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Is Your Money Still Safe in the Bank?
Why banks are failing and how can you protect your money
We just saw two of the largest bank collapses in US history. And they both failed due to mass panic causing a bank run. You may be wondering…
Why did this happen? Can it happen again? Should I be worried?
Let me provide you with some insight to help answer those questions.
Why did this happen?
The US financial system was built on what’s called ‘fractional reserve banking’. This fractional banking system only requires the banks to keep a certain portion of client deposits in their cash reserves. The rest of depositors’ money is free for the banks to do whatever they want with.
But most banks are publicly traded companies with shareholders to impress.
So they either invest the money to generate a return, or they loan it out to someone and profit off the interest.
However, during the Covid pandemic there was a major change made to the reserve requirements. The required minimum amount of depositor money needed to be held by the banks in their cash reserves was taken away. Removing that rule essentially made the US a no reserve banking system. The banks were then free to invest or loan ALL of their depositors’ money.
When demand for loans significantly dropped during the pandemic, the banks decided to invest even more of their depositors’ money. But the problem was that they invested into securities highly affected by changes in interest rates.
As the Fed has continued raising rates, the banks’ investments lost billions of dollars in customer deposits. When news of this leaked, everyone ran to the bank at once trying to withdraw all of their funds.
This is called a bank run. It’s when too many people try to withdraw their money at the same time and the bank can’t fulfill all the withdraw requests because they don’t have that much cash in their reserves. Massive bank runs like the ones seen at Silicon Valley and Signature lead to complete bank failures.
Can this happen again?
After the collapse of these two major banks, the US government and banking regulators came together quickly to make a plan that would stop widespread fear from causing more failures in the future. Here’s what they did:
First, they promised that they’d backstop all customer deposits at both banks and made funds available to all within 24 hours of the announcement.
The Federal Reserve also enacted a new program called the Bank Term Funding Program (BTFP). Its main purpose is protecting other financial institutions by ensuring they’ll always have enough money to meet withdraw requests. In short, it’s meant to keep more bank runs from happening.
The Fed will offer loans of up to 1 year to banks who may need additional funds to meet depositor demands. Any bank utilizing this program will have to pledge assets of their own as collateral.
These steps should help mitigate mass fear from spreading and causing more bank failures. But whether or not it will renew public trust is our banking system remains to be seen.
How to protect your money
The best way to ensure that the money in your bank accounts are protected is by having FDIC insurance. Let me elaborate on this:
The Federal Deposit Insurance Corporation (FDIC) is an independent US government agency that provides insurance to depositors in the event their bank fails. FDIC insurance covers up to $250,000 per depositor, per bank, for each account ownership.
In order to qualify for FDIC insurance, the bank must be a member of the FDIC. Most banks in the United States are FDIC insured, but it never hurts to double check and make sure that yours is too.
If you have less than $250,000 in a bank account, then your money is automatically insured. So even in the event of a bank failure, your money would be protected.
FDIC insurance covers all types of deposits including checking & savings accounts, money market accounts, and CDs. However, it doesn’t cover investments made such as stocks, bonds, mutual funds, or other securities.
Diversification is crucial when looking to protect large sums of money held in banks because any funds over the $250,000 FDIC insurance limit in a single account wouldn't be eligible for coverage.
It’s so important to understand what’s happening with our financial system and why. It’s also necessary to know about these FDIC insurance benefits so that you can plan accordingly and protect your money. I hope this article broke all of it down in a very easy to understand way and helps you feel more confident in your own financial plan.
These are unprecedented times we’re in, but those who stay informed will be in a good place to get through it all. I hope this weekly newsletter can be your way of staying in-the-know and confident with your financial plan.
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