By Matt Stephens, CFP®
Banks play a vital role in the economy, providing individuals and businesses with access to cash, credit, and other financial services. Despite their importance, it is possible for banks to fail. When they do, it is often a shock and can cause panic in the wider economy.
This past week, two major players in the banking industry, Silicon Valley Bank and Signature Bank, collapsed after too many customers requested withdrawals at one time and the banks were unable to raise enough capital to meet that demand. While most experts believe these failures are not part of a more significant economic crisis (myself included), everyday investors are understandably worried. Silicon Valley Bank was the second largest bank failure in U.S. history and Signature Bank was the third. Only the collapse of Washington Mutual in 2008 was larger.
Fortunately, after the 2008 credit crisis, additional safeguards were put in place that make it incredibly unlikely that bank customers will lose their savings, even in the event of widespread banking failures. In this article, we explore why banks fail, what insurance protections are in place, and why your savings accounts are safe.
Why Do Banks Fail?
According to an FDIC report banks can fail for several reasons, including undercapitalization, liquidity issues, safety and soundness, or outright fraud.
- Undercapitalization (the same reason normal businesses fail): This is when a bank doesn't have enough income to cover ordinary business expenses (or to meet regulatory requirements). This can leave it vulnerable to financial shocks and when a recession hits, the bank fails.
- Liquidity issues (or a run on the bank): This happens when a bank doesn't have sufficient cash or liquid assets on hand to meet its obligations when a large number of depositors withdraw their funds all at once. This is potentially a larger problem now that most withdrawals happen electronically instead of physically at the bank.
- Safety and soundness concerns (or risky lending practices): This is when a bank engages in high risk lending, such as subprime loans (to borrowers with low credit scores) or investing in volatile assets. These practices are more profitable to the bank, but have a greater potential for large losses. This was a huge issue during the 2008 financial crisis when several major banks failed due to their investments in subprime mortgages.
- Fraudulent activities: This is simply illegal behavior like insider trading or outright theft of customer funds. A small regional bank in Texas failed because the bank president and senior vice-president took out $21M of fraudulent loans to fund their lavish lifestyles over several years. This behavior can obviously cause significant financial losses for a bank and erode depositor confidence.
Banks that fail to manage these risks effectively may become insolvent and ultimately fail, jeopardizing the stability of the entire financial system and broader economy.
What Happened With SVB & Signature?
SVB and Signature Bank both failed due to liquidity issues stemming from what’s known as a bank run. A bank run occurs when a large number of depositors withdraw their funds from a bank over a very short period of time (usually a matter of days). Because banks lend out or invest the cash deposited with them, this high demand for withdrawals all at once can force the banks to sell off these investments in order to meet the liquidity need. If the bank has to sell assets at a loss (because of the speed or volume required), this can exacerbate liquidity issues and quickly cause a bank to become insolvent.
Silicon Valley Bank almost exclusively served tech start-ups and venture capital-backed clients, which were hard-hit during the economic volatility of 2022. As financing started to dry up for tech companies and venture capitalists couldn’t raise additional funding, clients began withdrawing funds from their accounts at SVB to meet the operating expenses for their businesses. SVB was forced to sell billions of dollars’ worth of long-term Treasury bonds at a massive loss to raise capital. This spooked other depositors, many of whom had accounts well above the FDIC-insured limits, and caused them to withdraw their money at an unsustainable rate ($42B in one day!). For context, the previous largest bank run in history was on Washington Mutual bank in 2008, which was $16.7 billion over 10 days. SVB could not meet their deposit requests and attempts to raise capital or sell the assets to a healthier bank were unsuccessful. The FDIC quickly stepped in as receiver and took over operations to prevent further damage.
A similar story unfolded at Signature Bank, which served mostly crypto investors. Like the depositors at SVB, many of the accounts held at Signature Bank were well above the FDIC-insured limits. Spooked by the failure of SVB, depositors at Signature Bank withdrew over $10 billion on Friday, March 10th. By Sunday, the bank was taken over by the FDIC to protect the stability of the U.S. banking system.
