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Bank Deposit dilemma, the Illusion of Cash
03 Aug 2022

Cash is King, a term that is often used to signify the importance of cash flow in analysing a business. Of course, having cash gives one power, power to make purchases and in an investment portfolio, if you invest in dividend paying stocks; the power to take an income to make those purchases.

Central Banks around the world have maintained interest rates close to zero per cent since the financial crisis. However, the power of cash is under threat. Interest rates are undeniably entering a cycle of tightening. The rates one can achieve on bank deposits are insignificant, detract inflation and your Euro is melting faster than an ice-cream in the hot Maltese sun.

Across Europe, people have a significant percentage of their wealth held in bank deposits. According to the European Fund and Asset Management Association (EFAMA), combined savings increased from €10.3 trillion to €13.4 trillion between 2017 to 2021. Subsequently, deposits as a share of total financial wealth rose from 37% to 38%. Rich Nordic nations such as Denmark and Sweden both held less than 20% of their wealth in deposits as did the Netherlands. In contrast, Greece and Cyprus held the highest deposits at 82% and 78% respectively. Interestingly, Malta too had a disproportionately high level of deposits at 66%, which had risen by over 7% during the report period, the largest increase in Europe.

Naturally, we have been through a crisis where expenditure patterns have been impacted and the ability to spend curtailed. Nevertheless, the picture at an individual country level reveals the difference in attitude amongst nations and the sophistication of investors towards financial products. The EFAMA data suggests the countries with the lowest deposit savings have some of the highest exposures to pension funds and other investment products. While those with the highest deposits have the lowest exposures. One possible answer for this difference, could be the perception amongst those in this latter group, that state pension systems can be relied upon to provide a sufficient income in retirement. However, the reality is likely to be very different, especially as these countries experience an ageing population and higher government debt levels.

The Capital Markets Union (CMU) economic policy, was launched by the EU to create a single European capital market. One of the CMU’s objectives is to encourage Europeans to better use their money and switch their savings into investments. In-turn these investments can move across Europe to benefit consumers and businesses and underpin economic growth. The CMU policy is especially critical in today’s environment of super low interest rates and surging inflation. According to the EFAMA, despite deposits increasing from 2017 to 2021, once inflation forecasts of 6.8% for 2022 are taken into account, European households will suffer a collective loss of purchasing power of around €1.4 trillion on the €10.3 trillion in deposits, equivalent to an astounding €2,779 per household. The EFAMA goes on to illustrate that if households had taken a more diversified approach and reduced their deposits to 25% of their wealth and invested 50% of this excess cash in UCITS bond funds and the other 50% in UCITS equity funds; their purchasing power would have expanded by €1.1 trillion by the end of 2021. This takes into consideration market volatility investors experienced during this turbulent period. It’s evidently clear, over this 5-year period the opportunity cost of keeping high deposits has been stunted wealth.

It is paramount investors take a long-term approach with their equity investments. The longer the investment horizon the greater the likelihood of achieving a positive return on your investments. And when markets turn bearish, it’s absolutely crucial to hold your nerve and ride out the underperformance till prices rebound. No one is able to predict with any degree of accuracy how share prices will perform. The more sensible approach is to diversify your wealth across different asset classes.

The fatal mistake of far too many households is to judge their income and wealth in nominal and not real terms, neglecting to adjust for inflation, more commonly known as ‘Money Illusion’. Banks can play a large role in improving householders’ financial education. With a view to making better informed financial choices and getting their money working harder. This combined with government support and incentives to encourage investments into pensions and tax-sheltered schemes would inspire individuals to take greater ownership of their financial futures. This way we can prevent people from burying their head in the sand and disproportionately increasing bank deposits. 

This article was written by Dipak Chouhan and published on the Sunday Times of Malta. Dipak is the Head of Business Generation at Bank of Valletta.

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Bank of Valletta p.l.c. is a public limited company regulated by the MFSA and is licensed to carry out the business of banking and investment services in terms of the Banking Act (Cap. 371 of the Laws of Malta) and the Investment Services Act (Cap.370. of the Laws of Malta).