Is a bank really the best place to leave all your money?

Most people don’t want to leave all their money under a mattress – so where else would you store it if not in a bank account? There are other solutions which are worth looking at, especially once we explore how the system works.

You’ve worked hard to earn your money, so you want to ensure it’s protected and easily accessed when you need it. Banks are the first place we all think of for storing our cash, with their thick steel vaults, shiny debit cards and unbreakable security.

Yet, somewhere deep down, not many people seem to really like or trust banks – just look at the Trustpilot reviews for any major bank and they’ll be mediocre at best. So why is that?

What banks do with our money

Traditionally, banks exist to serve two key functions:

1. Act as a dependable place for depositing cash.
2. Act as a lending institution for people who need more cash.

But did you know, for every ￡100 you deposit in your bank account, the bank may lend up to ￡98 to somebody else?

This is known as fractional reserving, a principle that relies on only a fraction of your bank balance to actually be held by the bank. It works as follows:

It is very unlikely that you will need to withdraw all of the money in your account at any given time. ?Realistically, most people will only ever request a very small fraction of their total savings to cover day-to-day spending and occasional one-off expenses. Therefore, the bank is left with lots of money that people aren’t requesting.

This creates an opportunity for the bank – it can use the rest of your money in other ways, without you needing to ever know exactly how.

So, it uses the surplus cash it has and provides loans, mortgages and other investments to make money while you wait. Your bank balance doesn’t change, apart from a small amount of interest the bank may pay you. ?

The problem with banking and the fractional reserve

You are still the owner of your ￡100. But, somebody else also now has ￡98 which they have borrowed from the bank. The bank has essentially created ￡98 of new money from thin air, which it can do because it knows you won’t be claiming that ￡98 any time soon. This leads to the following suite of issues:

Inflation in the economy.

By leaving all your money in a bank you inadvertently propel a system of money creation, which makes goods (including houses) more expensive, and makes it harder for you to buy.

One of the biggest reasons house prices are so expensive in the UK is because of the constant creation of new money for mortgage lending purposes. This creates a spiral effect, where house prices are pushed up by the extra demand. This means people can’t afford to buy homes without mortgages, and therefore the bank creates more money, which deepens the spiral.

Devaluation of your money.

By leaving all your money in a bank you inadvertently widen the rich-poor divide.

Because of the inflationary effect of money creation, your money now buys less. The people affected most by this are the poor, who have less money to begin with. Those who already have lots of money can weather the effects of inflation. Whereas those who have less cannot and therefore fall deeper into poverty.

Economic volatility.

By leaving all your money in a bank you inadvertently contribute to macro volatility.

As noted, the creation of new money causes house prices to increase to the point of unaffordability. Eventually, even top earners cannot afford a large enough mortgage due to the sheer increase in property values. Demand for homebuying suddenly drops and the house price bubble bursts. House prices plummet, and the cycle starts again.

There has historically been a roughly 30-year boom and bust cycle in UK house prices due to this mechanism of money creation.

Debt creation.

By leaving all your money in a bank you inadvertently propagate the negative effects of interest-bearing debt.

When the bank lends on loans and mortgages, it creates a system of debt for those it is lending to. The word mortgage is from Latin and actually means death-grip! Some recent analysis by StepChange concluded that the annual impact on the UK economy of problem debt is around ￡8 billion per annum.

Bailouts.

By leaving all your money in a bank you inadvertently incentivise the bank to take excess risk with your money – for free.

Banks don’t only use our money to lend on mortgages. They are able to invest in any way they like, as long as they hold a sufficient reserve. This means that, if the bank takes on too much risk and those risks don’t pay off, it could suffer big losses.

It is then you the tax-payer, the same person trusting the bank with your money in the first place, who is expected to bail out the bank to keep it running. And if the risks do pay off, it keeps the rewards without sharing the returns.

The bank is effectively incentivised to take risk, as it has everything to gain and nothing to lose!

Zakat for Muslims.

For Muslims, by leaving all your money in a bank you inadvertently ensure your bank balance reduces by 2.5% each year, making it harder to save up.

When putting money in a bank account you are effectively hoarding wealth. It isn’t benefitting you and the only person winning from it is the bank. In Islam the hoarding of wealth is discouraged, since circulation of wealth benefits everybody from rich to poor, whilst hoarding benefits nobody.

Therefore, it is compulsory to pay 2.5% of it away to charity each year, so that at least the poor may benefit from it.

Not halal for Muslims.

