Bank Failure Lessons and FDIC Insurance
If you’re reading this in mid-March 2023, it’s been a crazy week or so, no?
Two, count ‘em two, major bank failures (Silicon Valley Bank and Signature Bank - the 2nd and 3rd largest bank failures in history), followed by the Federal Reserve quickly swooping in over the weekend to save the day.
I don’t know if we’ve seen the end of this episode, or if more bank failures or other turbulence is around the corner.
But let’s press the pause button to think about three major takeaways from this mess:
Transfer any cash over FDIC limits to different banks
Match your investments with your time horizon(s)
The importance of diversification
Transfer any cash over FDIC limits to different banks
Are you holding a lot of cash?
If so, you might want to double-check how much is held where.
I suggest not holding any more than the FDIC insurance levels in any given bank (generally $250K per person, $500K for joint accounts of married couples). Anything up to those amounts is guaranteed/insured by the government. I’d suggest transferring anything above that to other banks.
If your bank failed, would your deposits be protected above the FDIC amount?
Maybe.
After all, that’s what happened with SVB and Signature Bank depositors.
Would I want to risk that cash on a “maybe”?
Nope.
So what’s FDIC insurance?
FDIC (Federal Deposit Insurance Corporation) insurance provides protection for you in the unlikely event of a bank failure. If you have an account at a bank that fails, and they can’t deliver your money to you, the government will make you whole up to certain limits.
Pretty much all major banks provide FDIC insurance, but not all banks do. You can check the FDIC website to confirm the insurance coverage for a particular bank.
Note: Credit unions can be covered by NCUA (National Credit Union Administration) insurance rather than FDIC. NCUA works almost exactly like FDIC, so the commentary below applies to credit unions too. To confirm whether a particular credit union is covered by NCUA, look it up on the NCUA website.
Standard approach
The standard amount of FDIC insurance offered for bank deposits is $250,000 per depositor, per insured bank, for each account ownership category.
For joint accounts with two people, this amount is raised to $500,000 (as there are two “depositors”).
Trust accounts
For trust accounts, the coverage works a bit differently. The term “trust accounts” includes formal trusts, such as Revocable Living Trusts, as well as informal trust arrangements, such as Payable On Death (POD), Transfer On Death (TOD), and In Trust For (ITF) accounts.
For these accounts, the FDIC coverage is generally $250,000 per beneficiary of the trust account. If the trust account names two beneficiaries for the account(s) at the same bank, $500,000 of FDIC coverage would be available.
As far as I’m aware, I don’t believe contingent beneficiaries named in trusts count toward this per beneficiary calculation; it’s only primary beneficiaries.
Examples
Below are a few examples to help us understand the limits of FDIC coverage.
1. You’re single, you have your accounts at one bank, and you have:
$50,000 in a checking account
$100,000 in a savings account
$250,000 in certificates of deposit
That’s a total of $400,000 deposited in one bank as one depositor (you), at one institution (your bank), and in one ownership category (single). If your bank were to fail, you’d be on the hook to lose $150,000 because the FDIC would cover only up to $250,000.
2. You’re single, you have your accounts at two banks, and you have:
$100,000 in a checking account at Bank 1
$150,000 in a savings account at Bank 1
$250,000 in certificates of deposit at Bank 2
That’s a total of $500,000 deposited as one depositor (you), at two institutions (two banks), and in one ownership category (single). Since you have $250,000 at one bank and $250,000 at another bank, all of your money is protected.
3. You’re married, you both have your accounts at the same bank, and together you have:
$500,000 in a joint savings account shared with your spouse
$250,000 in a certificate of deposit in just your name
That's a total of $750,000. All of this money is protected. The joint savings account is one ownership category (joint), where both you and your spouse are covered up to $250,000 each since you are two different depositors. The certificate of deposit is in a second ownership category (single), so the depositor (you) is covered up to $250,000 for that account.
4. You’re married, you both have your accounts at the same bank, and together you have:
$500,000 in a joint savings account shared with your spouse
$250,000 in a certificate of deposit in just your name
$600,000 in a trust account, where the trust names two primary beneficiaries (perhaps your children) receiving 50% each
That's a total of $1,350,000, all of which is protected except for $100,000. In this example, the joint account and CD are fully protected. The trust account is a different ownership category (trust), where each of the beneficiaries is covered up to $250,000, for a total of $500,000, which means $100,000 of that account would not be protected.
Resources
FDIC information on various account categories:
Handy-dandy FDIC insurance calculator that will tell you whether you’re fully insured:
Match your investments with your time horizon(s)
One of the reasons Silicon Valley Bank failed was because of the investments it held.
As more and more money poured in from depositors (mainly tech startups and venture capital money), SVB, very logically, decided to invest a good amount of the money. And they invested it in U.S. Treasury Bonds, which are considered pretty much the safest type of investment in the world, as they are back by the U.S. government. So far so good.
The problem was the majority of these Treasury Bonds were long-term securities, meaning they wouldn’t mature for 5, 10, 20, or 30 years.
The reason that’s a problem is because those bonds were needed for short-term liabilities, such as depositors withdrawing their money.
There was a mismatch.
When those depositors wanted their money, SVB had a hard time coming up with it because those Treasury Bonds had declined in value by quite a bit (when interest rates rise, Treasuries go down, especially ones that mature far in the future).
The lesson for us is that our investments should match our time horizon:
Short-term: For money you’ll need within a few years, consider keeping that money in cash held in bank accounts or other safe sources.
Medium-term: For money you’ll need within, say 3-7 years, consider having a mix of cash, bonds, and some stocks.
Long-term: For money you’ll need in around 8-12 years, consider having a more aggressive mix of bonds and stocks.
Really long-term: For money that’s for much later, consider investing it in stocks.
When we don’t abide by an approach like this, we start to jeopardize our ability to have the money when we need it, sacrificing either safety (if we’re invested too aggressively) or growth (if we’re invested too conservatively).
The importance of diversification
Silicon Valley Bank was focused on being the bank for tech startups, especially those flush with cash from venture capital infusions.
Having a niche as a business can have huge benefits. It can provide focus for the business and deliver concentrated expertise to its clients. The downside is that when things start going sideways for that target market, the company is going to be negatively affected too. So it’s best to make plans for that.
You, gentle reader, don’t need to worry about this as much if you’re not a business owner, but there is a very direct application to our investments.
Being diversified with your investments is very important. Diversification reduces your risk and, generally speaking, makes it more likely you’ll achieve your financial goals.
The main applications of this are:
Having a healthy balance between stocks, bonds, cash, and real estate.
Within stocks specifically, having a variety of exposures, such as to U.S., non-U.S., emerging markets, large cap, small/mid cap, a variety of industries/sectors, etc.
Investing in broad mutual funds should give you plenty of diversification in terms of not concentrating too heavily in any one stock, industry, or sector.
If you work for a company that has stock, be careful about how much exposure you have to that stock via your compensation program (RSUs, ESPP, ISOs, NQSOs, etc.).
Summary
I hope you weren’t negatively affected by the SVB/Signature failures. But we can all learn some lessons from them and make sure we’re positioning our finances in a prudent way.