Last week, Silicon Valley Bank, nicknamed SVB, experienced a bank run which collapsed the bank and threatened the deposits of thousands of individuals and businesses. Most of us are comfortable trusting the banks where we keep our money, but events like this leave that trust shaken. How could this happen, almost a century since the bank runs of the Great Depression? Should we all be keeping our money under our mattresses?
Bank runs are rare today, and when they do happen, they don’t have the disastrous effects they once did. However, they still are a risk inherent in the way banks do business. By understanding the financial regulations involved, you can learn strategies to ensure your deposits are safe.
What Is a Bank Run?
Many people got their first mental image of bank runs from “It’s a Wonderful Life.” In that film, people rush down the street in a panic before they appear at the Bailey Building & Loan, demanding their deposits back. George has to explain that banks don’t keep their money in the vault, they lend it out, and therefore they can’t give everyone their money back at once.
This is still the case. Your savings account isn’t a box at the bank with your name on it. If it were, you couldn’t earn interest and your bank couldn’t make money. Instead, it invests the money in various ways, like mortgages and bonds. However, it keeps some of the cash on hand in case you come in to withdraw your money. This is called fractional reserve banking. So long as only a few people make withdrawals on any given day, it’s fine. But if everyone comes in to ask for their money at once, the bank is in trouble. It doesn’t have that amount of cash on hand; it must take some time to cash in its investments. And if the investments have declined since then, they won’t be able to obtain that much money at all.
So when the news comes out that a bank isn’t doing well—that its investments have crashed or it’s having trouble keeping cash on hand—the depositors start to worry their money won’t be there. They rush to the bank to take their money out, hoping they’ll get theirs before the bank runs out of cash on hand. But it becomes a self-fulfilling prophecy, like stocking up on toilet paper when you think the store might run out. Since everyone withdraws their money, there is soon no cash left, and the bank can’t fulfill its obligations.
The Imperfect Solution
There are a number of regulations in place, both to prevent bank runs and to ease the pain when it does happen. Some of these failed in the case of SVB, and some were removed. Bank deregulation can seem attractive at times. Surely less red tape is good? But when things go wrong, we start to see what those regulations were there for.
Preventing Bank Runs
The first regulatory issue here is the end of fractional reserve banking. In the past, it was legally required for banks to keep a certain cash reserve on hand, in case people came to withdraw their money. But in March 2020, this requirement was removed, and banks were allowed to operate with no reserve at all. This makes bank runs more likely, since depositors know there isn’t much cushion between their deposits and a default on the part of the bank.
The second thing protecting bank customers is that, ideally, banks invest in stable, low-risk products which prevent them from actually losing your money. SVB’s investments were in products heavily affected by the Federal Reserve’s rate hike. So it started losing money, and depositors worried their money wouldn’t be there if they waited much longer to pull it out. At that point they started withdrawing their money, starting a run and quickly leaving SVB unable to pay everyone.
After a Bank Run
After a bank run happens, the government’s first solution is to find someone else to guarantee the accounts at a bank. This generally means another bank buys out the struggling bank, taking all its assets and paying out its customers. When Washington Mutual Bank failed in 2008, Morgan Chase bought it out. This meant all the customers now had accounts at Chase, which had no trouble paying out withdrawals as needed.
And if no one offers to buy the bank? Here we reach the final backstop: the FDIC, or Federal Deposit Insurance Corporation. This government institution insures your deposits at a bank, so that even in case of a bank run, you’ll get your money. Does the government have enough money to bail out every penny deposited at a major bank? Well, no. Instead, each account is insured up to $250,000. So if you were keeping $500,000 in a savings account at SVB, you’d be forced to settle for accepting half of that from the FDIC. For most ordinary people, this isn’t an issue—we don’t keep money like that in our savings accounts. But businesses regularly do, given they have to deal in large amounts of money all the time. So many Silicon Valley businesses stand to lose millions in this crisis.
So far, however, the Federal Reserve is saying nobody is going to lose their deposits. At the time of this writing, they are looking for a buyer.
How to Keep Yourself Safe
If you’re an individual with less than $250,000 deposited at any single bank, you don’t need to worry. The FDIC guarantees your deposits, so even if a run does happen at your bank of choice, you’ll still receive every penny you deposited. Of course a bank failure does have reverberating effects throughout the economy, so you’ll still want to make sure your investments are diverse and stable.
However, if you have a high net worth or operate a business dealing in large amounts of cash, you may need to take extra precautions. One option is to split your money among a number of different accounts. You may choose to have your company checking account at your neighborhood bank, but your savings split among two larger banks.
If that’s too complex, consider a sweep account. This is an account which “sweeps” any money beyond an amount you choose into another account, such as one or more money market accounts. This way you can interact with one bank and one account, but your bank ensures no single account actually contains more than $250,000. You’ll need to talk to your bank about the options they have and what protections they can guarantee for your deposits.
And in general, it isn’t the best idea to keep all your savings in a simple savings account. By investing it in something stable like bonds or a money market account, you could be making dividends. Though your money isn’t guaranteed in many investments, it tends to increase, and even a market dip rarely makes you lose all of it. Your advisor can suggest stable, low-risk investments for your savings.
Don’t Keep It Under Your Mattress
You don’t have to hide your money in a hole to keep it safe. In fact, that’s the way you guarantee on losing out—because you earn no interest that way. Instead, diversify your savings among bank accounts and investments, making sure it isn’t all in one place. A good financial advisor can help you spread out your investments in a diverse, lucrative portfolio. To meet the right person for you, contact us today.
