By: Edward J. Leach, CFP®, MBA
We have been getting a number of questions regarding Silicon Valley Bank and FDIC Insurance and thought it would be best to share a brief explainer video to shed light on how banks work, what happened to Silicon Valley Bank, and how you can maximize your FDIC insurance.
This video is the first of what we hope will be many videos to communicate our thoughts more efficiently on timely investment and financial planning topics.
We welcome your feedback and thoughts as we continuously work to improve our communications with you.
Transcript
Hi everyone. We've be getting a lot of questions over the last couple weeks of exactly what went on with Silicon Valley Bank. So we thought we would put this short video together just to kind of answer a few general questions that we've been getting.
One is that we need to understand how do banks work what exactly happened with Silicon Valley Bank? And then really the takeaway for everyone who's watching this is just the understanding of what is FDIC insurance and how much are you actually eligible to receive from the banks?
How Do Banks Work?
So to answer the first question of how do banks work, banks have a few main functions, and they're really simple. The first is they are there to take your deposits, meaning they're there to hold your money. On the flip side of that, they are also there to make loans or lend your money. Those are the primary two functions of a bank. Now, the next thing to understand is what can a bank do with your deposits?
When you bring money to a bank and you deposit it in your account, technically that is a liability to the bank. They owe you that money that you've deposited. So while they're holding your money, what exactly can they do with those deposits? They can either lend your money out via loans or they can actually invest your money, invest those reserves.
And at all times, banks need to have enough cash available to meet deposit withdrawals at all times. Because when you go to the bank and you request to take out a certain amount of dollars, if that bank tells you that money is not readily available, there's going to be a little bit of panic. And that's a little bit of what happened with Silicon Valley Bank, and we'll get to that in a little bit.
How Do Banks Make Money?
The next question is, how do banks make money? Essentially, when banks either make loans or investments, they collect interest in the form of income or investment gains. Any type of income generated by the two activities that they're doing with your deposits, either lending the money out or investing your money, that is the money that they make.
Now, at the same time, for you to deposit your money in a bank, a bank usually will have to pay you a competitive interest rate for you to keep your money there. So whatever the bank makes via lending your money out or investing your money and whatever they pay to depositors, the bank gets to keep the difference.
That's to cover their overhead, their expenses, and also to book profits for the bank. So that's how they frankly stay in business. These two activities for them are really important.
Silicon Valley Bank
In the case of Silicon Valley Bank, again, keeping in mind, what can a bank do with your deposits, and they need to have enough cash available to meet deposit or withdrawals at all times is, let's flash back to 2021 and what was happening. As everyone remembers, 2021 was the post pandemic calendar year. Venture capital startups were all really doing well. Money was coming in. Fundraising for these companies was really easy, and Silicon Valley Bank really specialized in the area of working with startups, specifically based on the West Coast and technology companies.
So they were very popular and there were very few individual depositors, meaning that it was mostly businesses and companies. And as all of this money was pouring in, in 2021, and, and let's take for example they had hundreds of billions of dollars coming in in deposits. They needed to do something with that money. And, and frankly, when that money was coming in, they couldn't lend it out fast enough. So they decided that they were going to take, let's say, for example, a hundred billion dollars of their cash reserves and purchase 10 year US government bonds at an interest rate of 1.5%.
Now, what do we know happened since 2021? Interest rates go up, and if there's anything that we've learned in 2022 or any investors learned in 2022 that when interest rates go up and they go up really quickly, what happens to bonds? Their bond prices go down, right?
If you flash forward to 2023, Silicon Valley Bank now has eight year US government bonds paying that one and a half percent because two years have already gone into that 10 year term. But if they sold it today, the value would maybe only be about $75 billion. And the reason for that is, flash forward to 2023 an eight year bond today may be paying close to 4%. So you as an investor is not going to pay a hundred billion dollars for those same loans. They're going to be marked down. And that's what happened to Silicon Valley Bank.
Now, what is also happening during this time period is that depositors started to realize and say, wait a second. I'm not getting a lot of money or interest keeping all of my reserves at Silicon Valley Bank, and I have millions and millions of dollars that I fundraise over the last couple years, and I can go out and buy 30, 60, or 90 day US treasury bonds that are paying me well over 4%.
