Mo Money Mo Problems

May 15, 2023 By Angel Irazola »
Money flying. West Financial Services

For many folks, the recent turmoil in the regional banking sector has added a fresh new layer of anxiety about their finances. The media has not helped matters either, calling it the 'greatest banking crisis since the financial crisis of 2008.' To be fair, it is the only banking crisis since the financial crisis. Nevertheless, at West Financial, we have heard from clients who question whether their investments are safe, or if they should be concerned. Based on this apprehension, we thought it a good idea to write a refresher on what risks clients assume when utilizing different savings instruments.

So, what happened and why should you care? In early March, a California bank by the name of Silicon Valley Bank (SVB) experienced what most have coined as a modern day customer run on the bank following an unannounced effort to raise new capital. The bank saw massive overnight withdrawals which led to its swift collapse and subsequent takeover by federal regulators. Two days later in New York, Signature Bank suffered the same fate, primarily related to exposure to cryptocurrency companies. This one-two punch led federal regulators and the Federal Deposit Insurance Corporation (FDIC) to guarantee all deposits at both banks, a surprising and very rare action. This would not have been such a big deal if not for the fact that SVB was the 16th largest commercial bank in the United States and approximately 90% of its customers maintained accounts larger than the regular FDIC protection limit of $250,000. Far from your local community or regional bank that normally have a very diversified client base, the unique depositor base of SVB was comprised of technology companies, their executives, and other institutional investors. The latest, First Republic Bank, also in California, was similar to SVB, which catered to the tech startup community. First Republic was also focused on serving rich coastal Americans, enticing them with low-rate mortgages in exchange for leaving cash at the bank.

In the wake of these situations, bank customers and market investors alike are struggling to understand what risks they are exposed to and how to mitigate those risks. Taking the former first, a person who opens a bank account for checking or savings purposes is known as a depositor of that bank. They essentially hand over their money to the bank and trust that bank will be good stewards of his/her funds. The risk that the depositor runs in placing their funds with the bank is the direct solvency of that bank. Through the evolution of the banking system, the federal government has created backstops to guarantee a certain amount of deposits at federally insured banks. By creating the Federal Deposit Insurance Corporation in 1933, the government mandated that it would guarantee up to $250,000 of funds for each depositor, by account category and by bank. So a depositor's main risk exposure is maintaining balances greater than $250,000 per bank in the case that the bank runs afoul.

Perhaps running through an example may highlight these limitations. John and Jane Smith have several bank accounts at their local community bank. They have a joint savings account with a balance of $350,000, John has an individual account with a balance of $300,000, and they have a revocable family trust, naming their three children as beneficiaries, with a balance of $700,000. The joint account is covered up to $500,000, John's individual account is covered up to $250,000 and the trust account is covered up to $750,000, thus having $50,000 of uninsured funds at their bank. An advisor may suggest that the Smiths transfer $50,000 from John's individual account to either the joint account or the trust account in order to be fully insured under FDIC guidelines. For more information on these guidelines, you may use this online resource from the FDIC:

Market investors, on the other hand, open an account at a broker-dealer and utilize that financial company to purchase publicly traded securities of third-party companies. These investors can own stocks, invest in debt instruments, purchase derivatives, and procure a series of other investment vehicles. The investor has considerably greater exposure to a number of risks, including market, interest rate, credit, liquidity and individual company risks. Investors are not protected by the federal government like depositors are, but they do have a different type of protection offered by the Securities Investor Protection Corporation (SIPC), a federally mandated, non-profit member-funded, United States government corporation created in 1970. SIPC covers up to $500,000 per customer of investable assets, as well as cash, that are custodied at the brokerage firm. It does not cover losses on investments in securities. Therefore, let's say that John Smith maintains an individual brokerage account and he is invested in a number of individual stocks, a few corporate bonds and carries a sizeable cash position. If the market tanks and John suffers losses on his stocks or bonds, SIPC does not cover that kind of risk. If, however, the brokerage itself becomes insolvent and John is not able to recover some of his assets, SIPC would then step in and cover up to $500,000 of John's investments, including a maximum of $250,000 in cash. For more information, the SIPC online resource can be found here:

Hopefully this brief refresher helps our readers regain insight and clarity on the main differences between depositors and investors. As long as you know the rules and act to limit your exposure to either kind of risk, you can move forward with calm and confidence. Indeed, identifying and understanding what kind of saver you are and in what form will help you navigate the financial storms yet to come.

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