While we have all seen the headlines about debt problems in the UK, falling house prices, etc, you would have thought that the banks would be struggling to make money.  Think again!

The only real way in which banks can lose money, from their traditional banking operations, is by writing off bad debts.  You may find this a little curious because surely as interest rates fall, their profit from each loan, each mortgage  and other instruments will fall – not always.

If you watch the interest rate which banks pay savers and charge borrowers, you may start to see a difference as interest rates fall.  The popular trick is to reduce savings rates by more than they reduce debt rates, thereby increasing the difference between what they can charge for loans, etc and what they will pay savers.  This then leaves the banks to use savers money to sell more competitive loans, when in reality it is the savers who are paying for this added competitive edge – an edge which sees their “turn” on savers money increase.

Can you imagine how much money the banks used to earn from current account holders, before they started paying interest on current account balances – this was money for nothing, and the banks were sorry to see this go!

So next time you wonder how the banks make their money in a falling market, you might remember the little tricks they like to play – at the expense of their savers!

Have you ever stopped to think about what actually happens to the money which you earn and put into the bank? Does it hold its value? How are you taxed? Is it really keeping pace with inflation?

While the majority of us just place what little we have left over into the bank and see interest accruing, do you really follow the path from earnings to savings? If you take a step back and consider the events in question you may be surprised just how much you are losing before you even start to spend!

The tax situation in this country is depressing in some instances, when you consider that from your initial remuneration you will pay the following :-

• National Insurance
• Income Tax
• Pension Contributions (tax free)

The when you place your money into a bank account you will pay :-

• Tax on your interest 
• Possible monthly bank fees.

Many people believe that there is a large element of double taxation in here, when you consider that you have already paid tax on your remuneration, and then you are charged tax on the interest that you earn.  While currently there are some attractive interest rates available, you are not really benefiting by the amount you may think.  When you take into account inflation and the cost of living, there are actually situations when you income will be falling in relative terms.

So how can you rectify the situation?

There are a number of factors to consider, including :-

• Making full use of tax free vehicles, such as ISAs.
• Placing your money in a high interest account.
• Checking that you are paying the correct rate of tax.

When you actually sit back and consider the amount of money which is taken from you before you even touch your money it is frightening, and what do you get in return?

As the internet continues to bring the latest news, views and offers straight to your door step, many people are now asking about the role of Independent Financial Advisers, and whether they are actually worth the money they charge. Surely it is time to “go it alone” and look after your own affairs online?

While those with substantial experience of the financial markets themselves may well be able to “cut out the middle man”, the financial markets are still very dangerous for those who do not fully understand them.  What level of pension are your after? What can you really afford? Should you use up the equity in your home? Which tax free investments should you consider?

For many people these questions may as well be written in a foreign language, as they may mean nothing - where do you start? Who do you blame if it all goes wrong? What protection do you have?

For those who are not up to date with the financial markets and the vast number of products on offer, it is still highly advisable to go through your own Independent Financial Adviser.  They do have the experience, they do have the knowledge and above all you are protected if they give you the wrong advice.  Cutting corners with regard to your future financial well being can be incredibly risky, and should be averted unless you know what you are talking about!

As we approach the Christmas period, many people around the world will be chasing up their Christmas clubs to ensure their vouchers and money are ready for the Christmas rush.  These are people who having been saving up for nearly 12 months in order to give their families a Christmas which they will remember.  But are Christmas savings clubs safe?

Many people will remember the Farepak disaster a couple of years ago, where many many people lost the majority of their Christmas savings when the company went under.  Unknown to the many savers, their money was not ring-fenced from the company, and when the company went under the receivers claimed these funds as assets of the Group.  Many savers lost thousands and thousands of pounds, with Christmas cancelled in a number of households.

While the rules in the UK, and other countries,. have been tightened after the Farepak collapse, it is still essential that you know who is looking after your money, and what degree of protection you have.  There are many legal issues to contend with, whereby unless ring fenced from the company in specific bank accounts, your money can be claimed back by the receivers in the event of collapse.  It is therefore essential that you know how the savings club is set-up, and what would happen in the event of collapse.

It is unfortunate but there are good solid savings clubs out there who have seen their business reduced by the Farepak chapter.  Many people are turning to good old fashioned savings bank accounts, and while they have ready access to the money, many are turning a blind eye until the Christmas period.

The choice is still there, and there are Companies out there who will look after your money properly, and ensure that you get the Christmas you always wanted.

While the announcement today that the UK Treasury will guarantee all Northern Rock customer deposits has been fairly well received - probably a case of better late than never - it does beg the question, why have the government changed their policy? Are they aware of more bad news in the sector?

Properties bought for cash

As we have mentioned on some of our earlier posts, the main component of any financial market is confidence. As we are seeing now, confidence is easy to smash but not so easy to build back up over a short space of time. The move by the Treasury today, which effectively guarantees that all Northern Rock customer deposits are safe, surprised many in the market due in the main to the historic role of the authorities not to become directly involved in free market business.

Many in the markets are asking why they performed such a major u-turn, after only hours early indicating that they were not prepared to step in above and beyond the current compensation arrangements available. Do they know something that will rock the sector again? Are they so desperate to restore confidence that this is the only action they can take?

We have regularly seen authorities in the US use such a tactic to try and soften the blow of future shocks and disappointments, but this is the first time we would have seen such action in the UK, if this is the case. No matter how hard the government try, they are not able to convince the financial markets that the worst is over. Such major changes in policy can also upset markets, with suspicion and a lack of direction being pushed to the forefront.

As the UK banking turmoil continues, with rumours that more banks may be in trouble and mortgage rates are about to rise, many are asking the question. “Is our money really safe?”.  The short answer to that is yes!

