News & Insights

Weekly update - Cash options in a high-interest-rate environment

This week’s update is written by Pierre Paul, who is in our cash management team in Guernsey.

UK base rate is currently 3.00% and the Bank of England is expected to hike their main monetary policy tool by another 50 basis points to 3.50% on 15th December. This time last year UK base rate was 0.10%; the Bank of England was under pressure to raise rates due to rising inflation and took its first tentative step of tightening monetary policy with a modest, wait for it, 15 basis point increase to 0.25% on 16th December 2021.

Tightening monetary policy to the extent seen in 2022 is a seismic change given that the base rate had been virtually zero since 2009. Not great news for borrowers, especially mortgagees on short-term deals, but a welcome difference for people with savings and companies with cash at the bank. With respect to, and sympathy for, borrowers, we felt this an appropriate time to look at cash management and the options available for earning interest on cash reserves.

Before proceeding further, a safety check is warranted – bank deposits are not 100% risk-free. Banks, like any business, can go bust, as seen with Northern Rock in 2008. Since then, the UK Government has implemented a number of measures to avoid a repeat of the bank bailouts (RBS and Lloyds) seen in 2008.

Two such measures are: -

  • Ring-fencing – This is where a UK high street bank’s retail arm is legally separated from its riskier corporate division. In the unlikely event of the retail arm’s failure the government would most likely provide support. On the other hand, if the corporate division ran into trouble there would be no government bailout and depositors would risk losing some or all of their money.
  • Increased capital – The regulators found that in 2008 banks did not have enough capital to provide a safety net in the event of losses on their lending. Since 2008 the Basel III regulations require banks to hold more capital and to be less reliant on short-term money market funding. As a result, banks are generally much more secure than they were in 2008.

The measures above mean that, if a bank’s loan book goes bad, that bank should have greater capacity to absorb those losses without needing support from its shareholders, bondholders or the government.

However, for retail depositors the real game-changer is the protection of deposits under the UK’s Financial Services Compensation Scheme “FSCS”. Briefly, this scheme guarantees the safety of deposits of up to £85,000 per customer. It must be noted that this scheme only applies to UK individuals. Amounts above £85,000 are not covered by the scheme and the FSCS does not apply to non-personal customers such as charities, companies and institutions.

Guernsey and Jersey have their own similar schemes, but the maximum sum protected is lower than the UK at £50,000 in both islands.

So, the lesson here is that banks are generally safer than they used to be but that placing money with a bank is not completely risk-free. Many depositors have more than £85,000 on deposit so the excess is not protected and, of course, if a bank does go bust a depositor will almost certainly be worried about potential losses and there will be a delay whilst the compensation scheme pays out protected monies causing unwanted anxiety and inconvenience.

So what other options are there? If you are a professional or institutional client then you could opt for offshore fiduciary deposits or segregated cash management.

Offshore fiduciary deposits

This is where we, on the instruction of a client, will place a deposit in that client’s name with a bank or banks based in the Channels Islands for a fixed term from one to 12 months. The minimum amount for this service is £500,000 and the fee charged ranges from 30 to 50 basis points. As well as placing the deposit we will arrange to open the account with the selected bank or banks, thus removing this chore from the client.

Segregated cash management

The minimum amount for this service is £1 million and it should be noted that as this service uses UK banks the interest earned is UK situs income, which may have implications for offshore residents or structures. Further, because of the UK aspect of this service offshore residents need to be mindful of UK inheritance tax law. Ravenscroft does not provide tax advice so any concerns in this area need to be referred to your tax consultant.

Where UK situs income is not an issue for clients then a segregated cash management service can invest a client’s money in a range of cash or near cash instruments including: -

  • Bank deposits – Overnight, fixed term and notice accounts
  • Certificates of deposit – Short-term banking bonds
  • Treasury Bills – Short-term government bonds
  • Commercial paper – Short-term corporate debt
  • Floating rate notes – Medium-term corporate debt

Of the above the investment types most extensively used by our cash team is the certificate of deposit.

A certificate of deposit or “CD” is a fixed interest instrument issued by a bank – A CD has all the attributes of a fixed deposit namely – an amount, an interest rate and a maturity date – but unlike a fixed deposit a CD can be sold before maturity giving the holder of a CD far more liquidity than the holder of a fixed deposit. The liquidity of a CD is very helpful if your cash investment horizon is uncertain.

A further feature of a CD is that because it is in effect a short-term bond it can be bought from the issuing bank or a money broker without the need to open an account with that bank or broker. This feature gives an investor access to as many banks as there are that issue CDs. Our standard counterparty list includes a minimum of 25 well-rated banks from the UK, Europe, Scandinavia, Canada, USA and Australia. Access to so many banks means we are well placed to diversify clients’ money, thus reducing concentration risk.

Spreading money across a number of banks raises the question of diluting returns but because we manage over £2 billion and because we aggregate at the point of dealing we enjoy economies of scale only available to wholesale money market participants.

This service is governed by a discretionary cash management agreement which is a legally binding document signed by the client and gives us the discretion to invest a client’s cash within the terms of the agreement without consulting the client. Because the agreement is individual to each client it means the terms are agreed in advance to ensure that the client’s needs and preferences are taken into account, meaning that our cash investment activity is aligned to the client’s objectives.

Our team of money market professionals has been providing this service to clients for over 25 years and some of our existing clients have been using this service in excess of 20 years.

During that time, we have seen UK interest rates at over 10% and more recently as low as 0.10%. As well as interest rate changes over the years, we have also witnessed evolution of the banking sector. Titans such as Barings and Merrill Lynch have disappeared. Other names such as RBS and Lloyds might not still be here without government support and other names like Deutsche Bank, Credit Suisse and Commerzbank are not the forces they once were.

As we move from 2022 and into 2023, we wonder what will happen to interest rates. For our cash clients we are hopeful that rates will remain at or about these levels in order that cash can once again generate a meaningful yield.

We hope you have a good week.

FINANCIAL PROMOTION: The value of investments and the income derived from them may go down as well as up and you may not receive back all the money which you invested. Any information relating to past performance of an investment service is not a guide to future performance.