If you hold cash in your wallet or purse, or keep it at home, it’s unlikely you’ll get it back if it’s lost. It’s also unlikely that you’ll be able to claim compensation for it, as it’s your loss. Protection against loss is one reason why significant amounts of money are usually held by financial institutions for their clients.

How safe is your money is when it’s held by someone else, such as a bank? What’s the risk of loss or disruption when you move your money?

What is money?

The majority of people think of money as cash in the physical form of banknotes or coins, or as an amount held in a current account or a savings account with a bank or building society that that can be physically withdrawn by them.

The modern meaning of money is evolving, and is currently subject to political, regulatory and legal scrutiny. This has important implications for investors and regulators. If wealth is held in money (rather than assets such as property), it’s important to determine the different types of money or monetary equivalents, and the related risks and protections. Each form of money comes with its own risk profile.

Who can hold my money?

Essentially the only entities that are permitted to hold your money are regulated financial institutions (subject to transactional exceptions). These include banks and professional custodians.

How are entities that hold my money regulated?

Financial institutions that accept your money as deposits or as client money in the UK are subject to extensive rules and regulations. Their conduct is supervised by the Financial Conduct Authority and the Prudential Regulation Authority, among other regulatory bodies.

A central purpose of financial regulations is to ensure the stability of the financial industry and protect its customers. This is achieved through detailed prudential requirements that aim to protect customers against the risk of losing or delayed repayment of their money in an insolvency. Conduct requirements aim to ensure that financial institutions’ behaviour and organisation is appropriate.

Systemically important banks are subject to regulators’ bail-in powers. These powers affect their customers’ rights to receive the money they’re contractually entitled to be paid. It’s uncertain what would happen to your money if your bank was subject to a bail-in.

One possible consequence is that you may have to accept shares in the rescued bank rather than get your money back. Bail-in powers are broad and there’s little practical experience of what would happen if they were exercised. Importantly, bail-in powers override any contractual terms that you have agreed with your bank.

Custodians that hold money on your behalf are subject to additional regulations under the client money rules.

How is money held?

Money held in ordinary deposit accounts has less regulatory protection than money held with custodians.

If your money is held in a bank’s deposit account, and that bank goes insolvent, you’ll be an unsecured creditor. This doesn’t necessarily mean that you’ll lose all your money, but it is likely to mean that it’ll take a long time to get some or all of it back.

If your money is held by a custodian in accordance with the client money rules, you’ll have significant extra protections. Your money must be separated from the custodian’s own money and held in accordance with the FCA handbook’s client money rules. A custodian and its senior management could face significant penalties if the client money rules are breached. If a custodian is insolvent, all your money should be returned to you from the custodian’s client money accounts.

Often, a custodian might require a right to hold your money through a third party (such as another member of the custodian’s group or an overseas bank). This is permitted subject to provisos under regulatory client money rules. It does add a level of risk, and in particular a cross-border risk as your account money might be held with an overseas entity.

You may want to include terms in your custody agreement that dictate how and when your custodian can use overseas entities or other members of its group to hold your money. You may also wish to state whether you’re notified of the use of third party sub-custodians or delegates.

What if my money is held through investment managers?

An investment manager won’t hold your money itself. Typically, you’ll need to appoint a custodian and authorise the investment manager to act as your agent. They’ll make withdrawals from your client money account and make agreed payments on your behalf, in compliance with your investment management agreement.

How can I reduce my risk of loss or delayed payment?

If your money is in a client money account with a custodian, you’ll have greater regulatory protection again loss or delayed payment compared to money held in a typical deposit account.

What about my cryptocurrency?

Cryptocurrency shares some of the characteristics as money, and its name suggests that it is a form of money. It’s possible for you to buy things with certain types of crypo-tokens (such as BitCoin). In this sense, crypto-tokens, like cash, can be used as a unit of exchange.

However, a crypto-token is not money from a legal, accounting or regulatory perspective. Crypto-tokens also exist and operate outside of the traditional banking system. If you have a cash amount stated to be in a bank account, you have a contractual right against that bank for the bank to pay that cash amount to you. This required cash payment is a debt owed by the bank to you.

If you’re holding crypto-tokens, you don’t have similar rights against the crypto-token system – it doesn’t create a debt scenario against an exchange. The IMF has indicated in a letter dated 23 February 2023 that crypto-tokens should not be recognised as an official currency or legal tender.

Crypto products are themselves currently unregulated. The regulation of crypto exchanges is evolving, and the risks are uncertain for crypto-token holders. The Financial Conduct Authority has recently issued a risk warning that you should be prepared to lose all of your money if you invest in crypto-tokens.

These risks include a perceived heightened money laundering risk, lack of legal clarity as to how to categorise crypto, and that much of the crypto-token sector sits outside of the Financial Conduct Authority’s current regulatory remit.

The deputy governor of the Bank of England has warned that last year’s collapse of FTX Trading, a crypto-token trading exchange, and subsequent sell off of US$3 trillion of digital assets, provides evidence that crypto-tokens are volatile products and that if you invest in crypto-tokens, that investment is not safe. However, it’s possible to hold certain types of crypto-tokens through direct custodians, custodial (and other) technology services providers and hybrid service providers.

The crypto-token industry is developing quickly, and how your crypto-tokens are protected is also developing. Concerns about safety aside, it’s accepted that crypto is here to stay. It’s attractive to many speculators and investors for potentially high returns, the excitement of a new product and as part of a diverse investments strategy.

Managing risk of loss in practice

In reality, it’s often impractical to use the protection of client money rules alone. A combination of client money accounts and deposit accounts are commonly used.

There may be a number of reasons why deposit accounts can be more attractive. Your credit position may be protected by a compensation scheme under the applicable regulations. You may have a relatively low amount of money in that jurisdiction and the costs and administrative burden of using a custodian may be off-putting. It may be that the money held in a deposit account with the nominated bank is considered to have an acceptable credit risk.

There may also be circumstances where having multiple custodians is desirable. This might be to spread the credit risk and relationships across multiple institutions. It could also be for operational or jurisdictional reasons, or to have a fall-back custodian (a shadow custodian) to mitigate a concentration risk of using just one custodian. Positions with a primary custodian can be ported to a shadow custodian.