What the impact of recent banking issues can mean for you
THE RECENT BANK COLLAPSE, starting with Silicon Valley Bank, has brought to light several key concepts in the personal finance sphere that we all need to be aware of when managing our money and trusting institutions with our savings and investments.
Silicon Valley Bank (SVB) was a prominent mid-sized bank on the West Coast that played a large role in angel investing for startups. Due to a conglomeration of factors, SVB became the biggest bank to fail since the 2008 financial crisis.
How could it happen
In 2018, Federal Reserve oversight was loosened on mid-sized banks, raising the threshold for federal scrutiny to banks that own greater than $250 billion. Thus, banks such as SVB were allowed to take on more risk.
Not only did they increase risk by angel investing in startups, but also by investing in Treasury Bonds and mortgage-backed securities with 10-year terms.
Bonds are generally considered safer investments, but one lesson highlighted by the SVB debacle is the concept of interest rate or duration risk. Treasury Bonds are loans to the government guaranteed to be paid back at a certain interest rate after a set term or duration. They have low credit risk because the government usually does not default. However, the longer the term of these bonds, the greater the risk that rising interest rates will devalue them.
Whenever the Fed raises interest rates, long-term bonds with lower interest rates sell at a lower price. After all, who would want to buy a 10-year bond yielding 2.5% if they can buy another bond today that offers a much higher yield? Bond prices are only an issue if we can’t hold the bond for its full duration and must sell before the term ends. That’s what happened to SVB: It suddenly experienced an influx of people wanting to withdraw their money and had to sell long-term bonds at a $1.8 billion loss. Failing to raise capital to cover that loss resulted in the collapse of this once-monumental bank
When the FDIC took over the bank, many depositors had a moment of panic as they realized that their deposits exceeded the limits of FDIC insurance. Silicon Valley trembled under the possibility that countless startups could lose millions.
The CEOs took to Twitter and, after much public pressure, the government decided to make an exception to bail out these companies and insure all of their depositors.
As individual savers are not so influential on Twitter, this crisis should bring to light the importance of FDIC insurance and its coverage limitations.
The FDIC defines itself as “an independent agency created by Congress to maintain stability and public confidence in the nation’s financial system.” The FDIC insures $250,000 per depositor, per FDIC-insured bank, per ownership category. That means a couple with a joint account would be covered for $500,000 total. Any excess amount could be lost in a bank failure. You can check if your accounts are fully insured at edie.fdic.gov.
It is important to note brokerage accounts that hold stocks, bonds, mutual funds and the like are not covered by FDIC insurance. Instead, they are covered by SIPC insurance, which has different rules.
When banks fail, it is natural to feel panicked. However, the United States does have safeguards, as evidenced by the FDIC and SIPC. Investing and saving will always have risks. Investors can mitigate the risk of bank or brokerage collapse by making sure their banks are members of the FDIC and brokerages are members of SIPC, and by knowing what limits apply to their coverage. Then, they can rest easy, invest with confidence, and live their lives.