“Hi, Prepare. What is happening to the banking system? Is it still safe for us to keep money there? What should we do? Thank you.” Gregg and Tami
Hello, Gregg and Tami. Your questions are on the minds of almost everyone after what has happened over the last two weeks. As you know, there have been several bank failures recently, causing concern and panic for many people. It is important to understand exactly what is going on before making any drastic moves.
It may come as a surprise to many people that banks are not required to keep all of people’s deposits on hand. We have a ‘fractional banking system’, which means banks are only required to keep a certain percentage of deposits on hand. Currently, that percentage is only 10%. For example, if a person deposits $1,000 in a bank account, the bank is not required to keep all the deposits in the bank’s cash vault. They are only required to keep $100, as reserves, and may lend out the other $900. So, 90% of customers’ deposits leave the bank and go to loans for other people or into investments that the banks make.
Banks essentially do two things with depositor money; they either lend that money to other people or businesses, or they buy bonds with the funds. Banks largely buy government-backed securities (treasuries) that will mature at par value. Generally, the risk for banks are that the loans they make could go bad (credit risk) or the bonds they buy could decline in value (duration risk). And because interest rates have risen so quickly, the bonds in their securities portfolio are showing a marked-to-market loss (when interest rates rise, bond prices decline).
Since depositors can demand their money from the banks at any time, the bank may have to sell bonds before maturity to meet the redemption requests, which is causing massive losses for banks because interest rates have risen so sharply recently. Again, this risk is called duration risk, which is basically a timing mismatch between liabilities (demand deposits) and assets (bonds) for the bank. And since some banks did not manage their investments into bonds properly, they are being forced to sell at losses.
Fortunately, large banks are required to comply with a conservative standard in their securities portfolio because they are deemed Globally Systemically Important Banks (GSIBs). However, Silicon Valley Bank and Signature Bank were not GSIBs and ran more aggressively. As always, we always recommend you only keep the maximum at each bank that is FDIC insured. It is also important to understand the difference between an account at a bank and an investment account. When a customer deposits money at the bank, it becomes a liability of the bank (i.e., put on the bank’s balance sheet to loan). This is why there is FDIC insurance for depositors to protect the depositor from the bank’s balance sheet risk. On the other hand, an investment account held by the major custodians (like TD Ameritrade, Charles Schwab, Fidelity, Morgan Stanley, etc.) is held in a segregated account for you and does not become part of the firm’s balance sheet.
To get your retirement planning questions answered or to sign up for a retirement course, visit the Prepare Institute website (www.theprepareinstitute.org) to contact us and/or find a retirement course or class near you.
Content is for educational and informational purposes only. It is not intended to be used as the sole basis for financial decisions, nor should it be construed as advice designed to meet the particular needs of an individual’s situation. You should contact your retirement and tax professional before utilizing any of the information in this article.