9 Questions Clients Are Asking About Bank Failures, Deposit Insurance

When an individual trusts a financial institution with their hard-earned savings, they generally assume the money will be there for them when they need it.

But what happens if that institution has serious financial troubles and needs to be taken over, as was the case recently with Silicon Valley Bank and Credit Suisse?

With fresh concerns looming about other financial organizations, including the brokerage titan Charles Schwab, the question is likely in the minds of many clients.

Simply put, there are key safeguards to protect investors in such circumstances, but the ultimate level of coverage depends on many factors. These include the type of institution being considered, one’s specific investments, and how their accounts are structured and titled.

According to experts with Buckingham Wealth Partners, financial advisors can deliver a lot of peace of mind to their clients by proactively communicating with them about the protections their accounts enjoy. It is also critical to spotlight and respond to cases where clients’ decisions about where to invest assets and how to title their accounts may be putting their wealth in unnecessary jeopardy.

To that end, Buckingham’s Kevin Grogan and Brian Haywood hosted a webinar on Wednesday to present facts that all advisors should know about the sources and limits of different types of deposit insurance. They also discussed the deposit insurance questions coming in most commonly from clients.

Grogan is chief investment officer at Buckingham, while Haywood directs the firm’s fixed income trading desk. According to the pair, many client investors have only a vague understanding of the deposit insurance protecting their various accounts, and there are more than a few broadly held misconceptions that can lead to poor decisions and excess anxiety.

Here is a rundown of Grogan and Haywood’s top insights about deposit insurance nuances, the questions clients are asking, and what steps advisors can take to ease client fears and better protect their wealth.

1. What is the FDIC, and why is it important?

While clients have often heard the acronym, relatively few understand exactly what the FDIC is.

As Haywood explains, the FDIC is shorthand for the Federal Deposit Insurance Corp.

Stated simply, the FDIC is an independent agency created by Congress in the immediate wake of the Great Depression to maintain stability and public confidence in the nation’s financial system. It has never missed an insurance payment in its history, Haywood points out.

As the name suggests, the FDIC insures deposits, but it also examines and supervises financial institutions for “safety, soundness and consumer protection.”

It also is the entity tasked with making large and complex financial institutions “resolvable” when they become insolvent, and it manages receiverships.

2. Are there limits on FDIC protections?

As Haywood emphasizes, the FDIC offers a significant degree of asset protection, but there are limits based both on the amount of assets under consideration and the type of accounts in which the assets are held.

Covered accounts generally include normal checking accounts, negotiable order of withdrawal accounts, savings accounts, money market accounts, certificates of deposit, cashier’s checks and money orders.

As Haywood says, the FDIC covers cash and similar assets deposited in “basically any standard account issued by an insured bank.”

Examples of commonly held but uncovered assets include stocks, bonds, mutual funds and annuities held in brokerage accounts — although these may enjoy other types of insurance protection.

Even when an account is covered, there is normally a $250,000 insurance limit that applies per depositor for each insured bank. That is, a given individual can enjoy far higher than $250,000 in coverage, but not if all their money is held in one account in one institution.

3. What are ownership categories, and why do they matter?

Ownership categories are the designations according to which the FDIC considers and applies its “per depositor, per insured bank” insurance limit.

The common account ownership categories include single accounts, joint accounts, retirement accounts, revocable trusts, irrevocable trusts and employee benefit plan accounts, among others.

Put simply, each of these is a separate ownership category that gets its own insurance amount within an insured institution, the Buckingham experts explain. In other words, insurance coverage is capped at $250,000 per depositor, per insured bank, for each account ownership category.

Therefore, a given individual or couple could enjoy more than $250,000 in protection for assets held in a single institution, presuming those assets are held across different ownership categories.

4. Is there a difference between bankruptcy and receivership?

As Grogan and Haywood explain, in a Chapter 11 bankruptcy filing, the goal is to restructure the business while simultaneously attempting to satisfy the needs of parties that have an economic interest in the estate.