What Does This Mean for Other Banks?
While the effects of the SVB and Signature Bank failures are hard to predict, the FDIC has reacted swiftly to prevent further damage. Regulators have invoked a “systemic risk exception” which allows the government to reimburse uninsured depositors. The Fed has also set up an emergency lending program to provide funding to eligible banks at risk of bank runs. While I believe this was the correct and necessary decision for the short-term, I do have concerns about the long-term impact of these policies.
Small and midsize banks are at the most risk, since they tend to focus on niche clientele who are more susceptible to industry-specific problems. Shares of regional bank stocks took a beating on Monday, March 13th, as investors tried to process the news of SVB and Signature Bank. For example, First Republic Bank's stock price was down over 60%. Larger banks, including Wells Fargo, Bank of America, and JPMorgan were less affected, falling just 7%, 3%, and 1%, respectively on the same day.
What About FDIC & SIPC Insurance?
Despite the uncertainty surrounding the health of the overall banking system, there are safeguards in place to protect depositors and investors from losing their hard-earned savings.
Both the Federal Deposit Insurance Corporation (FDIC) and Securities Investor Protection Corporation (SIPC) provide insurance to preserve your assets and are backed by the full faith and credit of the U.S. Government.
The FDIC is an independent U.S. government agency that was established in 1933 to insure bank deposits. The FDIC insures deposits up to $250,000 per depositor, per account ownership category, per bank. This coverage includes checking accounts, savings accounts, money market accounts, and certificates of deposit (CDs) issued by FDIC-insured banks.
SIPC is a non-profit organization established by Congress in 1970 to protect investors against losses due to broker-dealer failures. SIPC provides up to $500,000 in insurance per customer for cash and securities held by a broker-dealer. This coverage includes stocks, bonds, CDs, and mutual funds held in a brokerage account. Fidelity Investments (where we hold our client assets) carries additional insurance protection above what is standard with SIPC.
It’s important to note that SIPC insurance does not protect against losses due to market fluctuations, but only in the event of broker-dealer insolvency or fraud.
How to Safeguard Your Savings
The most important thing to remember is that FDIC insurance has a limit to its coverage. Up to $250,000 per depositor, per account ownership category, per bank is insured. If you have more than that in a single account at a single bank and that bank fails, that money is absolutely at risk and needs to be moved. Trust accounts are a separate ownership category and each account holder in joint accounts are is insured up to the $250,000 limit, so those are some ways to safely have more than $250,000 at a single bank.
If you have accounts with multiple banks, just make sure you spread the deposits out so that each account is under the FDIC limit. Remember to regularly review your account balances and adjust them as necessary. By knowing the coverage limits and eligibility requirements, you can keep your money safely in the bank.
How We Can Help
I know most people don't typically keep more than $250,000 in bank accounts, but if you’re worried about the recent bank failures and how this might impact your finances, please reach out to us for guidance. My team and I can help you understand your options and develop a plan to protect your assets, minimize your risk, and make sure you're on track. Schedule a 30-minute call with me today.
Matt Stephens is a financial advisor with AdvicePoint, a financial services firm based in Wilmington, North Carolina, specializing in retirement income planning, tax-reduction strategies, and charitable planning. Matt spends his days guiding clients as they make the leap from career to retirement. He loves simplifying complex financial issues and giving unbiased answers in plain English. His team goes beyond just professional investment management with their client-focused and high-touch approach, building plans as unique as each client.
Matt obtained degrees in Business Administration and Communication Studies from UNC-Wilmington, holds the Series 66 Investment Advisor License, Chartered Retirement Planning CounselorSM, CERTIFIED FINANCIAL PLANNERTM, and Behavioral Financial AdvisorTM certifications, and was a recipient of the 2019 Wealth Management Thrive Award. Outside of work, Matt enjoys spending time with his wife, Brooke, and their two young children. They attend Port City Community Church, where Matt has volunteered since 1999. His favorite pastime is surfing. To learn more about Matt, connect with him on LinkedIn.