The Fall of Farepak Illustrates the Dangers of Borrowing From Customer Accounts

Recently I’ve seen several financial analysts talking about how Starbucks is a bank. Customers can load their Starbucks rewards accounts with money before they purchase their coffee. Then they can use their Starbucks card to purchase coffee using the money stored in the rewards account instead of using their other debit and credit cards.

These rewards accounts give Starbucks access to a lot of money. In 2016, Marketwatch reported that the Starbucks rewards accounts contained $1.2 billion. By 2019 this balance had risen to $1.6 billion. That means Starbucks can spend the money in these accounts on its own projects instead of issuing corporate bonds or taking out loans, so Starbucks can open new stores at a lower cost than other coffee shop chains because its interest expenses are lower.

Other retailers and neobanks have seen the success of Starbucks’ rewards program and realized that upfront payments provide an inexpensive source of financing for their upcoming expansion plans. But there are risks involved with these programs, and the story of the British retailer Farepak illustrates them. Starbucks is a well-managed company with a strong balance sheet, but Farepak’s parent company European Home Retail (EHR) wasn’t.

How Christmas Clubs Work

Farepak operated a savings program called a Christmas Club. With these programs, you save small amounts of money during the year to pay for a gift basket at Christmas. For example, if you saved $20 per month for 12 months you’d collect a total of $240 to spend on a Christmas basket.

A Christmas Club account also pays interest. So if the bank pays 6 percent interest on savings when a deposit is kept at the bank for a full year, you’d earn partial interest on each deposit you make to the Christmas Club account. This would work out to an average return of 3 percent, so you would earn $7.20 in interest and you’d end up with $247.20 to spend on the Christmas basket.

These programs work the same way in Britain. The main difference would be that the British depositor would save £20 a month instead of $20 in the US. But either way, the bank gets to access the money in the account for a full year and it pays interest on the balance. Programs like this are often considered socially beneficial because they encourage low-income workers to save money.

How Farepak Got Into Financial Trouble

Farepak was a British company that sold Christmas baskets, or hampers. It was founded in 1935 and thrived for nearly 70 years before it got into trouble. By that point it had been acquired by European Home Retail and was operating as a subsidiary of EHR. Farepak’s agents collected money from customers who signed up for the Christmas basket scheme. The money was then stored in Farepak’s accounts at the bank HBOS. EHR then used this money to buy other retail stores. Its subsidiaries included Kleeneaze and Kitbag.

The Christmas basket program was run by a third-party financial services company called Choice. After a customer enrolled in the savings plan, Choice obtained a voucher for a Christmas basket from a retail partner such as Tesco. Originally, retailers like Tesco did not make Choice pay for the vouchers when they were issued. The stores trusted Choice to send in the payments after Christmas.

But in early 2006, Choice defaulted on its loans while owing British retailers £50 million. Farepak now needed to find a new partner to run the voucher program. But the other voucher companies wanted upfront payments and would not let Farepak wait until Christmas to pay them back.

The Bank’s Role in the Scandal

Meanwhile, EHR was using the Christmas club money in Farepak’s accounts to make interest payments on the loans it took out to pay for its acquisitions. So neither EHR or Farepak had enough money to pay for the vouchers. Farepak asked HBOS for a bridge loan but the bank wouldn’t approve it. It’s likely that Farepak would have survived if HBOS provided a loan of £3 to £5 million.

After HBOS rejected the loan request, it encouraged Farepak to continue collecting money from its Christmas club members. But Farepak did not collect enough money to pay for the vouchers and save itself, and other banks turned down its loan requests as well. As a result, EHR and Farepak went bankrupt in late 2006 while owing the Christmas Club members £37 million. And 120,000 people did not get a Christmas basket that year.

Eventually, British judges decided that HBOS was partially responsible for the scandal. The bank initially set aside £2 million to compensate the Christmas Club members. Then, in 2012, HBOS added another £8 million to the fund after being criticized for its behavior by a judge. Lloyd’s Banking Group bought HBOS in 2009 so the second payment came from Lloyd’s.


Many analysts think that Farepak should have placed customer funds in a separate account to prevent this situation from happening. This would have prevented HBOS from using the Christmas Club members’ savings to repay EHR’s loans. The money saved for Christmas baskets would be safe even if EHR and Farepak collapsed.

But if a company with a rewards program segregated customer accounts it could not use the money in the rewards accounts as a source of low-cost loans. And that company would have less incentive to offer big discounts and deals to customers who deposit money in its rewards accounts. So there’s a trade-off involved here. Many customers would be willing to deposit money in accounts managed by a reputable company like Starbucks if they received rewards or perks for doing this.

Any company that makes a decision like that should tell its customers what it’s doing up front, instead of letting them think that their deposits are secure when they aren’t. And the customers should earn a higher interest rate on their deposits or get bigger rewards from the company if their account balances are at risk.

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