If you’ve been paying attention to the news, you’ll have seen this past week that there was a decently large bank in California that collapsed and failed. This bank is the Silicon Valley Bank and although the hope is right now that it’s an isolated incident (mostly serving startups) the worry is that its not and more banks might fail. As a young professional, this is pretty unnerving as we think of banks as being super safe places to keep your money. This proved not to be the case this week, if your bank was Silicon Valley Bank. I wanted to do some of my own research and share so that you can better understand why this happened and what it could mean for you.
How does a bank fail?
Firstly, I was a little surprised to learn that since 2001, 561 banks have failed, although 465 of those failed during the great recession. That still leaves 96 banks that have failed in non-great recessionary times. That leads to the question; how does a bank fail?
Banks are a business, and businesses are in the business of making money. Banks do not in fact take your deposit, put it in a nice envelope with your name on it and then lock it away in a safe until you are ready to withdrawal it. Instead, banks lump all that money together and in many cases, lend that money out. Money gets lent out in a variety of ways – via credit cards, via mortgages, car loans or other personal loans. If you borrow money from a bank you’ll pay an interest rate, and the bank takes your deposits from your savings/checking account and lends it out for a fee (interest). The good news is that banks will give you a share of this return in the form of interest on your savings accounts, although most big banks pay very low interest rates, but high-yield savings accounts will pay like 3.5% as of right now in March 2023.
Banks have been doing this for hundreds of years, dating back to the middle ages even. In todays modern world there are rules set by the Federal Reserve called reserve requirements and so a bank can’t lend out all the money it takes in. So, assuming your bank is responsible in their lending, you shouldn’t have any issues! But, as history has shown us, this is not always the case.
What is FDIC Insurance and why does that matter
In the midst of the Great Depression, the US government realized that people didn’t really trust banks anymore. Some of them had made bad decisions but most people were spooked and went to pull their money out of the banks (wouldn’t you?). This led to a banking holiday in March of 1933 when the US government mandated all banks close for a few days in hopes of people chilling out a bit. I remember a funny story growing up about a bank in our area that was one of the ‘only banks during this time not to close’ during this mandated banking holiday, and it was due to the fact it was in such a remote location that it didn’t get the news to close in time. But, most banks did close and later that year in 1933, the government instituted the FDIC – the federal deposit insurance corporation, a government agency that would insure deposits against loss.
Today the FDIC is still around and kicking, and it’s proud of the fact that depositors have never lost a penny of their money in the event of a bank failure (which as we’ve seen, does happen). The FDIC covers amounts up to $250,000 per depositor, per bank. So that means Mrs. Money and I (co-owners of our savings account) are insured up to $500,000. We do not have $500,000 in a savings account and even if I had that kind of cash hanging out, I probably wouldn’t keep that much in a savings account that doesn’t pay enough interest to keep up with inflation. But it’s good to know that my money is safe.
The FDIC covers all sorts of accounts – checking, savings, money markets, CDs but does not cover stocks, mutual funds, insurance policies or anything in a safety deposit box. Food for thought!
The best thing is that FDIC insurance is provided to you for free! Of course this is assuming that your bank participates so I would say trust but verify…would hate to find the one bank that doesn’t offer it.
Why you shouldn’t really worry
A lot of depositors at the failed Silicon Valley Bank were startup businesses, and I actually learned preparing for this article that business accounts can also fall under the FDIC insurance up to $250,000. The problem though is that many of these accounts had more than $250,000 meaning they will not have that money guaranteed.
If you (or your business) had over $250,000 in Silicon Valley Bank, you will file a claim to see if you can recover your excess funds. The FDIC in situations like this will step in and take over for the bank; they’ll pay out the $250,000 per owner and then work to sell off the assets (i.e. bankruptcy) or try to sell the bank itself. Selling the defaulted bank happened a lot in 2008 – I used to bank with Wachovia which failed (or was going to fail?) and got acquired by Wells Fargo. So Silicon Valley Bank may very well get bought and it’s not like they had $0 assets (at least it doesn’t look like they did) so I would imagine depositors over $250,000 will get some of their money back but I suppose I really have no idea.
All that to say, if you or your business has over $250,000 in the bank, a) congrats and b) I suppose you should give this some thought. Banks can fail, we saw it just last week. Your options would be to open another account at another bank and hope that bank doesn’t fail (but knowing that if it does your $250,000 would be safe), or just take the chance? Banks don’t often fail but these things are hard to predict!