equal amount for registered retirement plans.

BTW, the total paid out to investors of failed investment firms over the last 40 years amounts to a mere $36 million. See what a boring country this is?

Obvious point: If you hand over money to an investment outfit, ensure it’s part of CIPF. This is a lesson learned the hard way by Earl Jones victims. That guy was operating as a financial advisor with absolutely no credentials – and yet people entrusted their life savings to him.

Another one: CDIC has got to get with the game and dramatically increase its coverage. A hundred grand just doesn’t cut it anymore. In the US, the FDIC provides $250,000 worth of coverage each on a range of accounts. Some countries, like Ireland, have insured every dollar deposited at every bank. If Ottawa is quite convinced our banks are the best in the world (which we’re incessantly told), then what’s the problem? Cough it up, Jim.

Finally: No major Canadian bank is going to fail. Earnings this week may be lousy, and stockholders may get beat up for a while, but no depositors will be left on the sidewalk. There is no longer a government in the developed world ready to tolerate a bank failure in which public liabilities go unmet. If you don’t know that by now, you’ve not been paying attention.

This is also why I’ve been saying financials strike me as one of the safest sectors in which to invest. No limit now to the public money which would be shovelled in.

This means, of course, you might wish to stick that put, and long a call.

Garth's latest podcast is here.