About the FDIC
FDIC (Federal Deposit Insurance Corporation) and SIPC (Securities Investor Protection Corporation) were implemented to create some sense of credibility and safety for depositors and investors.
The FDIC was created during the Great Depression in 1933 to give depositors confidence that their money, up to $2,500 at the time, would be there if their bank failed for any reason. The goal of creating the FDIC was to restore confidence after nearly 9,000 bank failures due to the depression.
It worked, and almost 100 years later, we’re still using the same system, just with a higher limit of $250,000.
The FDIC has four main functions. It insures deposits (up to $250,000), examines and supervises financial institutions, works to keep our complex banking system operational and manages receiverships when banks fail. Anything over the FDIC insurance limit is not insured and subject to bank failures and the hope of a government bailout.
· Single accounts are insured up to $250,000 per person.
· Joint accounts are insured up to $250,000 per co-owner ($500,000 total).
· Some retirement accounts, like IRAs are covered up to $250,000 per owner.
· Other types of accounts like corporations, pensions, and trusts have $250,000 limits
based on the type of account and the beneficiaries of those plans and accounts.
As a depositor, when you put money in a bank, you are effectively trusting the bank will run its business well and manage its risks appropriately. There’s no guarantee your funds above the FDIC limit are safe from loss because as a depositor, you are providing money to the bank for the purposes of bank business.
Depositors are different from investors in that investors are supplying equity to a business in hopes to earn a return. The value of an investor’s investment fluctuates with market demand. Depositors have no interest in investing but want to have their money held safely and be immediately accessible. This was why the FDIC was created, to create a safety net for deposits under the FDIC limit.
What is SIPC then?
Image from SIPC website
The SIPC is thought of as the FDIC equivalent to brokerages, but it’s actually a non-profit corporation created 50 years ago under the Securities Investor Protection Act. The SIPC’s main role is to oversee the liquidation and closure of failing brokerages when a firm is bankrupt, in financial trouble, and customer assets are missing.
The key points of SIPC coverage is that it protects up to $500,000 in assets which includes up to $250,000 in cash. The purpose of the coverage is to expedite the return of missing property during a brokerage failure – the main point in this is, “missing property.” Property in this case means missing assets and missing investments, which represents mishandling of them or a failure to segregate them properly. SIPC coverage is limited to the custody function of a broker dealer. The SIPC will not step in and protect against market-based losses. Investments, or securities, owned in a brokerage account are required to be segregated from the business of the brokerage. Securities owned by a customer are not available to the firm for trading, managing, or making loans like deposits at a bank are.
SIPC security coverage protects stocks, bonds, treasuries, CDs, mutual funds, and money market mutual funds. A more detailed list is available at the bottom of this link.
Is my money safe anywhere?
The question posed is a little tongue-in-cheek. Banking, investing and the business of money is a trust-based model. If you make a dollar and then turn around and give it to another business to hold on to, the implied agreement is, “I trust you to take care of this.” This is true, most of the time, for most of these businesses; but as with all things in life, risks do exist. In 2021, there were 4,237 commercial banks insured by the FDIC with a total of 72,405 branches. Are all of these bad? No. Are all of them just as safe as each other? As we found out with SVB, the answer is no. It’s not time to rush to the bank and try to figure out how to bury all of your money in the backyard. Instead, there are some steps you can take to diversify your cash and add in additional layers of protection, rather than relying on a governmental bailout for deposits over the FDIC limit.
A Few Ideas
· The FDIC protects cash up to $250,000 per owner. So, if you have a spouse, open a joint account and your coverage will extend to $500,000 at that institution.
· Want to hold cash beyond the FDIC limit? You can run around town opening bank accounts, but the easier approach is to consider opening a single brokerage account. Once your cash is there, you can purchase certificate of deposits, CDs, from other institutions in order to extend FDIC coverage. CDs are covered up to $250,000 per institution, so you can diversify your CD exposure between banks in a single account, thereby extending your FDIC coverage. Because CDs are technically a security as well, you will also be covered by SIPC.
· Let’s say you don’t trust banks to keep deposits safe and want explicit protection on your money. Then you can open a brokerage account and buy treasury bills, notes, and bonds. These securities are backed by the full faith and credit of the U.S. government which guarantees interest and principal payments will be paid on time. This means that at maturity, investors in US treasury securities will be made whole. Should your treasuries be mishandled and lost by the custodian, SIPC coverage covers them as well since they are a security.
· Finally, for investors worried about SIPC coverage being limited to $500,000, many custodians purchase additional supplemental coverage above and beyond SIPC limits. The purpose is to give customers peace of mind that if something happened to the brokerage business, that their investments would be safe. For example, Charles Schwab’s supplemental insurance is provided by Lloyd’s of London and protects up to $600 million, including cash of up to $1,150,000, in the event that SIPC coverage is exhausted.
Cash can be diversified.
If FDIC coverage is concerning, it’s possible to diversify cash allocations to provide different types of protections through coverage used by organizations like the FDIC, SIPC supplemental custodial coverage or a combination