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Deposits, trusts, & investment management accounts

Published

Atty. Jun de Zuñiga

Atty. Jun de Zuñiga

A hypothetical example for this article is a P50-million lotto winner who has had no experience in funds management but who now suddenly finds himself with enormous cash resources. Obviously, rather than store the cash in a personal vault which is just too risky, he would need a bank to safekeep his funds.

He can be started with the simplest product, a savings deposit account, which can be followed by a checking account to facilitate his disbursements for big ticket items like car, house and lot, furnishings, and luxury vacation expenses. He may also place some funds in time deposits where, in consideration of said funds being locked in (cannot be withdrawn) for a certain period, he can be given higher interest than that given for savings deposits. Soon after, he will be presented with a menu of other bank products he may invest in for possibly even higher returns. These products could include trust accounts and investment management accounts (IMAs).

If the client puts in the P50 million in a deposit account, there arises a creditor (client) – debtor (bank) relationship between them which means that the bank has the obligation to pay back the money upon withdrawal. If the bank decides to lend out the same money to a borrower and that borrower subsequently defaults and fails to pay, the bank is nevertheless obliged to pay back the client his money. The bank is a debtor with obligation to pay the deposits, regardless of whether its borrower pays or not.

The relationship becomes different however where the client and the bank enters into a trust or IMA agreement. In such arrangement, the client in effect authorizes the bank, as trustee or agent, to lend his money to a borrower with the client benefiting from the interest paid by the borrower, with the bank earning only its commission and handling fees. It is as if the client is the lender himself with the bank acting only as a conduit. Since the client gets the bulk of the interest payments, he thus earns more as compared with the interest paid on his deposit account.

However, if that borrower defaults or fails to pay, the client suffers the loss since the bank has no legal obligation to pay the investment. Moreover, his investment is not covered by PDIC insurance since it is not considered a deposit. These are the risks attendant to trust accounts and IMAs.

Furthermore, chances are that the client may not even have had conducted a credit evaluation on the financial capability of the borrower since he may have just relied entirely on the recommendation of the bank to whom to lend his money.

Trust accounts and IMAs could already be considered as sophisticated financial products and, for consumer protection, regulations require banks to explain fully to their clients that these products are not deposits and, therefore, not guaranteed nor covered by PDIC insurance, and that these could result in losses being absorbed by the clients. Moreover, the banks are mandated to exercise a higher degree of diligence in evaluating, recommending and monitoring the accounts to whom the funds will be loaned, with the care as if these funds are their own funds. Thus, in case of breach by the bank of its fiduciary duties, the client may have basis to sue the bank, not for collection (since the bank is not a debtor) but to restore the damages he suffered arising from the bank’s negligence.

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The above comments are the personal views of the writer. His email address is jzuniga@bsp.gov.ph

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