For Muslims, by leaving all your money in a bank you inadvertently enter an impermissible contract (even if you choose not to take the interest).

When putting money in a bank account you are effectively lending money to the bank with interest. The money is guaranteed through the Financial Services Compensation Scheme (FSCS). It is not permissible for Muslims to earn money on money, or where the capital is guaranteed.

This is because in Islam it is necessary to take risk on capital in order to earn reward, otherwise it becomes ribba.

Is there any difference with Islamic banks?

Islamic banks operate under the same regulatory infrastructure as conventional banks:

• Regulated Islamic banks create money and use fractional reserving in the same way as above, resulting in the same adverse outcomes of inflation, rich-poor divide, economic volatility and risk taking.
• Islamic bank lending is still debt-based, with the same potentially adverse effects of problem debt. There is also difference of Islamic scholarly opinion on whether the lending mechanism is really halal.
• Zakat is still payable for Muslims, as the deposit contract is structured the same, whereas Islam discourages hoarding of wealth.
• Regulated Islamic bank accounts are also protected by the FSCS. This means, although they may operate a profit-sharing mechanism, the actual contract is not halal for Muslims since capital is guaranteed! Islamic bank account terms state explicitly that although FSCS protection is offered, if you rely upon it the contract will not be halal.

What are the alternatives?

Of course, we all need a functioning bank account for everyday transactions – but what should we be doing with the rest of our money?

We have seen above that there can be several unintended consequences of leaving all our funds in a bank account. At the same time, there is also a need to be able to protect your wealth and use it when required.

It’s super important to protect the value of your wealth, not just the amount of wealth you have. Over time, if your bank balance stays the same, your purchasing power actually decreases as inflation causes the cost of goods and services to increase. Therefore, the only way to preserve the value of your wealth ie your purchasing power, is for it to increase in line with or greater than the rate of inflation.

When investing, your capital is at risk and you could get back less than you put in. The riskier the investment, the higher the potential for losses. However, by leaving funds in a bank account you guarantee that the value of your wealth will reduce since it is eroded by inflation, and if you are Muslim you must also pay away 2.5% in zakat every year.

The safest bet is therefore generally to leave minimal amounts in a bank account for everyday spending. Then take a balanced investment approach with the rest, in line with your risk appetite and experience.

Below are some of the options available:

E-money accounts.

These operate similar to bank accounts, but without any money creation. You get a debit card and can live comfortable knowing your funds are securely ring-fenced.

• No fractional reserving or lending
• But also no return
• Muslims must pay zakat

Consider using an e-money account to store the funds you need for everyday transactions and incidentals over the next 6 months. Most of the new digital banks like Starling Bank , Tide , Monzo Bank etc offer e-money accounts. There is also Algbra in the Islamic FinTech space, though not as well established.

100% halal savings accounts.

These are few and far between; fortunately Pfida offers exactly that.

The returns are very competitive for the relatively low risk profile, and it is simple to set-up and manage with no investment experience required.

• Funds are used for real social purpose
• Returns are tax-free for most
• No zakat to pay for Muslims

There’s also no money creation and funds are 100% property-backed.

Property.

This is a relatively low risk asset class with long-term growth potential.

• Exempt from zakat
• Tax-free allowance, depending on structure

Investing in property has never been easier if you don’t have the capital to buy a full property. As well as through Pfida’s property-backed savings accounts, you can get direct exposure to property returns through the likes of Yielders and CrowdToLive? , starting from as little as ￡100.

Stocks and shares.

These are slightly riskier, but tend to outperform in the long run.

The issues for Muslim investors are that zakat calculations can be very complicated, and there are very few options available to invest in unless you subscribe to the opinion that it’s ok to invest in a company that has up to 30% ribba. I personally do not follow this opinion, but some scholars have allowed it to increase options available.

• Tax-free allowances apply

If you aren’t experienced with this type of investing, you can speak to a financial adviser to help you build a portfolio. Check out companies like Simply Ethical and Islamic Finance Guru for accessible options.

Commodities.

Typical investments such as gold and crypto can be quite volatile, but with the potential for high returns. The best investors always reserve a small allocation for high-risk investments.

• Usually taxed as income or capital gains
• Muslims must pay zakat

Wahed and Minted both offer easy access gold portfolios, and MRHB.Network provides access to crypto investments.

Conclusion

In summary, to protect our wealth and our economy, we need to think much broader than just leaving our money in a bank savings account. It may seem daunting to get into investing, but there are so many options available now to make it easy even if you have never invested before.