Are My Bank Deposits Safe? Navigating through the Current Financial Crisis

Given today's economic climate, we have received a number of inquiries from clients concerning the safety of funds that they have on deposit with their financial institutions. As both businesses and individuals try to cope with the current situation, we thought it would be helpful to provide some information about how the U.S. banking system is structured to protect customers if a financial institution fails. It is important, however, to remember that not every banking entity is in trouble. There remain many strong financial institutions nationwide that are working hard to continue providing the same high level of service that their customers have come to expect.

Banking System 101

To make sense of this situation, it is necessary to understand how the banking system works and how it is designed to protect the individuals and businesses who deal with it. Unlike most other countries, the United States has a dual system of bank regulation that involves the federal government, as well as each of the states. As a result, the method of examining a particular institution, and the conclusions drawn by the examiners, may differ, depending on whether the institution is state or federally chartered. Regardless of which regulatory agency actually conducts an examination, however, the Federal Deposit Insurance Corporation (FDIC) will have concurrent jurisdiction if the deposits are federally insured. The reason is that the FDIC has responsibility for protecting the Deposit Insurance Fund (DIF) that insures those deposits.

Whether an institution is examined by the FDIC or another agency (such as the Office of the Comptroller of the Currency, the Office of Thrift Supervision or one of the state agencies), there are common indicators that the capital of a particular institution is, or is about to become, impaired. For example, the assets held by the institution may be deteriorating in quality or the business practices of the institution may be deemed as unsafe and unsound. When those or other warning signs appear, the examiners will alert the institution's leaders and work with them to make the necessary corrections.

Preserving the Assets

No matter the circumstances, regulators will not wait until an institution's balance sheet reaches zero before acting. Once they recognize that a particular situation has gotten out of hand, they will usually take control of the institution, so as to preserve the remaining assets to the greatest extent possible. Taking control does not always mean pulling the institution's charter. In most cases, however, it does mean that the FDIC will be appointed as the receiver for the institution and will immediately take over its operation. At that point, the FDIC will do what it can to maximize the return of deposits to customers and to make certain that creditors also realize as much as possible on their claims. The equity and debt holders of the institution may not fare as well, but the FDIC will also do what it can to look after their interests.

The first thing the FDIC may do is try to sell the failed institution to a stronger entity. If it is sold as a whole, the depositors and creditors will likely notice no changes whatsoever, aside from a new name. In many instances, the buyer may even pay a premium to acquire the assets of the failed institution as a means of building its own core deposits and/or expanding into new geographic areas. If the entire institution cannot be sold, the FDIC will preside over an orderly liquidation of the individual assets. This liquidation generally takes the form of an auction, with the insured deposits and unimpaired loans being the most desirable assets, followed by bank-owned real estate and other tangible assets that may fit nicely within the existing or proposed business model of the bidders.

Whether there is a sale of the entire institution or just its parts, the equity holders and debt holders will likely take a significant haircut, as the funds received by the FDIC must be applied to any claims in the order prescribed by law. First, the expenses of the receiver (i.e., the FDIC) must be paid. Then, any insured deposits that have been paid out to the depositors must be restored to the DIF. After that, the creditors of the failed institution (including depositors, to the extent that their accounts exceeded the FDIC's insurance limits) are paid, with secured creditors having rights to their collateral according to state law. If there are any funds left, the debt and equity holders may then get a portion of their investment back.

When the FDIC takes over an institution, it will quickly determine who is insured and for how much. It does this by closing the books as of the end of the day on which the institution has been taken over, and then sending a notice to those whom it believes may have a claim against the institution, including the depositors. The notice will inform the recipients of their rights and the time period within which those rights must be pursued. Anyone who receives one of those notices should pay very close attention and act quickly, as the deadlines for bringing claims are strictly enforced.

Insured depositors typically receive their funds very quickly. After that, it can take several months, or even years, to settle some claims, depending on the nature of the claims and how successful the FDIC has been at selling the institution or its assets. Another factor is whether the FDIC has had to set aside significant reserves for litigation or similar matters. This is not to say that the FDIC will, in every case, wait until the end of a receivership to settle up with the claimants. It may elect to make interim distributions when there is enough money to do so.

What Are My Insurance Limits?

The FDIC insurance limits, while set by law, may affect each depositor in a different way, depending on the depositor's specific circumstances. For example, each individual is insured in his or her own name up to $100,000 per institution, regardless of how many accounts he or she may have with that institution. Any money held in joint accounts or in accounts for the benefit of someone else (such as a trust or a custodial account) will have its own insurance limits. For example, if a husband and wife each have $100,000 in separate accounts and $200,000 in a joint account, they could be insured up to a total of $400,000. If they also happen to be the beneficiaries of trust accounts at the same institution that were created for their benefit by certain family members, they would each be eligible for an additional aggregate $100,000 of coverage under those accounts. Furthermore, any money held for the benefit of those same depositors in retirement accounts, such as IRAs, would be separately insured up to a total of $250,000 for each depositor. For entities, such as corporations and limited liability companies, the rules are essentially the same as for individual accounts. However, such entities are not eligible for separate insurance under joint and other types of accounts.

(Editor's note: On October 3, 2008, Congress temporarily increased FDIC deposit insurance. For revised coverage limits, visit www.fdic.gov.)

One type of account with which there may still be some coverage uncertainty is the so-called sweep account. Although the limits of coverage are clear, the uncertainty hovers around when the account's funds are actually "swept" out of the institution and into a separate investment vehicle, because at that point they cease to be deposits (at least until they are swept back) and thus lose their deposit insurance. The question then is whether the funds were swept away before or after the FDIC took control of the institution. To address that issue, recent FDIC guidance states that it will consider such funds to still be in the account at the end of the institution's business day (i.e., when the books were closed for the day), and thus still be insured bank deposits until that point in time.

It should also be noted that brokerage accounts are not FDIC-insured. In most cases, such accounts are insured by a different federal agency known as the Securities Investor Protection Corporation (SIPC). The amount of insurance provided by SIPC is $500,000 per account, with rules for different accounts being similar to the FDIC's rules. The important thing to remember about SIPC insurance is that it insures the return of the securities held in the investor's account, but it does not guarantee the value of those investments. Although the investor may get his or her shares of stock back, the value of those securities may have eroded while the investor was waiting for them to be returned. The $500,000 of SIPC insurance may also include up to $100,000 in cash being held for the investor by the same brokerage firm.

Knowledge Is Power

As Sir Francis Bacon once said, "Knowledge is power." Hopefully, this article has given you some insight into the current financial crisis and its potential affect on your bank deposits. For a more detailed explanation of FDIC insurance, visit http://www.fdic.gov/. Click on "Deposit Insurance," then "Are My Deposits Insured?" and then "Your Insured Deposits." This will lead you to a printable PDF titled Your Insured Deposits: FDIC's Guide to Deposit Insurance Coverage, which provides specific examples of how the insurance coverage works. Don't hesitate to contact your Much Shelist attorney to discuss any specific questions you may have.