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Sunday, 18 May 2014

Dual Currency deposits and the minimum wage

Not an obvious combination, but a though provoking juxtaposition.

About a year ago, it may have been more, I wrote about a pernicious product sold by a lot of banks in the Far East called a Dual Currency Deposit, or some variation on the same. The whole idea was to induce a customer to place a deposit with an apparently high rate of interest, with the catch that the deposit could be repaid by the bank in one of a choice of currencies. The choice being the bank's.

Which wouldn't be so bad if the capital redemption was converted at the spot value prevailing at the redemption date.  But oif course it wasn't. The conversion rate was fixed at the outset, and on the face of it, it might have been a reasonable forward rate. In practice the value of the eventual spot rate would be very different from the fixed rate and the bank had the option to put the cheaper currency back to the customer saving far more the customer had been paid as an interest premium.

Now, sometimes the customer could win. If the future spot rate was the same as the fixed rate in the contract, then the customer didn't lose on the redemption and got paid some extra interest.  But the bank always made money, With the implied currency option against the customer, the bank could write an option with the market to close out the position and pick up an option premium which would be worth substantially more than the bank would pay the customer in extra interest.

Basically the customer got screwed because he didn't understand the risk or the value of the currency embedded in the deposit contract. And yet when pushed on the points, they repeatedly said that their customers were indifferent as to whether they were repaid in currency A or currency B. And often the customers could be persuaded to say the same.  Which kind of missed the point.  The customer could have withdrawn his deposit and converted it into the other currency if the urge took him at the end of the contract. The issue was never the currency but the value of money that would be repaid.

So what has that got to due with the National Minimum Wage? On the face of it not very much, until we realise the role of the NMW's first cousin, the Zero Hours Contract.  For years we were told by its advocates that an NMW wouldn't have an effect on employment, whilst its opponents said that it would be devastating for unemployment/ In came the NMW and apparently employment levels didn't change, and even as the minimum wage increased we were told that there was no impact on levels of employment.

But what we did see was an increase in the number of zero hours contrctas. What is a zero hours contract? A zero-hour contract is a contract of employment used in the United Kingdom which contains provisions which create an "on call" arrangement between employer and employee. The employer asserts that they have no obligation to provide work for the employee. The employee agrees to be available for work as and when required, so that no particular number of hours or times of work are specified. The employee is expected to be on call and receives compensation only for hours worked

Sounds great for the employer, because he gets a free option over when to call on workers. All businesses have peak periods so the employer only needs to pay for workers when they are busy.  We really like this way of working because it gives us flexibility.  And the employees like it too because it is flexible for them too. Or at least that is what some of them are wheeled out to say to the cameras.

Where have we heard this all before. Ah yes the dual currency deposit.  The employee thinks that he is getting a "flexible" deal, when in practice the option is being exercised on him, and only when it suits the business. Arguably the higher minimum wage means the worker is being paid a premium (at least over the previous rate) and like the bank in the DCD above, the employer is willing to pay this premium because the employee doesn't understand the value of the option he/she is giving the employer through the ZHC.

Moral: there is nothing wrong with ZHCs that couldn't be fixed by some serious option pricing.

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