FDIC, SIPC & Bank Runs

I’ve recently gotten a few questions from clients about FDIC insurance and keeping money safe at banks and other institutions, in light of the failures at Silicon Valley Bank and Signature.  I thought it’d be helpful to create a post on this topic that you can all refer to in the future.  I think everyone knows the FDIC magic number by now…  $250k  How that $250,000 applies to different types of assets, accounts, and institutions seems less understood. 

For cash accounts, FDIC insurance covers $250k per person, per account type (individual, joint, IRA, corporate, trust, LLC, etc.), per bank.  It is not $250k per account.  If you only have individual accounts at a bank, regardless of how many accounts over which that money is spread, then your coverage is simply $250k  If you have only have joint accounts at a bank, then each person on the title of the joint account has $250k of coverage, regardless of the number of accounts.  If you have individual and joint accounts at a bank, then you have $250k of coverage on your individual accounts (in aggregate), and separately, you and each of the other owners each have $250k of coverage on your joint accounts (in aggregate).  I won’t get into the nuances of trust accounts and corporate accounts, because our clients don’t generally have that much cash sitting in those types of accounts, but if you want to read the rules, straight from the proverbial horse’s mouth, the FDIC website does a great job of explaining how FDIC insurance applies to all different account types.  The limits apply per bank, so if you want a higher limit, you just need to spread your cash across more than one bank.  Again, FDIC insurance only covers cash in bank accounts.

FDIC insurance is important because with bank accounts, your deposits are the working capital of the bank, used to make loans or investments to generate a profit for the bank.  A bank run causes a bank failure if the bank’s assets are illiquid and/or have fallen in value too much to safely cover withdrawal requests from depositors.  That’s when regulators step in and close the bank, like they did with Silicon Valley Bank and Signature Bank.  They attempt to sell off bank assets while repaying depositors with those proceeds (oversimplified, but that’s the general process).  In those situations, the FDIC guarantees immediate availability of insured deposits to depositors either using the bank’s assets, the FDIC insurance fund, or other borrowing facilities set up by the Federal Reserve and Treasury.  They typically pay a dividend on uninsured deposits as well, from the leftover bank assets after accounting for all insured deposits.  As other assets are sold, additional dividends are paid in an attempt to make all depositors whole.  However, if there aren’t enough assets to do that (remember, the regulators step in when it looks like there aren’t going to be enough assets), then uninsured depositors lose their money.

Unlike with banks, in brokerage accounts, your securities (stocks, bonds, mutual funds, etfs, derivatives) are completely segregated from the assets/liabilities of the broker.  Only fraud or other illegal actions by the broker could expose your securities, and regulation requires strict internal controls and audits to prevent that.  That’s why it’s important to use a US-based broker with an established history (or a foreign broker with similar characteristics and similar foreign protections if you are outside the US).  Most of our clients have their brokerage accounts at TD Ameritrade, which is owned by Schwab (and will soon be integrated into Schwab), and Schwab definitely fits that description.  There is no risk to brokerage accounts as a result of a bank run.  Schwab bank could completely fail and Schwab as a business could file for bankruptcy, and while it would cause a headache and potential service disruptions, none of that would expose you to loss of your securities.  In practice, even if Schwab bank were to fail, it’s just one division of the company, and a likely suitor would come along and purchase the non-bank divisions, possibly facilitated by the US government.  Additionally, each brokerage customer is protected with up to $500k of SIPC insurance, which guarantees the securities that are held (in a segregated manner) with the broker.  Finally, most brokers purchase additional insurance protection for customers.  For example, TD Ameritrade provides each customer with $149.5M of protection for securities, above and beyond the SIPC insurance, subject to aggregate policy limits. SIPC’s only currently open case is that of Bernard L. Madoff Investment Securities LLC (a classic example of why you want to have your assets in accounts in your own name, in the custody of a brokerage that is not also your investment advisor!).

Cash in a brokerage account is a hybrid between cash at a bank and securities in a brokerage because brokers “sweep” cash into a bank account to earn interest.  However, unless you have more than $250k, that cash is FDIC insured in those bank accounts, so no risk there either.  Most brokers use multiple sweep accounts at different banks, so you really have $250k times the number of banks in the program as an insured cash limit.  We don’t hold anywhere near that amount of cash in client accounts unless a deposit is made or a withdrawal is being facilitated in excess of the insured amount.  Even then, the cash is only held for a very short amount of time.

To summarize:

  • You should keep bank account cash below $250k per person per account type at any one bank if you want to stay within FDIC insurance limits.  Split your assets between banks, if necessary, or add them to brokerage accounts and invest them in assets like US government t-bills if they are assets upon which you don’t want to take any risk.
  • FDIC insurance is what protects your assets in the case of a bank run.
  • Cash held in a brokerage account that is swept to a bank account is treated just like cash held at the bank account and is subject to the same FDIC limits.
  • Brokerage assets (other than cash) are not exposed in a bank run because, unlike bank deposits, they are segregated from the assets of the broker and are not subject to the broker’s creditors.
  • Brokerage assets can be at risk in the case of fraud or other illegal activities by the broker (as in the case of Bernie Madoff’s fraudulent broker which conveniently “held” the assets of those who hired him as their investment advisor).  That’s always the case and that’s why brokers are highly regulated, required to have internal controls in place, and are audited regularly.  In the case any securities are lost, SIPC and additional insurance provided by the broker guarantee the return of the securities, up to insurance limits.

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