What Does a Bank Failure Mean for You?

Bank failures are scary. But there are ways you can protect your finances.

The failure of SVB and Signature Bank two weeks ago, coupled with the private bailout of First Republic Bank by eleven large banks, has caused people to question the safety of their bank accounts and assets held in brokerage accounts.

Should you be concerned? Of course.

Should you take all your money from the bank or brokerage account and put it under your mattress? Of course not.

Here is what we know so far.

Silicon Valley Bank and Signature Bank failed because depositors made a run on the banks. A bank run occurs when many customers look to withdraw their money from the bank at the same time (think George Bailey and the Bailey Savings and Loan). They did so over concern for the safety of their money. As more and more people withdraw funds, the bank must be able to meet the increased demand. Because banks do not keep 100% of their customers’ deposits on hand in their vaults, banks who experience a run must sell non-cash assets to keep pace with the demand from depositors.

As you can imagine, it can be difficult to sell assets at their true worth if the immediacy of funds is a significant concern. Accepting a lower price may not be acceptable during normal banking operations. Still, during a run on a bank, the bank may be forced to take a lower price just to be able to return depositors’ funds. The snowball effect of continually selling assets at depressed values reduces bank reserves more quickly. It can lead to a default, where not all funds can be returned immediately to the bank customers.

In the case of Silicon Valley Bank, what made things worse was that a large segment of their customer base was concentrated in early-stage businesses where demand for cash could be quite large. Given the slowing economy and high-interest rates, many of the bank’s clients needed to withdraw funds quicker than Silicon Valley Bank expected.

The runs on both of these banks resulted in regulators taking control of the bank. At the same time, the U.S. Treasury released a statement that all deposits would be protected, and no depositors would lose money. This promise did not extend to shareholders and bondholders for these banks.

You may ask, “Why would anyone put their money in a bank if these events can happen?”

The fact is that keeping money in a bank is still safer than keeping it under the mattress. FDIC Insurance provides deposit insurance to depositors in U.S. banks. The FDIC was created in 1933 in response to thousands of bank failures during the 1920s and early 1930s. In addition to cash held in banks, FDIC Insurance covers CDs, Money Market Deposit Accounts (MMDA), cashier’s checks, and money orders.

The insurance provided by the FDIC is not unlimited. The amount of FDIC Insurance is limited to $250,000 per depositor, per insured bank, for each ownership category. As an example, a checking account owned by an individual is insured for up to $250,000. If another person is added to the ownership of that account, then the insurance for that account increases to $500,000. Someone who owns an individual bank account and a joint account would have $750,000 of coverage.

It is important to note that FDIC Insurance is only available to banks that participate in the FDIC Insurance program. While it is most likely your bank participates in FDIC Insurance, if you wish to confirm, you can contact your bank or use the following link: https://banks.data.fdic.gov/bankfind-suite/bankfind.

Both SVB and Signature Bank participated in FDIC Insurance, so depositors who meet the above criteria will be made whole. The Treasury Department issued a statement the weekend following the bank failures that they would also cover deposits in excess of the FDIC Insurance limits.

The guarantee by the Treasury Department was seen by many to mean that the U.S. Government would guarantee deposits in excess of FDIC Insurance for future bank failures. Treasury Secretary Janet Yellen has been careful not to make this blanket guarantee.

We, too, find it hard to believe the U.S. Treasury won’t backstop deposits for future bank failures. There is precedent, however, for the government to treat separate institutions differently. In 2008, Bear Stearns was bailed out by the Federal Government, but they subsequently allowed Lehman Brothers to go out of business.

There is an easy solution to this issue. We recommend that you keep your cash balances below the FDIC Insurance limits. For cash accounts above the limits, there are some simple ways to increase the limit.

One common way is to open a new account at a different institution and transfer enough cash to get below the FDIC limit. Another way is to add your spouse to an individual account or add a Transfer on Death (TOD) beneficiary. There are potential gift tax issues with adding a non-spouse to an individual bank account and adding TOD beneficiaries can result in uneven distributions of your estate to your heirs. Before doing either of those things, consult your financial planner or estate planning attorney to ensure your estate plan remains intact.

Cash held in brokerage accounts also qualifies for FDIC Insurance. Schwab and T.D. Ameritrade employs a multiple–bank version of FDIC Insurance whereby cash balances up to $249,000 are held and insured at a Primary bank – with additional cash up to an additional $249,000 held and insured at a Secondary bank. Any cash in accounts that exceeds $498,000 is held at an Overflow Bank, which provides $250,000 of FDIC Insurance coverage for a total of $748,000.

Brokerage accounts provide an additional type of insurance for securities held in accounts. The Securities Investor Protection Corporation (SIPC) oversees the liquidation of member brokerage firms that have gone bankrupt or are in financial trouble and customer assets are missing. This last criterion is important as most brokerage firm bankruptcies don’t result in missing securities. That is because reputable brokerage firms such as Schwab or T.D. Ameritrade holds client assets at third-party depository institutions and custodians segregated from the brokerage firm’s assets. You can read how Schwab protects your assets here: https://www.schwab.com/legal/account-protection. You can read how T.D. Ameritrade protects your assets here: https://www.tdameritrade.com/account-protection.html.

So, what happens next? 

SVB and Signature Bank are the only two U.S. banks needing a government bailout. First Republic Bank depositors have not made a run on that bank, with eleven banks’ private infusion of cash being seen as a move to help sure up the banks’ collateral if depositors request their money back.

It seems reasonable to think that other banks may come under pressure from depositors. So far, the U.S. government has done a good job of easing people’s concerns.

We will continue monitoring the situation and update you as things change. We have reviewed the cash held in our client’s brokerage accounts and determined that they are covered under the FDIC Insurance (or multiple-bank version of FDIC).

We recommend you check your bank balances held at your banking institutions to be sure they are below the FDIC-insured deposit limits.

If you have any questions, please do not hesitate to contact us.

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