Sunday, August 1, 2010

Dear Graham, I don’t understand how banks can fail when they run out of cash. How can they lend out more than they have?
Under the traditional banking system, depositors put their money into a bank account and got paid interest on it.
The bank would then lend out this deposited money and charge interest at a rate higher than they paid to the depositor. This difference was kept by the bank as profit.
Good interest rates would attract customers to put their money into the bank and the bank did a prudent job of only lending the money to someone they were confident of getting it back from.
Banks were regarded as safe havens for your money - hence the expression: ‘As good as money in the bank.’
This model worked fine but could occasionally backfire.
If all the depositors decided they wanted their money back, like at Northern Rock in the UK, for example, the bank would fail if it didn’t have enough money in reserves.
Also, if it lent the money foolishly to people who had no intention of repaying the debt, this could also cause the bank to fail, again if it didn’t have enough money in reserve.
If banks have demand for borrowing that exceeds what customers have on deposit, or they have in reserve, they can and do borrow the money from other banks and financial institutions.
If, as above, the bank lends foolishly, it still has a debt to repay and no revenue coming in and no reserves - putting depositors’ money at risk.
Interestingly, we came across a bank recently that will never lend out more than it has on deposit or that exceeds what it has in reserve.
So just how safe is my money in a bank?
The safety of your money depends on how much you have and in what jurisdiction the bank is.
After a recent announcement, money held in a UAE- owned bank is safe for all residents. This has now been extended to include foreign banks that have “significant operations” here, though this term still needs to be clarified properly.
Germany recently announced it will  protect all depositors, while the UK has raised its depositors’ protection scheme to £50,000 ($80,000).
The two main Channel Islands - Guernsey and Jersey - offer no depositors protection but are keen to set such schemes up. The banks there are usually  wholly owned subsidiaries of UK banks and, for the sake of their reputation, it is unlikely they would be allowed to fail if it all possible.
The Isle of Man will protect 75 per cent of your money up to a maximum of £50,000. The new limit in the US is $250,000, while Switzerland will safeguard 30,000 Swiss francs ($26,500) per depositor and there is a reported additional voluntary fund of four billion francs.
There are many other jurisdictions and it is not too hard to find details of protection with a quick search on the internet.
I paid a deposit on an apartment here more than a year ago. Until now, nothing has happened and no building has started. Feeling a little worried, I went to visit them and they ‘unofficially’ offered me my money back but would not put it in writing.
I have had the opportunity to sell it on at a profit and I wish I had taken the money as I now feel I have wasted my time. Is there anything else I can do about this?
We’ve heard of a development that was sold off-plan and the developers got the figures wrong.
They had calculated what it would cost to build the project, added their profit, sold it all off plan and sat on the money.
When they eventually went to start construction, the building costs had risen considerably and they didn’t have enough money to complete the project.
Their cunning plan was to simply return the money to the purchasers and forget about the whole thing. Many of the buyers had already ‘flipped’ the apartments at a profit but the money to be returned to them was the original purchase price. Now the developer has been instructed to complete the project.
On the other hand, your developers may be looking at giving you your money back as they now know they can sell it at a higher price.
We have said on many occasions - stick with the main developers that have a track record of completing projects and hopefully on time. In your case, you can still get your money back. At worst, wait until completion or sell now.
Graham Wolverson is an Independent Financial Adviser with Joie de Vivre International Insurance Brokerage LLC. Email him at: graham.wolverson@7days.ae