How safe is your money at your bank?

With the recent events in the news about the Silicon Valley Bank (SVB), Signature Bank, and First Republic Bank, the question “how safe is my money at my local bank“ is on lots of people’s minds.  When you deposit your money at the bank in a checking or savings account you are essentially giving the bank money in exchange for an IOU plus interest that they will pay you back later.  Interest is usually lower for a checking account than a savings account because checking accounts have greater liquidity. Then the bank will take your money and invest it in assets that have higher returns than they are paying out to you. The difference between the interest that the bank is taking and paying out is called the credit spread, and this is one way that banks make their money.  The complication is that savings accounts and checking accounts are cash on demand (meaning that you are able can get your money back at any time) but the banks invest your money in long term obligations such as treasuries, home mortgages, and business loans. The banks cannot demand that these loans be paid immediately back to cover their cash flow needs.  So, if a run on the bank occurs where more people withdraw money in a short period of time that the bank cannot cover with deposits and reserves, the bank is said to be insolvent, meaning they cannot fulfil the claims of the creditors (remember the IOU) due to a lack of funds.  At this point usually the federal government steps in and takes control of the bank.

If you love history like I do, you’ll be interested to learn that after the stock market crash of 1929 there were a series of banking crises in 1930 and 1931.  These two events help to lead to sustained economic downturn known as the great depression.  More than 4000 banks had collapsed from 1929 to 1933.  The loss from theses closures was projected to be ~ $1.3 billon.  One President Roosevelt’s first actions as president was signing into law the Bank Act of 1933.  This act created the Federal Depository Insurance Corporation or FDIC for short. This separated commercial and investment banking.  It also established federal oversight to the commercial banking sector.  These oversights exist today and with different administrations the regulations tend to become more or less restrictive depending on market conditions.

The FDIC and National Credit Union Administration (NCUA) are both U.S. Government agencies that have insurance funds which the member banks are required to pay insurance premiums.  As a result of those insurance premiums each account title is insured up to $250,000 (as of 2023) per banking institution (not branch).  So, let’s take the simple case.  If you are single and have less than $250,000 in a single bank you are covered.  If you are single and have $900,000 spread evenly across different Banks (not the same bank but different branches of the same bank) you will be covered.   If you are married and have a joint account, you are covered up to $500,000 ($250,000 for each of you).  Now if you are like me and do not exceed the scenarios listed above then you are covered and don’t need to worry.  But there are more complicated scenarios. Let’s say Harry and Sally have the following accounts at Empire Street Bank (a fictitious FDIC insured Bank):

 

How much of the total $925,000 is insured at Empire Street Bank?  Based on the information provided above there are Four account titles that are insured at Empire Street Bank.  Harry is insured for $250,000. Sally is good for $250,000 and the Joint holder for $500,000.  So, based on this they should have up to $1,000,000 of FDIC insurance at Empire Street Bank which should cover their $925,000 of deposits, right?  Well, nothing is that simple. Let’s take a closer look:

So based on this scenario $25,000 of the $925,000 is not covered.  If they wanted full coverage Harry could transfer $25,000 out of his checking to Sally’s checking and they would be covered.  Now what if Sally wanted to add a CD in an IRA and fund it with $240,000, would that be insured at Empire Street bank?  The answer is yes.  The IRA would be a different account title and as such that is insured for $250,000.  Confusing, right?!  If you are unsure of insurance levels, feel free to reach out to your bank or your financial advisor.  Another question to ask is “how much money should I be keeping in the bank?”  But that is a question for another day and another newsletter.