In a receivership, the goal is to maximize returns of the assets typically to one or more creditors.

Notably, the FDIC has significant authority to proactively put a bank into receivership if there are grave concerns about its future solvency and its potential effect on the overall banking system.

5. What happens if a bank actually becomes insolvent? How does the FDIC step in?

Typically, the FDIC arranges for a financially sound bank to take over deposits.

“They basically take over and then put up the failing bank’s assets for auction,” Haywood explains. “They solicit bidders in the form of solvent banks. If and when a bid is accepted, they transfer those assets from the FDIC to the new entity.”

For the vast majority of account holders, this process is seamless, and they simply see their banking services shift from the insolvent bank to a new bank.

If the FDIC can’t find a bank to take over the assets of the failed bank, they can also liquidate the bank.

“They don’t like to do this, because this is the situation in which any uninsured deposits would normally be wiped out, which is not great for anyone,” Haywood points out. “It also causes so much more administrative work on their end, so they typically work very hard to find a new solvent bank.”

6. What was special about the Silicon Valley Bank failure?

As the Buckingham experts explain, the reasons Silicon Valley Bank failed earlier this year are both “telling and somewhat unique.”

In simple terms, the bank had a large deposit base but a small base of depositors, and it had invested heavily in long-dated bonds that rapidly lost value.

Critically, a lot of the money parked in the bank was uninsured, because the depositors were running well over the $250,000 “per depositor, per insured bank” limit. Clients who began to worry about the stability of the bank realized their assets were insufficiently protected, and this triggered a bank run that destroyed SVB.

However, because it was such a large bank failure, the federal government evoked the systemic risk exception rules. The practical effect of this was lifting the insurance cap, and they covered all deposits.

7. What steps can one take if they have more than $250,000 in cash to deposit?

According to Grogan and Haywood, there are various steps to take in this situation.

“The general idea is to diversify cash holdings across banks,” Haywood says. “The client can either manage that directly or by engaging with a service that will do it for them, and it’s great when these services are linked to higher interest rates.”

The Buckingham experts noted that a variety of services are available on the market today to help wealthier clients maximize FDIC coverage while earning interest around 4%.

At Buckingham, clients are encouraged to use a service called Flourish Cash, but there are several other trusted services that do a similar thing, Haywood says.

Clients can also consider holding some of their wealth a credit unions, which are regulated and insured separately.

8. What happens if a brokerage fails?

As Grogan explains, the Securities Investor Protection Corp. (SIPC) protects customers if their brokerage firm fails. Brokerage firm failures are rare, he notes, given the mandatory separation of client deposits from the firm’s general account.

If it happens, however, the SIPC protects the securities and cash in a client’s brokerage account up to $500,000.

While they both insure deposits, one notable difference between the FDIC and the SIPC that the latter is not a government entity but rather a nonprofit service funded by all of the custodians and broker-dealers, who pay premiums to provide protection to clients if one of the member institutions fails.

It is critical for clients to understand that the SIPC does not protect against bad advice or poor investment strategies. It simply addresses the (unlikely) possibility that a brokerage firm fails after doing an inadequate job of segregating client assets from the firm’s own assets.

9. Should clients spread investments across brokerages to maximize SIPC protection?

While there is some nuance to consider, Grogan and Haywood say, it is generally not necessary to spread out one’s assets across multiple brokerage firms merely to maximize SIPC protection.

This is because brokerage failures are both far rarer and also functionally different from bank failures, given that brokerages should not be mixing client assets and their own assets. If a brokerage firm fails, it’s likely that another stable brokerage will step in and serve the customers’ needs, and the underlying client investments themselves shouldn’t be affected.

“So, it is less of a dangerous situation in that sense,” Grogan says. “Also, as with SVB, you could easily envision a scenario where the likes of a Charles Schwab would be deemed systemically important.”

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