Depositors went to their banks, started pulling out their cash, moving it over to brokerage accounts, purchasing those treasuries. At the same time, what has happened since 2021, a lot of these startups have burned through a lot of cash. Growth has slowed down, fundraising has slowed down, and they need to meet payrolls and they need to meet their overhead costs. So what was at the time in 2021 Silicon Valley Bank thinking they have a lot of stable depositor dollars became very unstable in 2023.
As soon as depositors realize they can get more interest than short-term US treasury bonds, they start withdrawing their money. The word gets out, the bank may not be able to meet deposit withdrawal requests. And the reason for that is because they have to disclose what the reserves they have on their financial reporting. So again, when you start digging under the hood and word gets out that there's a chance that they're going to be struggling and meeting depositor needs. And specifically what happened with Silicon Valley is they realize they couldn't just sell these at a markdown. So they went out and said, okay, well I need to make up the difference of this $25 billion. I'm going to do it via raising stock or raising debt. And that plan quickly got shut down and panic ensued over that weekend. And the confidence in the bank breaks, which again, you now have a bank run, meaning that everyone loses confidence in that bank and they don't know if their money is going to be there.
So everyone tries to pull it out all at once, which is obviously what is going to create this issue. So the FDIC stepped in that weekend and the Federal Reserve and guaranteed all bank depositors. And the reason that they did that is because of the word confidence is that you do not want any type of small, smaller bank to have any type of depositors lose confidence in not being able to get access to their money. So that, that kind of hopefully calmed a lot of that down. Now, signature Bank also had another issue and some other banks are on the radar. However the FDIC did come in and take the necessary steps to make sure that those depositors would have access to their funds immediately. So the takeaway from this is FDIC insurance is really important to pay attention to.
FDIC Insurance
Now for the majority of folks, frankly, it's rare that you're going to come up against this because no one is carrying this amount of cash in their banks. But we wanted to bring it to everyone's attention, that if you are a single individual, you can have up to $250,000 of total FDIC insurance coverage at any individual bank.
If you are a married couple, you can actually have up to a million dollars of FDIC insurance. And the reason for that is because each spouse can have $250,000 deposited into each individual account, which is a unique registration and as well as $500,000 in a joint account. So if you put all of that together, if you had a million dollars at x, y, Z bank, if you set it up this way where each individual account had 250,000 and a joint account had 500,000, you'd actually be fully insured for businesses at any individual bank you have up to $250,000 of FDIC insurance.
How to Increase FDIC Coverage
So when looking ahead at the, you know, options for insuring more than the traditional FDIC insurance, there are a lot of FinTech solutions that are popping up that essentially partner with banks to expand on the amount of FDIC insurance that they can provide. For example, as everyone knows we talk about Flourish Cash. What Flourish Cash does is they partner with program banks, which can provide additional FDIC insurance, and they can also negotiate higher interest rates. So at Flourish Cash, for example, a single depositor can have up to one and a half million dollars of FDIC insurance. A couple can have up to $6 million of F D I C insurance.
Again, by setting up two individual accounts for each depositor plus a joint account, a business can have up to one and a half million dollars. And I want to call out specifically this last part, the businesses, because $250,000 for most businesses is not a lot of FDIC insurance to have at a single bank. And what we're finding is, and frankly we do this for ourselves at Highland, is leveraging one of these platforms like Flourish to be able to have any overflow of cash outside of the operating bank or the operating cash that you use for your business to overflow into something like Flourish just to make sure that the FDIC insurance coverage is there at all times.
So this is a, just a quick summary and overview of the takeaways of what's happened over the last couple weeks. We'd love your feedback on this video, so feel free to share. Thank you.
Ed Leach, CFP®, MBA, is a Partner and Wealth Advisor at HIGHLAND Financial Advisors, LLC in Wayne, NJ, and works directly with clients advising them on their financial planning and investments. Ed’s work focuses on the unique needs of business owners, helping them extract value from their businesses while creating efficiencies in their business and personal financial plans. He is also a member of NAPFA, which is dedicated to serving fee-only advisors.