While the recent turmoil has been brought about by events elsewhere in the world, which have had a knock on effect to confidence and the financial position of some UK banks, it is a situation which will not last for ever.  However, if one of the major UK banks were to close then this would send shock waves through the whole system, and have disastrous consequences for the sector.  This is something which neither the Bank of England nor the other major banks would allow to happen..

Some may remember Barings Bank and what happens there, but this is totally different as that was brought on by a rogue trader and slack financial controls.  Northern Rock, no matter what people may say, are actually a victim of circumstance, although it is highly unlikely that they will remain an independent company for much longer.

The financial system is all about confidence and this is something which will and does effect all in the sector.  The possibility of one of the major banks going out of business would push many customers to retain their savings “under the bed”, and a return to a fear of the sector - this will just not happen.  If the worst ever did happen then there are various compensation systems in place whereby victims would be covered for over 90% of their savings.

The Northern Rock saga is just the beginning of the situation and more banks will almost certainly get dragged into the situation.  While the Bank of England have taken the positive step of offering assistance to the Northern Rock, the market and the lack of confidence is a larger issue. The Bank of England can influence the markets in conjunction with there worldwide banking partners, but there will be a natural process of recovery as participants come to terms with what is happening, and confidence slowly begins to rise in due course.

As surprising as it may seem, the US stock market has hit a new all time high, against a backdrop of a creaking economy, an over extended housing market and the lowest levels of savings per member of the population for a long time.  So what really is driving the markets, and why?

There are a number of factors which are currently driving the markets which include :-

Corporate Activity

The US corporate sector is currently going through a period of major reorganisation, with many companies becoming the subject of takeover approaches or merger offers.  This has led to a highly speculative attitude from investors, who are determined not to miss out on the “next big deal”.  As price valuations get pushed to the limit, there are many investors who will suffer large losses in due course. 

If each corporate rumour where to occur, we would be seeing takeover and mergers everyday for the next year, and this is just not possible.  As some stage there will be a realisation that share valuations are being pushed to the limit, and it is just not viable for many to be valued so highly.

Feel Good Factor

Many American citizens have seen a major increase in the value of their properties over the last few years, with more and more “releasing equity” from their homes to further extend their investment portfolios.  This has led to a rush of new money into the market, which has squeezed prices higher and higher, with echoes of the 1987 crash - over exuberance and irrational investor behaviour.

Conclusion

There are now real concerns that the market is being primed for a major fall at some stage in the not too distant future.  Recent figures from the economy showed that retail spending fell sharply last month, a move which was discounted by many still chasing the next big takeover.  US average debt is growing, savings rates are at there lowest for some time and many home owners are struggling to cover their rising mortgage payments -  a recipe for success?

As the interest rate cycle continues to move still higher, we are regularly hit with the news that this is good for savers who are feeling the full benefit, but who really makes the money as interest rates rise?

You will not be surprised to see that the banking corporations can very often increase their profit margins in a rising interest rate market, and the chances are that you will not even notice it.  This is done using a very simple trick - increase borrowing costs by more than savings rates, thereby increasing your profit margins in an instant - but does it really have a major impact?

Let us show you how the situation can work :-

Prior to the last interest rate rise, let us assume the following :-

Base Rates   5.50%

Consumer Saving Rates   5.25%

Consumer Borrowing Rates 6.50%

In this situation a bank would make 0.25% on each pound of savings, if they were to put that straight back on deposit, however if they were to lend that to a customer  they would make 1.25%.  The profit margin for each situation would be :-

Placing consumer savings on deposit :-

100 * (0.25/5.25) = 4.76% profit margin

Lending consumer savings to borrowers :-

100 * (1.25/5.25) = 23.8% profit margin

However, let us assume that interest rates rise to 5.75% (as they have), and consider the following changes :-

Base Rates   5.75%

Consumer Saving Rates   5.40%

Consumer Borrowing Rates 6.80%

As you will see, in this situation savings rates have increased by less than the rise in base rates, while borrowing rates have been increased by slightly more.

The calculations are now :-

Placing consumer savings on deposit :-

100 * (0.35/5.40) = 6.48% profit margin

Lending consumer savings to borrowers :-

100 * (1.40/5.40) = 25.92% profit margin

While these increases in the profit margin of the banks may not sound much on the face of it, when you consider that the industry deals in billions of pounds each year, even a small increase in profit margins can have a massive impact upon the profitability of a company. 

This is just one of the ways that the banks use interest rate rises to increase their profitability, a technique which very often goes unnoticed unless you actually sit down and work out the figures!

While many in the banking sector have often highlighted the “free banking” culture whenever there has been any criticism of the sector, what is “free banking” and did it ever really exist?

The term “free banking” is often a very difficult one to understand because if you check the facts, have we ever really had “free banking”? Have our savings always kept pace with base rates? Have we never been charged for any traditional banking services?

The cold facts are :-

· Current accounts do not normally attract the same interest rate as deposit accounts, thereby many of us are “losing” out with our current account balance - a back door charge?

· Deposit account interest rates are nearly always less than the base rate at the time - enabling banks to “borrow” your account balance and either place on deposit in the banking system, at a higher rate, or use to fund loans to customers, at a much higher rate.

· Charges for statements are becoming more and more common, and have proved to be a nice little income stream for the banking sector.

· While not very common as yet, some banks have brought in extra charges for customers who would like a face to face meeting with an adviser and have less than a set limit in their accounts. 

· Telephone banking - there are charges incurred when phoning this service.

These are just a few of the “hidden” charges which we all probably encounter on a  regular basis, but are not necessarily aware.  So for the “free banking” myth to be used as an excuse for introducing yet more charges seems to be a very risky strategy for the banking sector. 

As they say in business, there is no such thing as a “free lunch” - perhaps the same applies to banking services, there is no such thing as “free banking”?