Is Your Money Safe…in a Bank?

The collapse of US Bank in 2023

You traditionally deposit your money in the bank. Common sense would suggest it makes sense. After all, banks keep our money “safe” and accessible while providing extra financial services (cards, loans, mortgages). 

However, in early 2023, international headlines reported a Domino of US banks collapse. These events raised a legit question: Is your money safe in a bank?

Banking regulations and client protections are country related. While in today’s article, I outline some examples for US clients, you can look for similar features in your country. Generally, each country sets up regulations to protect clients and increase trust in the financial sectors to make you feel your money is safe enough in their accounts.

Fractional Reserve Banking

When you deposit money in the bank, the bank doesn’t just put that money in a vault. Banks invest your money by issuing loans and buying bonds. They only hold a small percentage of client deposits as cash. To be clear, when you deposit money in your bank, that money does not stay in your bank account. The bank reallocates it; the money is re-purposed to achieve yields.

The bank can promise you a certain deposit interest (for example, a 2 % interest rate), because the bank expects to use the money and make much more (for example, a 4% or more).

This practice, highly regulated at National Level by the Central Bank and the Ministry of Finance, is called Fractional reserve banking. It is a system in which only a fraction of bank deposits must be available for withdrawal. As such, banks only need to keep a specific amount of cash for clients’ withdrawals and can create loans from their deposits.

Fractional reserves work to expand the economy by freeing capital for lending. It is an intelligent system that works like a charm until it doesn’t. Historically, governments have increased fractional banking limits to boost the economy.

When a bank doesn’t manage its investments and loans well, it risks collapsing and being unable to give clients their money back.

The FDIC

The Federal Deposit Insurance Corp (FDIC) is an independent agency of the U.S. government that protects you against loss of deposit if your bank or thrift institution fails and is FDIC-insured. To keep public confidence, the federal government created the agency during the Depression in 1933.

The FDIC insures money in a US bank up to $250,000. If the bank fails, you will get your money back. Nearly all banks are FDIC insured in the US. You can check if your bank is insured by FDIC here.

FDIC deposit insurance covers checking accounts, Negotiable Order of Withdrawal (NOW) accounts, savings accounts, money market deposit accounts (MMDAs), certificates of deposit (CDs), cashier’s cheques, money orders, and other official items issued by an insured bank.

If you have over $250,000 in individual accounts at one bank, over $250,000 is considered uninsured.

If you have multiple individual accounts at the same bank, for example, a savings account and certificate of deposit, those are added together, and the total is insured up to $250,000.

A married couple can easily protect $1m at the same bank by having two individual accounts and a joint account (250K+250K + 500K).

You can also move to another financial institution. Moving your money to other financial institutions and having up to $250,000 in each account will ensure that the FDIC insures your money.

Historically, the FDIC says, it has returned insured deposits within a few days of a bank closing. It will either provide that amount in a new account at another insured bank or issue a cheque.

If the Bank Goes Bankrupt, is your Investment money safe?

Customers should closely examine their investments in their bank to know how much of their assets are insured by the FDIC.

FDIC deposit insurance does not cover stock investments, bond investments, mutual funds, life insurance policies, annuities, municipal securities, safe deposit boxes or their contents, US Treasury bills, bonds or notes, and crypto assets.

The FDIC offers an electronic deposit insurance estimator, a tool to understand how much of your money is insured per financial institution.

Is Your Money Safe at StockBrokers?

You don’t necessarily invest through your Bank. Chances are, you use online brokers. They often offer good value for money with their services. The good news is that, historically, it is rare to see stockbrokers going bust.

By “simply” buying and selling securities, they don’t have to manage liquidity and cash like a bank. They don’t normally hold saving accounts.

Unlike a bank, a stockbroker buys and stores investments on your behalf. For instance, if you invest $10,000 to buy 100 shares in an exchange-traded fund (ETF), your broker purchases and stores your 100 shares for you. Even if your broker collapsed, you’d still own those 100 shares in that ETF. The securities in your brokerage account are yours and separate from the broker’s other assets. They are, effectively, in their vault. Unlike Banks with your current / cheque/ deposit / saving account, stock brokers can’t use customer assets to finance their businesses.

