FedGroup Views on Guarantees

Posted on

By John Field, CEO FedGroup

The recent crisis enveloping African Bank brings to mind the 2002 banking crisis that crippled Saambou – similarly hobbled by risky micro-lending practices. Despite African Bank performing well through previously trying periods, its performance more recently, notably following the resignation of founder and CEO Leon Kirkinis, has seen the flailing organisation placed under curatorship by the South African Reserve Bank.

The unsteady performance of any financial institution rightly places investors on high alert. They would be wise to question the security of funds placed in financial institutions. Are their investments, deemed to be “guaranteed”, indeed as safe as houses?

It is a fitting analogy, as unlike a secure investment, where monies invested are secured against an asset, such as property, the term “guarantee” is a very loose one. Furthermore, investors rarely question the conditions of the guarantee.

Generally speaking, the public confuses a guarantee with security. For example, does the guarantee maintain that an investor will get the full investment back, or that the investment will benefit from interest if it makes profit?

By contrast, secured investments are secured against an asset (property, in the case of participation mortgage bonds).

In the case of part bonds, these are secured by a registered bond in favour of the investor, and as such are safe from other claims. A guaranteed investment, as an example could be an investment in a bank. Should the institution collapse, as in Saambou’s case, investors will not receive money until the secured creditors receive their money in full.

Lending money can be a risky venture for banks. As the market dips, that risk increases – more so at the lower end of the market, which is more financially vulnerable. That risk is passed proportionately back to the investors who invest money either through shares or direct loans to the bank.

Often it is the public’s misunderstanding of the terms “guaranteed” and “secured” that result in a guaranteed investment placing the funds in jeopardy. The investing public needs to be educated regarding the difference between guaranteed and secured, as well as regulated and unregulated entities.