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The FDIC Has Limits: If Your Bank Fails, How Safe Are Your Deposits?

Sep 5, 2023

If you follow the business news, you'll recall the bank failures that occurred last spring. It began with Silicon Valley Bank's collapse and was followed in short order by Signature Bank in New York and First Republic in San Francisco. These failures were attributed to poor risk management by the banks and loose oversight by regulators. But the stage was set by the Federal Reserve's extraordinarily fast tightening of monetary policy in the preceding year.

The Fed's turnabout took bankers, and everyone else, for that matter, by surprise. Banks that had failed to hedge on interest rate risk and whose deposits were concentrated in a single sector, technology in this case, suffered the consequences. Concern swept markets for weeks afterward. Who would be next? But by mid-May, those fears had been swept aside by worries that Congress would cause the U.S. to default on its debt.

Now, the vulnerability of regional banks is back in the news. In recent weeks, credit rating agencies have lowered grades on a dozen banks amid growing risk from weaker funding, large deposit outflows, and rising interest rates. Six banking giants were placed on review for potential downgrades. So are we headed for another round of bank failures? And what does this mean for our own financial well-being?

I believe we are headed for another period of anxiety about the regional banks. Just today, Federal Reserve Chairman Jerome Powell dispelled wishful thinking that the fed was done with rate hikes. He made it clear that another quarter point increase remained on the table for the fall. Regional banks have been counting on the Fed to loosen the reins soon. High interest rates reduce their income and lead depositors to demand higher returns on their deposits. Otherwise, they take their money elsewhere.

Banks remain vulnerable for another reason: excessive exposure to a single market sector. Last spring it was technology. Today it's commercial real estate. If you follow the news, you've seen reports of a collapse in demand for office space that is accompanied by work from home practices. It's uncertain whether the demand for office space will ever return to pre-pandemic levels.

Many more banks are exposed to commercial real estate risks than they were to the technology sector. What does this mean for you and me? The good news is our deposits are earning more. The bad news is the borrowing costs are much higher. With mortgage rates above 7%, it's especially tough if you're buying or selling a house. But how safe are our bank deposits?

If your bank is insured by the Federal Deposit Insurance Corporation, your deposit is guaranteed up to $250,000 per account holder. How solid is this guarantee? When SVB, Signature Bank, and First Republic failed last spring, the FDIC made depositor accounts available the very next day. So the guarantee is rock solid, but it's limited to $250,000 per account holder. So be certain your account is below that limit.

The FDIC has chosen to ignore this limit in the past insuring accounts without limit. But don't count on that in the future. The FDIC's financial resources may not always allow for such assurance.

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