Extra Cases

Banks. If you own shares or bonds of your bank, and the bank fails, that’s a problem. The value of the shares decreases or goes to zero. The Bond contract won’t be respected. In that case, you lose the money (your investment) because you bought assets of a company that went bankrupt. However, on a case-by-case basis, governments could help negotiate and recover part of the losses. 

Banks. If you have money deposited at your bank – as discussed above (checking accounts, Negotiable Order of Withdrawal (NOW) accounts savings accounts, money market deposit accounts (MMDAs), certificates of deposit (CDs), cashier’s cheques, money orders) – those amounts are insured, as long as the bank in your country is part of an insurance mechanism (in the US is the FDIC). The insurance has a ceiling. Over a certain amount, your money is not insured.

Banks or Stock Brokers. If you own shares or bonds of other banks or companies, and your Bank/Financial Institutions/Stock Broker goes bankrupt, you are still the legal owner of assets. Those assets and accounts will be moved to a new financial institution. You will still access and manage them without any price fluctuation or risk. You need to learn how to access the new account and wait to let the authorities transfer such assets or accounts.

Is your money safe in your “home” currency? 

Suppose your salary is in Euros, dollars, or any other hard currency (which is not likely to depreciate suddenly or fluctuate significantly in value). In that case, you are already in a good spot. However, that is only the case for some of us worldwide.

I had cases working abroad when I was paid in local “weak” currency. If that is the case, the question arises: is your money safe in such currency? For wealth accumulation and protection, common sense would suggest saving and investing as much as possible in hard currency to reduce currency risk (Currency risk is based on the assumption that the currency’s value in foreign nations is on a continuous rise and fall trend). With long-term planning, hope is not a plan. If your local currency and economy are “shaky”, take the proper measures: diversify, reduce your currency risk, and buy safe assets locally or internationally. 

The Elephant in the Room: Inflation

What do you think about inflation? Inflation is commonly perceived as an increase in the prices of goods and services. Classic economic theories embrace annual inflation of around 1.5 – 2% in the US (each country has its historical averages). Just enough to move the economy forward without causing concerns. 

However, Inflation can be rightly called a hidden tax for two reasons:

1. It is often caused voluntarily by the government (through quantitative easing, printing new money). The IFC reports how “long-lasting episodes of high inflation are often the result of lax monetary policy. If the money supply grows too big relative to the size of an economy, the unit value of the currency diminishes; in other words, its purchasing power falls, and prices rise”. As with any macroeconomic analysis, there are many moving pieces to monitor and theories to consider. For instance, after COVID, the disruption of supply chains and the limited availability of workers were blamed for higher inflation. The logic was the following: higher demand for goods and services, with lover supply, caused the increase in prices.  The argument is solid but should not hide the years of quantitative easing and lax monetary policy!  

2. It silently destroys the actual value of your money if not properly invested. The bottom line is that you still lose purchasing power year after year. Instead of taking away your money (taxes), it elegantly reduces the value of your earned and deposited money. 

You have undoubtedly heard the importance of investing in assets with an edge against inflation (Real Estate or Stock are popular examples). Keeping your money in a bank account is only safe at face value.

Therefore, the new question would be: Is your money safe, despite inflation?

For instance, if you keep 250,000 dollars in a bank account for one year, the FDIC ensures this amount in the US. You might feel like it is safe. Even if the bank goes bankrupt, you will still get your money. That’s right. However, in real terms, if you have (as an example) 7% inflation, at the end of the year, that amount is still 250,000 dollars, but you can consider losing 7% of purchasing power. This would not be an estimation or a rare occasion like having your bank go bankrupt.

Inflation is a 100% sure event. It can be high or low, based on your country’s economic circumstances, currency, and global economy, but you can hardly escape it. It must be monitored and mitigated. The way to mitigate it, creating an asset allocation (with inflation-edge assets) based on your investment goals and risk appetite, is the holy grail of Personal Finance and Investment Wisdom.

Bottom Line

Overall, applying diversification is a good idea to keep your money safe:

1. Select well-respected Banks and Financial Institutions (more than one)

2. Be aware of the insurance ceilings and create individual or family accounts to maximize such ceilings

3. Recognize your portfolio is not insured and managed in the same way by all institutions (Banks, Stock Brokers, or non regulated financial institutions)

4. Recognize the level of risk of each asset class, investment product, and institution. Adjust your Portfolio accordingly

5. Currency risk must be recognized and mitigated

6. Inflation must be monitored. Don’t keep your money idle

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