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FDIC Insurance: What it is, How it Works and the Large Banks’ Backstops

In the wake of Silicon Valley Bank’s (SVB) failure and the ensuing concern over the health of the banking system, many are looking for information on deposit insurance, mainly Federal Deposit Insurance Corporation (FDIC) protection and other ways to protect their cash. Fortunately, the Federal Reserve has stepped in and backstopped depositors but still concern remains about some regional banks with weaker balance sheets.

Alongside FDIC insurance, there exists other programs such as Securities Investor Protection Corp. (SIPC). How does this work and how is it different from FDIC protection? And lastly, how well backstopped are deposits at the biggest banks by their balance sheets?

What is FDIC Insurance and How Does it Work?

The Federal Deposit Insurance Corporation (FDIC) is a government agency that was created in the wake of the Great Depression aimed at preserving confidence in the banking system by protecting depositors. The FDIC provides deposit insurance up to $250,000 for each deposit ownership category in the bank. (More on this later).

In the event of a bank failure, the FDIC first attempts to sell the deposits and loans of the failed institution to another and then they become customers or borrowers from the new bank. The FDIC historically has seized banks on Fridays, sold them over the weekend and re-opened them on Monday under new ownership. The goal is to minimize disruption to the public.

Now on the topic of ownership categories and how insurance for your assets could be north of $250,000. Consider a married couple, let’s call them John and Jane: they each have individual accounts at Bank ABC and also open a joint account. They would get the following protection:

Source: FDIC, Roundhill Investments

How Does the FDIC Work?

The FDIC insurance fund, known formally as the Deposit Insurance Fund (DIF) is not funded by taxpayers - it’s funded by assessments on banks. That's right, the banks for it. Each quarter, the bank’s pay an assessment based on their risk-weighted assets less their tangible equity. In other words, they pay the assessment based on their risk-weighted total liabilities, not just their deposits. But the exact calculation of how they determine the assessments is complex and we won’t get into that here.

The FDIC is also a bank supervisor and is regularly in communication with its member institutions. When it starts to be concerned about one, it normally communicates immediately with the bank and with the state banking regulator or the Office of the Comptroller of the Currency (OCC). Once this state chartering agency or the OCC closes the bank, the bank is put into receivership and the FDIC is appointed the receiver by a court. From there, the FDIC seeks a resolution, usually through a sale, as discussed above.

How Frequently is the FDIC Called Upon?

Source: FDIC, 2023

Banks fail for lots of reasons. They tend to happen a lot at once during financial crises but even in relatively good times, banks fail. From 2015 to 2019, an average of five banks failed every year. Those 25 failed banks had a combined $13.8 billion of assets and $10.6 billion of deposits, per FDIC data. So these were relatively small banks.

During the Great Financial Crisis (GFC), from 2007-2010, 325 banks failed, an average of just over 81 per year. Those 325 banks had $644 billion of assets and $455 billion of deposits.

During the market crash in March 2020 that coincided with the onset of the covid-19 pandemic, there weren’t too many bank failures. This was largely due to the fact that the Fed and other global central banks stepped in with massive support for the banking system. Just four banks failed in 2020 and none in 2021.

What is SIPC Insurance and How Does it Work?

In addition to the FDIC, investors may hear about the SIPC. This works similar to the FDIC but covers brokerage accounts, not bank accounts. FDIC protection only covers bank deposits, money market deposit accounts and certificates of deposit. SIPC protection, created in 1970 via the Securities Investor Protection Act, covers additional assets such as investment products including mutual funds and ETFs. But note, the SIPC does not insure against losses, it just insures against failure of the broker-dealer member firm that holds those assets for clients.

Similarly to the FDIC, SIPC member firms pay into an insurance fund to protect investors. SIPC coverage does work slightly differently than FDIC coverage. The main difference is that protection is per account, not per customer, and the limit per account is $500,000 (of which not more than $250,000 in cash). Bringing back John and Jane, if they each have individual investment accounts and a joint account, they would have the following protection:

Source: SIPC, Roundhill Investments

What Coverage Do the Deposits at the Big Banks Have?

On average, nearly half of the deposits at the largest U.S. banks - Bank of America, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley and Wells Fargo - are uninsured. To be precise, based on company disclosures, 59% of the group’s interest-bearing deposits were uninsured. But this headline number can be a bit misleading and not tell the full story.

Source: Company Filings, Bloomberg, Roundhill Investments, March 2023

First of all, these are global banks with global operations and global deposits. And as such, it makes sense that deposits outside the U.S. would not be subject to FDIC protection. Now, there may be local deposit protection in various jurisdictions but for the FDIC analysis, these count as uninsured.

For example, time deposits make up just 9% of Wells Fargo’s total interest-bearing deposits. Of those time deposits, 9% are non-U.S. deposits. So international deposits skew the numbers a bit.

Also, corporate deposits inflate the numbers. These banks have massive corporate and wholesale banking operations and it’s impractical for large corporations to divide up their cash into enough legal entities and accounts to be fully insured. Consider a company with $1 billion of cash that it wants to protect - it would need 4,000 accounts with different ownership structures to qualify for FDIC coverage.

So although the headline number of 59% of deposits being uninsured can be scary, it doesn’t tell the whole picture. And now with the Fed explicitly backstopping deposits with its emergency powers, it’s likely that depositors of all sizes will continue to be made whole.

The information contained in this blog is for informational purposes only and does not constitute financial, investment, tax or legal advice. The information expressed herein reflects the opinion of Roundhill Investments (“Roundhill”) on the date of production and are subject to change at any time without notice due to various factors, including changing market conditions. Where data is presented that is prepared by third parties, such information will be cited, and these sources have been deemed to be reliable. Roundhill is separate and unaffiliated from any third parties listed herein and is not responsible for their products, services, policies or their content. All investments are subject to varying degrees of risk, including the risk of the loss of capital, and there can be no assurance that the future performance of any specific company, strategy or product referenced directly or indirectly in this blog will be profitable, perform equally to any corresponding indicated historical performance level(s), or be suitable for your portfolio. Past performance is not an indicator of future results.

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