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Bright on Rock

The silver lining in the bank funding crisis is the lessons it has taught us about risk

Many of us have never before witnessed scenes like the Northern Rock savers queuing up to withdraw money. There are certainly lessons for us all to learn. First, the guarantee underpinning bank and building society savings is not as comprehensive as most people thought. Second, all savings and investments have a number of risks attached to them. Finally, living on a mountain of debt is not a sensible way for individuals or companies to behave over time.

Many people have been surprised to find out that their bank deposits are not entirely safe – a point the Government emphasised by providing a guarantee of the full amount to Northern Rock investors.

This has probably made the ordinary investor less trusting of the financial services industry than ever. Many savers interviewed in the streets outside Northern Rock branches had well in excess of £35,000 invested and suddenly found themselves at a level of risk beyond anticipation.

Millions of other savers realised the unintended risks they are taking with their own bank savings.

But perhaps this cloud has a silver lining. The Government and regulators have come to realise how difficult it is to run a trusted, sophisticated financial services industry. They were caught short in the real world, which has risks which cannot be eliminated or controlled.

There is no such thing as a risk-free world. There are a number of risks which can affect all forms of savings and investment:

l Capital risk. Capital is at risk through poorly run businesses as well as the systemic risks that face all economies of the world.

l Inflation risk. Capital may not be protected if the annual interest earned is less than the rate of inflation.

l Currency risk. The purchasing power of savings in a globalised world can be substantially changed by fluctuating exchange rates.

l Volatility. Investment values fluctuate as economic circumstances change.

There are no risk-free savings and investment vehicles. The recent banking turmoil and credit crunch should reinforce lessons learned from with-profits. Even if capital risk is minimised, it does not eliminate inflation, volatility and currency risk.

This lack of understanding was emphasised by the comments of one Northern Rock investor who was tempted to keep all her £750,000 savings under her mattress.

The lesson that should be underlined is the importance of diversification in savings and investment portfolios. Having a balanced portfolio across a range of investment types and with more than one institution is key to protecting capital against the range of risks to which we are all exposed.

This can only reinforce the need for good quality financial education and advice in the modern world. Perhaps this will force a more focused response to the retail distribution review from intermediaries, providers and consumers?

Some age-old adages do prevail. If it seems too good to be true, it most probably is too good to be true.

Ever rising house prices, ever rising expenditure on the NHS and other Government projects, more holidays, more consumer goods, and so on, mean that things have been too good to be true for quite some time. We now know this has been propped up by mountains of debt and the credit crunch has called on the ability to repay these debts.

“This time it’s different,” people like to say but this is one of the myths that seems to have recurred a few times over the last 20 years. Perhaps we should spend time reminding ourselves that history has a nasty habit of repeating itself.

It occurs to me that never has sound, objective financial advice been a more premium product. I would certainly pay a fee for that and perhaps these traumatic events will create an environment which will help financial advisers and customers begin to feel more confident about fee-based financial advice.

Robert Noach is head of UK financial institutions at Schroders

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