The news on Friday, March 10th, 2023 of Silicon Valley Bank’s (SVB) closure by regulators was surprising for many and raised questions about what is or is not FDIC-insured. We’ll take a moment to review what bank account holders should know and what FDIC insurance entails.
The Federal Deposit Insurance Corporation (FDIC) was created in 1933 during the depths of the Great Depression to help customers feel confident in placing their money at U.S. financial institutions. In general, thousands of banks, large and small, are “FDIC-insured”, meaning backed by the FDIC, which protects deposited customer funds up to $250,000 at any one institution1. Not all accounts, account types, and financial institutions are backed by FDIC insurance though, so it is important to stay informed and consider whether a financial institution is FDIC insured before entrusting them with your funds.
In the case of SVB, the 16th largest bank in the U.S., the news about its meltdown caught many by surprise. SVB is commonly used with silicon valley area startups. Reportedly, a number of venture capital and private equity firms warned their startup portfolio companies to remove their deposits from SVB for the time being and park them in treasuries2. SVB essentially had a run on the bank and was no longer able to pay out the deposits requested. The FDIC has taken over SVB bank for the time being.
A bank labeled as ‘FDIC insured’ covers each depositor up to $250,000, backed by the Federal government. For example, if a bank were to go belly-up, as a customer, any money I keep at that bank in my savings account would be returned to me up to a net of $250K. So, If I have $600,000 in a savings account at the bank, I am guaranteed by the backing of the Federal government to get back at least the $250,000 in the rare event of the bank’s failure. The fate of my other $350,000 might be temporarily uncertain.
When a federal or state regulatory agency closes a bank, the FDIC steps in to ensure depositors can access up to their insured $250K in short order4. From there, the FDIC takes over collecting and selling the assets of the bank, along with settling debts, which include the claims for account holders with account sizes above the $250K limit as of the date of bank closure1.
This $250K coverage applies to each bank with FDIC insurance coverage, so if I had checking or savings accounts at multiple banks, I would be covered for $250K at each institution, and for each type of account, or ownership category (see our article on FDIC insurance for different accounts (link will be added when the other document is approved and posted)).
It is important to note that bank insolvency is exceptionally rare. SVB’s March meltdown constitutes the first bank failure since the 2008 financial crisis, and the second largest in U.S. history as reported by news outlets on March 10th2.
Most investors hold investment assets in brokerage accounts with the brokerage firm acting as a custodian. When your funds are invested, whether, in stocks, bonds, mutual funds, treasuries, or a combination of all of these, you directly hold a security, or a slice of the basket of securities, that you purchased. These funds are not subject to FDIC coverage because the assets within those accounts are owned and invested by you, or on your behalf like with a limited power of attorney commonly used for financial advisors. FDIC insurance is intended to primarily back cash deposits at banks.
There are more differences between bank accounts and brokerage accounts though. Brokerage institutions commonly have Securities Investor Protection Corporation (SIPC) insurance, covering investors up to $500,000 for accounts invested in securities, or $250,000 in cash if that bank gets into financial trouble5. In a hypothetical brokerage failure situation, another financial institution will commonly buy the brokerage assets from the troubled bank, where those assets and accounts would be transferred to the new institution, often with minimal impact on brokerage customers and their accounts.
One reason behind the FDIC insurance for banks lies in the common practice of banks to use the cash deposit reserves of customers to fund lending and investment operations at the bank. Banks are essentially–and legally we should add–borrowing money from their deposit holders and paying a nominal yield on the account owner’s cash. If, or in SVB’s case, when, the bank gets into trouble, it’s the account assets where cash was being held that receive that FDIC insurance coverage. Brokerage firms, regulated by the Securities and Exchange Commission (SEC) are not allowed to use client assets for company purposes5. These accounts, such as the type commonly used for Highline client accounts custodied at Charles Schwab and TD Ameritrade Institutional, are kept separate and bank lending on these funds is not allowed.
There are differences with FDIC insurance coverage depending on who owns a particular account, how the account is held along with a few other distinctions. For more information on FDIC insurance coverage for various types of accounts, check out our article on 'What coverage does the FDIC provide for my accounts?'.
Reported weak and lower-than-expected earnings, higher interest yield from government treasuries than bank savings or money market accounts, and predominantly lending to pre-revenue and pre-profitable startups got SVB into hot water. The bank also had a sizeable amount of long-term bonds purchased back when interest rates were low. As interest rates increased, SVB lost money–at least on paper–on the bonds. In a move that is sure to be a cautionary tale in business schools, SVB chose to lock in those bond losses by selling its long-term bond holdings and realized around $2 Billion in losses2. The firm attempted to raise outside capital this week, and was unsuccessful, leading to Friday’s regulator actions.
A startup that could not be profitable in a zero interest rate environment just a few years ago, is likely to struggle with federal funds rates up to 4.5%-4.75% where the cost of capital is much higher. We may also be seeing the lagging impact of higher interest rates that often take 12-18 months to trickle through the economy. At this point in time, it’s unknown what effect SVB will have on the many startups that used SVB for their company operations, or what impact SVB could have on the larger startup world.
By all accounts, SVB’s failure is a one-off event given the higher risk of who they were lending to, namely startups, and the venture capital industry’s influence to have their companies withdraw their deposits. While we do not know the full impact of SVB, it highlights a continued need for caution in this current market environment. We will likely touch on SVB in future articles. If you have questions about Highline’s outlook on the matter, please contact your Highline advisor.
Investments are not FDIC insured, have no guarantee, and may lose value.
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