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Our clients often ask if our products are capital-protected.
This article aims to address that question and shed light on the financial risks around cash allocation.
Understanding what "capital protection" really means
When you deposit your cash in a checking account or term deposit, your capital is "guaranteed." Other, more complex financial products, such as structured products, may also offer so-called "capital protection".
What this means is that your bank or counterparty is contractually committed to returning your deposited funds. However, does this make your deposit risk-free? The answer is no, because your bank could fail and, as a result, be unable to honor its contract.
We often overlook the fact that, although banking institutions are subject to strict minimum capital requirements, they are highly leveraged and therefore exposed to the risk of failure.
- In the United States, the regulator (FDIC) has recorded 567 bank failures between 2001 and 2024. Last year, you surely heard about the sudden collapse of Silicon Valley Bank, which held $170 billion in deposits (mainly from businesses). It came very close to taking down a large part of the American startup ecosystem with it.
- In Europe, there is no comparable official database, but numerous banks disappeared during the 2008 crisis and subsequent Eurozone crisis. In France, we remember the dismantling of Dexia in 2011, a bank that was very active in financing local authorities.
State deposit guarantee
To maintain confidence in the banking system, most countries have established deposit guarantee schemes. In France, this system ensures depositor compensation up to 100,000 euros per bank, per customer.
But beyond this deposit guarantee limit, any funds held in the bank are exposed to the default risk of the institution. In 2013, depositors at Cyprus's largest bank, the Bank of Cyprus, faced a levy of approximately 50% on accounts exceeding 100,000 euros.
Below the 100,000-euro limit, a residual risk may still remain - the ultimate risk: sovereign default. The probability is extremely low in wealthy countries. For instance, the French state has not defaulted on its debt since 1797.
With T-Bills-backed money market funds, you're protected against the risk of bank failure
🛡️ You may wonder: is there a way to shift one's cash exposure from banking risk to sovereign risk? The answer is yes, through Treasury Bills and money market funds which are exclusively invested in T-Bills.
European prudential regulations for banks explicitly recognize that sovereign securities, such as T-Bills, carry lower risk compared to bank deposits. Specifically, assets allocated by banks to money market funds backed by T-Bills—such as those offered by Spiko—require only a tenth of the regulatory capital compared to the same amount held in bank deposits.
What about interest rate risk?
Now that we've discussed credit risk, you may be wondering about interest rate risk - the concept that stems from the fact that rising interest rates cause the market value of fixed income securities to fall. Since Treasury bills are a type of fixed-income security (to learn more, visit: An introduction to Treasury Bills), it's important to consider how money market funds, such as Spiko's, are shielded from this risk.
We will address this question in detail in our next article.
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