Federal Deposit Insurance Corporation (FDIC)

Among the heap of federal agencies tasked with oversight of the financial system, one you may have heard uttered at rapid speed toward the end of commercials for banks – or perhaps written in tiny letters at the bottom of the screen – is the FDIC.  But just what does this hastily sprayed acronym have to do with your money and how relevant is it to a FIRE investor?  

The FDIC, or, as it’s known by its government name, the Federal Deposit Insurance Corporation, provides supervision of financial institutions, such as, for example, the bank where you keep your checking and savings account.  In a nutshell, the FDIC checks to make sure that the bank follows a subset of the panoply of federal laws and regulations that govern how your bank can operate.  Perhaps the most well-known of things that the FDIC oversees is the amount of reserves and liquidity a bank has on hand.

Liquidity and reserves essentially boil down to how much cash the bank keeps available to pay out to depositors.  You shouldn’t be surprised to learn that a bank does not take every dollar deposited into a checking account and hold it in a vault for safekeeping (or a metaphorical vault like an electronic ledger, because so few people use cash nowadays).  If they did, they wouldn’t make any money.  Instead of holding your money, banks take it in and lend it out, charging interest to borrowers.  The spread between how much they charge for loans, and how much they pay you in interest (very little…), is how banks make their money.  (Mostly, there are other ways).

But, banks can’t lend out 100% of their deposits at any given time, or they’d have no money available if a depositor wanted to withdraw money, or do something like pay bills out of their account.  So, banks keep on hand a certain amount of reserves, or liquidity, which is basically cash on hand that can be used when depositors need it.  One of the things the FDIC does is monitor how much a bank has in reserves to reduce the risk that a bank won’t be able to make a payout when requested.

But monitoring is not why the acronym FDIC is shouted at you toward the end of commercials for banks.  Nor is it why you’ve heard of this would-be obscure financial monitor.  The reason you’ve heard about the FDIC is because they insure deposits in financial institutions.  FDIC insurance covers you, the depositor, in the event that a bank is unable to pay out to its depositors.  It’s for this reason that sticking your money in a savings or checking account is so safe in the US – because it’s insured if something goes wrong at the bank.

Basically, your deposits in checking, savings, CDs, certain money market accounts, and certain other financial instruments are insured up to $250,000 per account.  By putting your money in different accounts and different banks, each one is subject to a separate $250,000 limit – meaning that if you have two checking accounts, each at a different bank, you’re covered for $250,000 at each one, for a total of $500,000.  Because of this, you don’t really need to worry about your bank going under – your money will be protected within the limits of the FDIC insurance.  And this is why banks make it apparent to you in their commercials that FDIC insurance applies. 

What’s the big catch?

Well, FDIC insurance essentially applies only to cash accounts (physical and cash in a ledger).  FDIC insurance does not protect losses sustained from investments like stocks, bonds, mutual funds, ETFs, etc.  The government is not in the business of directly insuring your investment losses (though of course there are things the government does that keeps the stock market afloat, but that’s not the topic here).

While the FDIC reduces the risk of making cash deposits, it does not directly reduce the risk of your investments.  Now, does it reduce the risk of investing generally by seemingly preventing runs on banks at the slightest sign of economic hiccup?  Maybe.  But that wasn’t the question.

So what does exist to protect investors? 

Lesser known than the FDIC, the SIPC, or Securities Investor Protection Corporation, provides some (but not all that much) protection to investors.  The SIPC is not a government agency or a regulator; however, federal law does require that most securities broker-dealers become members.  The SIPC does not insure against investment losses; rather, the SIPC is a backdrop in case your broker-dealer itself fails – meaning that if the firm holding your investments goes belly up, they can’t take the value of your investments with it.

In the event that a broker-dealer is on the brink of collapse, typically the first thing that the SIPC will try to do is transfer who holds your security interests.  After all, if you buy a share of stock, you own that share of stock – it shouldn’t really matter who the custodian is.  This means that you simply transfer your custodian, and the real effect is that you log in to a different website or app to check your balance.

But, if something worse happens, and your securities can’t be found, the SIPC provides insurance of up to $500,000 of your net equity, including $250,000 in cash.  So in the end, you have some protection if your security interests disappear because of a failing brokerage firm.

Let me stress, however, that the SIPC does not protect you from bad investments.  If you invest in stock, the company goes bankrupt, and the stock value is zeroed out, that’s your loss.  The only thing you can do is use the loss to offset some taxes.  Nor does the SIPC help if you’re defrauded or lose your securities interests due to some other type of third-party interference.

What does all this mean?  It’s some reassurance that your cash balances in banks are safe in the event that the bank suffers from a major hiccup.  If you’ve saved for years and now keep some of your balance in cash, the chances of being wiped out are almost nil, in part because of protections offered by the FDIC and SIPC.

But it’s also a reminder of the risks associated with investing.  There’s some protection if the broker serving as your custodian liquidates, but you own the market risk if you invest.  Nobody’s going to come in and refresh your balances if you suffer market-related losses.

Now, if you’re defrauded, there are other remedies, and I’ll get into those in future posts.  But for now, just another reminder to watch out for your risk, only take on what you can handle, and invest prudently.