The recent failures of Silicon Valley Bank and Signature Bank, and the negotiated bailout of First Republic Bank, all within the span of a week, brought back haunting memories for consumers of bank failures during the Global Financial Crisis. According to data maintained by the Federal Deposit Insurance Corporation (FDIC), between 2008 and 2010, 322 banks failed. Another 185 banks failed in the four years following.
Surprisingly, banks fail fairly routinely. Even excluding data from 2008-2014, years when bank failures were significantly higher, on average, 3-4 US banks fail each year. Most of these bank failures are small regional banks with names most Americans would not recognize and average assets of $430 Million. These banks aren’t making National news when they fail. When banks as large as Silicon Valley Bank and Signature Bank fail, with assets in the hundreds of billions of dollars, people notice. What should the regular investor take away from the most recent bank failures?
Maintain Bank Account Balances Below the FDIC Insured Threshold
In fall 2008 I was cutting my teeth as an engineer working at a pharmaceutical facility outside of Portland, OR. I was keeping my nose to the grindstone, aware of the general state of the economy but certainly not keeping up with daily news. One day I received a new debit card in the mail and was made aware that my bank, Washington Mutual, was acquired by JPMorgan Chase. Embarrassingly, it wasn’t until reading about the latest banking troubles that I learned, for the first time, what had happened. Washington Mutual was, and still is, the largest bank failure in the history of the FDIC. At the time of its failure, it custodied an estimated $307 Billion in assets. Clearly, I was blissfully unaware and entirely unaffected. This anecdote illustrates the point that the average person who maintains less than the insured balance in their accounts will feel no material impact from a bank failure, thanks to the FDIC.
In the aftermath of the Great Depression, Congress created an independent agency called the FDIC “to maintain stability and public confidence in the nation’s financial system.” In addition to providing oversight of financial institutions, the FDIC provides depositor insurance. At the time of its creation, the FDIC insured limit was only $2,500, but has since been increased to $250,000. This limit is extended to every depositor, at every insured bank, for each ownership category. This is important to understand, so further details are below.
Per Individual – Each individual is insured, meaning if Sarah and Ben are married and Sarah opens a checking account at Bank A, she is protected up to $250,000. Similarly, if Ben also opens a checking account at Bank A, he is protected up to $250,000.
Per Ownership Category – In the example above, if in addition to their individual checking accounts, Sarah and Ben also open a joint checking account together at Bank A, that joint account also receives FDIC protection totaling $500,000; $250,000 for Sarah and $250,000 for Ben. This is because each ownership category is eligible for insurance coverage, and a joint account is a different ownership category than an individual account. However, if Sarah also opened up a savings account in only her name at Bank A, in addition to her checking account, FDIC insurance would be limited to $250,000 total, for the checking and savings accounts combined because the two accounts are not unique ownership categories (they are both individual accounts).
Per Bank – Individuals surpassing the $250,000 insured limit at one bank have the option to open an additional account at another bank to ensure FDIC coverage for any balance above $250,000. By spreading their funds across different banks, they can enjoy complete FDIC insurance for all accounts.
From a practical perspective, what this means is that if a bank fails, its customers will be able to continue to deposit and withdraw funds from their accounts without interruption, so long as they are below the FDIC insured limit. Balances greater than the FDIC insurance ceiling risk the excess amounts being frozen, and the possibility of less than 100% of the account balance being recouped. There are some nuances that are important to understand about FDIC insurance, and the FDIC website has several helpful videos and tools, including this calculator to help consumers confirm that their bank account balances are covered.
Most crucial for consumers to understand is that for their deposits to be safeguarded, banks must be members of the FDIC and pay FDIC premiums. Most banks prominently exhibit their FDIC membership, and customers should confirm their bank’s membership status.
Understand How Investment Accounts are Protected
For most, it’s relatively easy to maintain account balances at any individual bank below the $250,000 threshold. Investment accounts, such as IRAs and non-retirement accounts, can easily exceed this amount, and it is important that investors be aware of how those funds are protected.
Like FDIC protection for bank accounts, the Securities Investor Protection Corporation (SIPC) provides protection for brokerage customers. SIPC coverage extends up to $500,000, but does not cover all types of investments, such as cryptocurrency, futures contracts, or insurance accounts. Important to note is that cash held in brokerage accounts is only protected up to $250,000.
On top of SIPC insurance, most brokerage companies maintain excess SIPC insurance from private insurers that extends insurance coverage by hundreds of millions of dollars. Like FDIC insurance, SIPC insurance extends only to member companies, and it is critical for consumers to confirm that their investment accounts are receiving this protection.
The Silicon Valley Bank Failure was a Great Primer on Bonds
Silicone Valley Bank clearly took on too much risk, which led to its ultimate collapse, but they weren’t trading in multi-tranche Collateralized Debt Obligations or betting in Las Vegas; they were investing in Treasury bonds. So how could investing in US Government bonds, which are considered low-risk investments, go so wrong? The answer is a great primer on how bonds work.
For individual bonds, provided the investor holds the bond to its maturity, and the borrower continues to make payments, the investor is guaranteed the rate of return specified when the bond was purchased. If the investor wanted to sell that bond before its maturity, however, they would be subject to the price that another investor was willing to pay for it. When interest rates have gone up since the original bond was purchased, as was the case in 2022, the price that another investor is willing to pay for that bond will be less than the original purchase price.
Specific to SVB, rather than letting depositor funds stay in cash, SVB purchased Treasury bonds that paid around 2% interest. As interest rates rose throughout 2022, Treasury bonds hit the market with significantly higher interest rates, over 4.5%. The bonds that SVB held, paying 2%, looked much less attractive. Notably, this would not have been a problem if SVB had been able to simply hold those bonds to their maturities. Even though “on paper” the bonds appeared to have lost money, they would have received all their money back at maturity. Unfortunately, SVB did not have enough liquidity to meet depositor’s withdrawal demands, which forced them to sell their low-yielding bonds before maturity for less than they purchased them for, losing billions in the process.
For ordinary investors who have individual bonds in their portfolio, if those bonds were purchased prior to late 2023, they are likely showing a negative return on the performance report right now. As long as those bonds are held to maturity, the negative return will correct itself once the bonds mature. It is, as they say, only a “paper loss”.
The recent failures of Silicon Valley Bank and Signature Bank, and the bailout of First Republic Bank, serve as a reminder that banks fail fairly routinely, and investors need to be aware of the potential risks. Throughout history, the government has implemented protections such as the creation of FDIC and SIPC to shield investors from direct impact due to bank failures. Despite this, such incidents serve as a timely reminder of the safeguards in place, prompt consumers to ensure that they bank with institutions that are members of these crucial safeguarding organizations, and a reminder that investing, even in relatively “safe” investments, involves risk.