Banking In a Shifting Economy

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Domestic banks are safe… unsafe… not sure? Here is an historical perspective on banking in this shifting economy.

Most Americans alive today have experienced a world where domestic banks were considered an unsafe place to hold their money. Indeed, since 1933, banks in the United States have had a system backed by the government to protect depositors called the Federal Deposit Insurance Corporation (FDIC). This program currently guarantees up to $250,000 per depositor for funds maintained in a bank that is a member of the FDIC program. This protection is the foundation of the belief held by most Americans that banks are a safe place to hold their money.

A Historical Perspective on Bank Failures in a Shifting Economy

For a historical reference, prior to and during the Great Depression, approximately 9,000 banks failed, leaving their depositors with no recourse to recover their funds representing about 40% of the then-existing banks. Compare that with the last 10 years where: 18 banks failed in 2014, eight banks failed in both 2015 and 2017, five banks failed in 2016, four banks failed in both 2019 and 2020, no banks failed in 2018, 2021 or 2022, and two banks have failed so far in 2023. This small number of failures, coupled with the fact that no depositor has ever lost a penny of insured deposits since the FDIC was created, can help explain the reason for confidence in the banking system and its security.

Up until this month, this system was working well. Unfortunately, the shifting economy was working in the background to destabilize some banks. To understand this impact, one has to understand what banks do with the money deposited with them. The fact is that banks don’t just hold the money deposited with them in a vault waiting for people to come looking for it when they need it. By law, they actually only have to hold 10% in reserve for such purposes. Up to 90% of the money deposited by the bank is actually reinvested with the purpose of earning money and stimulating the economy. That home loan or car loan you have from a bank, for example, is being funded by deposits by you and your neighbors in that bank.

How a Bank Fails in a Shifting Economy

Banks invest the deposits in other types of assets as well, all with the intention of making money for their investors, but also to fund the banking operation and allow customers to have free checking and other perks. Due to rising inflation, the federal government has taken action to raise the cost to borrow money from the government. Known as the federal funds rate, this interest rate is used by the government to try and indirectly manage overall interest rates, inflation and unemployment. In March 2022, the federal funds rate was raised .25% for the first time since December 2018. For the over 4 years between changes, the federal fund rate was near zero. Today the effective federal fund rate is 4.58%, up from .33% a year ago after that first 2022 rate hike.

With effective interest going up almost 4.5% in one year, investors who have their money tied up in long-term investments are feeling the impact. That home mortgage you have at 3% is now losing money for the bank instead of making money. The long-term government bonds purchased by a bank which were secure and making money in a near-zero interest rate environment are now an anchor weighing down a bank and limiting their options to pivot in a changing economy.

The result is foreseeable: some banks are having issues and are not in a position to quickly and effectively liquidate in the event that a large percentage of their depositors want their money at the same time. As of March 22, 2023, two banks have failed due to deposit demands exceeding available funds, Silicon Valley Bank and Signature Bank. The fear that other banks would suffer the same fate has led the Federal Reserve, which is the central bank of the United States, to implement what is being called a backstop to provide cash to banks in the event of withdrawal requests in excess of their reserves. Titled the “Bank Term Funding Program”, this fund will offer one-year loans to banks on favorable terms to allow them to satisfy customer demand while they take action to liquidate or otherwise manage assets as necessary to respond to the demands of depositors if necessary. The Federal Reserve has allocated $25 billion for these potential loans.

Calming Fears

Knowing that there is money to cover deposits if necessary is calming fears of bank customers. This makes the likelihood of a run on more banks less likely. That means few if any banks will actually need to apply for and take loans out of the Bank Term Funding Programs.

For consumers and businesses alike, it is reasonable to believe that deposits up to the FDIC limit of $250,000 are safe. If you have more than that amount in any one bank, you should consider diversification. With the two bank failures this year, the FDIC has said all depositors will be made whole, even if their deposits exceeded the FDIC limit. At a hearing before the U.S. Senate on March 13, 2023, Treasury Secretary Janet Yellen made no commitments that this additional protection would continue if more banks failed. As such, the safest bet is to limit one’s risk exposure if possible, by staying within the FDIC-insured deposit amounts. Another prudent choice would be to discuss alternative options with one’s bank as well as to see if there are investment vehicles available where funds can obtain additional FDIC coverage.

Jennifer Felten, Esq. is the principal owner of RELAW, APC, a boutique real estate law firm specializing in Escrow Title and Brokerage Law, Real Estate Development, Estate Planning and Probate. Ms. Felten has worked in the real estate industry since 1993, both on the transactional side as an escrow officer, and now as an advisor and litigator on the legal side. Currently she is licensed as an attorney, notary and real estate broker and can be reached at RELAW, APC.