It’s a wonderful life … thanks to insurance protection

Hearing a “run on a bank” may evoke black-and-white images of 1929 or scenes from a certain classic holiday movie starring Jimmy Stewart. But just recently, a number of factors contributed to the collapse of three large banks: Silicon Valley Bank, Signature Bank and First Republic Bank.

Fortunately, we’ve come a long way since pre-1933 when a bank failure meant the customers would lose all of their money with no recourse. Now, should something catastrophic and fraudulent happen to a financial institution, account holders and investors can breathe a little easier because of protections in the form of the Federal Deposit Insurance Company (FDIC), the National Credit Union Administration (NCUA) and Securities Investor Protection Company (SIPC).

No one could be blamed for wanting to get their money out of a bank after even the faintest rumors of trouble there. It’s a natural response, but it’s just not a necessary one anymore.

In response to the thousands of banks that failed in the 1920s and early 1930s, the FDIC was established “to maintain stability and public confidence in the nation’s financial system.” FDIC protection covers deposits only. It does not extend to securities, mutual funds or “similar types of investments.” According to the independent government agency, “Since the start of FDIC insurance on Jan. 1, 1934, no depositor has lost a penny of insured funds as a result of a failure.”

Every account in banks that are backed by the FDIC are insured up to $250,000, so their account holders would receive up to that amount of their money back if the bank were to fail. That applies to every account. If a holder has multiple accounts, it will cover each of them the same way. If the amount surpasses $250,000, it doesn’t necessarily mean the account holder won’t get the rest of their money back, but it may depend on how long it takes the FDIC to recover those funds.

These recent bank failures happened for a variety of converging reasons. Fears of a financial calamity caused by the pandemic prompted the Federal Reserve to move the federal funds rate to 0% and increased the money supply (M2) more than 40% over the span of two years. After COVID’s initial shock to the economy subsided, and with stimulus checks in hand, both businesses and consumers found themselves with extra cash to spend. As banks received these deposits, and due to continued economic uncertainty, many chose to invest in Treasury bonds and other U.S. government debt securities, presumed “safe” investments. However, these instruments yielded next to nothing owing to the Fed’s stance on monetary policy caused by the pandemic.

As rising inflation began to permeate throughout the economy, the Fed was steadfast in its belief that inflation was transitory, choosing to remain accommodative with monetary policy throughout 2021. By the time it realized inflation was instead persistent and not transitory in early 2022, the Fed had no choice but to act aggressively, hiking interest rates nine times in 15 months, over 500 basis points, or 5%.

Rate hikes continued throughout 2022, which meant the values of these existing low-yielding Treasury bonds began to fall, especially those with the longest maturities. This is because bond values have an inverse relationship to interest rates. Due to the magnitude and persistence of hikes, bonds that held the longest maturities watched their principal values plummet. Surprisingly, many of these banking institutions were not properly hedged against potential interest rate risk, leaving customer deposits largely unprotected. When word began coming out in early 2023 that many of these banks’ bond portfolios were significantly underwater, customers wanted their deposits back and the bank runs began.

As previously mentioned, the FDIC guarantees account holders the recovery of up to $250,000 of their money, but, based on account registrations, about 90% of Silicon Valley Bank accounts exceeded those limits. In this instance, the FDIC transferred all of Silicon Valley’s deposits to a newly created “bridge bank” that the agency is operating, giving depositors full access to their money.

In late May, however, the FDIC proposed a “special assessment” for the country’s largest banks in which they would pay the majority of the nearly $16 billion it cost the agency to cover Silicon Valley Bank and Signature Bank’s uninsured deposits. If the proposal passes, banks with more than $50 billion in assets would start paying the assessment over the span of two years, beginning in June 2024.

What the FDIC does for banks and savings associations, NCUA’s Share Insurance Fund does for federal credit unions and the “overwhelming majority” of state-chartered credit unions. It also has the same $250,000 limit of protection.

While the SIPC was created under the Securities Investor Protection Act, it is a nonprofit membership corporation that is not an agency of the federal government. Its focus is “restoring customer cash and securities left in the hands of bankrupt or otherwise financially troubled brokerage firms.” Although it “expedites the return of missing customer property” up to $500,000 for securities and cash (with a $250,000 limit for cash only), the SIPC is not the securities equivalent of the FDIC. It has no authority to investigate or regulate its members, and it does not cover the value of the investment. It will replace missing stocks and other securities if possible.

Nevertheless, it is helpful to know there is an organization that will step up if a brokerage firm goes bankrupt or falls into financial trouble, especially since investors spooked by the bank failures earlier this year subsequently moved billions of dollars from banks into investment accounts.

One of the lessons learned for many investors is regarding where they should keep their money. Unless they have a liquidity event coming up, they may want to consider limiting the amount of money in the bank to under the FDIC $250,000 threshold — practically speaking, the investor will get a better yield in an investment account anyway.

Even though data is indicating rate hikes are starting to work, it is too early to tell what the Fed will do next. Conventional wisdom says at some point this year and into next, the Fed will start to cut interest rates, and possibly significantly, creating another issue for banks and investors.

The easiest way to prevent economic misfortune is for investors to confirm their bank is insured by the FDIC. The majority are, but it should still be verified before leaving money there. They should also talk with their financial advisor to make certain where they are keeping their money is appropriate for their circumstances.

In the event of an FDIC-insured bank failing, the worst thing account holders can do is withdraw their money. That is what happened at Silicon Valley Bank, Signature Bank and First Republic Bank and what ultimately made them insolvent. Rather, account holders should understand that if their balance is within the FDIC insurance limit, the mechanisms are in place to protect their money and help ensure they continue to have a wonderful (financial) life.

To learn more, connect with our team.

Baker Tilly Wealth Management, LLC (BTWM) is a registered investment advisor. BTWM does not provide tax or legal advice. BTWM is not an attorney. Estate planning can involve a complex web of tax rules and regulations. Consider consulting a tax or legal professional about your particular circumstances before implementing any tax or legal strategy. The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought.

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