Are Deposits Above the FDIC Guarantee Fully Backed by the Government?  A review of Past Bank Failures and an Alternative Solution to Traditional Banking

Over the past week the world has seen several banks collapse.  Fortunately for the customers of the banks that have failed, at least to date, the Federal Deposit Insurance Corporation (FDIC) along with the Federal Reserve and the Department of Treasury stepped in to fully insure the deposits.  The government felt the need to intervene to prevent other parts of the economy from being contaminated from the banks’ financial collapse.

However, many questions remain for employers and retirement plans who have more deposits in a bank than the FDIC guarantee.  For example, Newsweek reported that the California State Teachers’ Retirement System had 11 million in Silicon Valley Bank (SVB) stock as of January 31, 2023 in addition to banking exposure in excess of the FDIC guarantee.  While it is clear that the11 million in SVB stock is worthless, the California State Teachers’ Retirement System is fortunate that the government is fully guaranteeing its deposits in SVB.  A key question all employers and retirement plans need to think about for the future is will the government always fully insure bank deposits above the FDIC guarantee.  The remainder of this paper will explore the basics of the FDIC insurance program, what a customer could expect to receive in a scenario where the government does not step in to fully back deposits that exceed the FDIC guarantee, and how Bitcoin may be a solution employers adopt once market conditions fall into certain parameters.

The Federal Deposit Insurance Corporation (FDIC) Insurance Program

The FDIC insurance program fully guarantees 250,000 held in bank accounts.  The FDIC website states “Deposit insurance is one of the significant benefits of having an account at an FDIC-insured bank—it’s how the FDIC protects your money in the unlikely event of a bank failure. The standard insurance amount is250,000 per depositor, per insured bank, for each account ownership category. And you don’t have to purchase deposit insurance. If you open a deposit account in an FDIC-insured bank, you are automatically covered.”

While the $250,000 insurance program is great for deposits that are held under the threshold amount, many businesses are forced to have bank accounts well in excess of the insured amount to have enough operating capital for day-to-day activities.  This leads to the question of what happens to deposits held in excess of the FDIC guarantee when a bank fails?

What Happens to a Customer’s Deposits that Exceed the $250,000 FDIC Guarantee When a Bank Fails?

This question is answered on the FDIC website.  A customer who holds deposits at an FDIC insured bank that fails will be “awarded” a receiver’s certificate which entitles the customer to receive payments but not necessarily recover the full amount of the deposit depending on the bank’s financial health.  The FDIC website states “By law, after insured depositors are paid, uninsured depositors are paid next, followed by general creditors and then stockholders. In most cases, general creditors and stockholders realize little or no recovery. Payments of uninsured funds only, called dividends, depend on the net recovered proceeds from the liquidation of the bank's assets and the payment of bank liabilities according to federal statute. While fully insured deposits are paid promptly after the failure of the bank, the disbursements of uninsured funds may take place over several years based on the timing in the liquidation of the failed bank assets. The dividend payment history for all failed banks closed since October 1, 2000 is available at https://closedbanks.fdic.gov/dividends/index.asp.”

The quote above from the FDIC website should give all entities who hold deposits in excess of the FDIC guarantee pause.  Not only does an entity have to worry about receiving less back than was deposited at the bank above the FDIC insurance limit of $250,000, but the timing of receiving that amount may take years!  This would cause any entity, particularly a business, problems due to the shortfall in operating cash.

The chart below provides an overview of the last 10 banks to fail in the United States.  The FDIC, Federal Reserve, and the Department of Treasury stepped in to fully insure all deposits, including deposits above the FDIC guarantee, for customers associated with the two most recent bank failures.  The remaining eight bank failures shown on the chart illustrate the percentage paid for deposits in excess of the FDIC guarantee along with the timing of when the money was paid.  Please feel free to click on the link for each bank, provided in the first column, for additional details provided on the FDIC website.

Bank customers who hold more than the FDIC insurance limit should closely review the other eight bank failures and the amount customers recovered for amounts that exceeded the FDIC guarantee.  It was reported that a staggering 85 percent of the deposits in SVB were uninsured!  The high percentage of uninsured deposits is proof the dilemma facing entities with large cash holdings is not isolated but rather expansive.

What Entities with Deposits in Excess of FDIC Guarantee Need to Know Regarding the Future

Guidance on how the government plans to handle deposits greater than the FDIC guarantee in the future is necessary for entities to operate in today’s uncertain financial environment.  If the government is going to fully insure an amount greater than the current $250,000 FDIC guarantee or all deposits, that should be disclosed so customers can plan accordingly.  Under that scenario, any run on a bank would cause deposit holders to be more concerned with runaway inflation as money may need to be printed to fully insure the deposits.

Alternatively, if there are scenarios where the government does not plan to backstop customer deposits that exceed the FDIC guarantee, customers who have amounts above the FDIC guarantee will need to closely monitor the balance sheets of banks.  Additionally, strategies such as having multiple bank accounts that all fall below the FDIC guarantee threshold must be explored.  Another alternative strategy to potential banking problems for amounts in excess of the FDIC guarantee is holding bitcoin.

Is Using the Bitcoin Network a Viable Alternative to Store Value Above FDIC Guarantee?

One alternative place entities could store money above the FDIC guarantee is on the Bitcoin blockchain.  One innovative feature of the Bitcoin network is the public ledger.  The public ledger is one of the features that allows the Bitcoin network to operate without a trusted third party.  The public ledger has recorded every single transaction that has occurred on the Bitcoin blockchain since Bitcoin’s inception!

The Bitcoin network ushered in a new accounting system known as triple entry accounting.  Under the traditional accounting system, two book entries are required for every transaction a person or business makes, one debit and one credit, hence the name double entry accounting.  Bitcoin’s ledger creates a third place an entry is placed which provides proof to everyone that the transaction has occurred.  As a result, the Bitcoin ledger is constantly performing an audit as it validates each block approximately every 10 minutes.  This is an astonishing accomplishment as it allows the parties to know with absolute certainty how much bitcoin is contained in each wallet.

Bitcoin is solely operated under a set of rules administered by the nodes that control the Bitcoin network.  A node is a computer or server that is running the Bitcoin protocol software.  The nodes are interconnected and combined the nodes form a decentralized network.  A node is able to send and receive messages from other nodes within the Bitcoin network.  Collectively, the nodes verify the transactions that occur on the Bitcoin blockchain.  However, there is no node that is superior to the other nodes.  Instead, the Bitcoin protocol is controlled by a consensus of all the nodes.

The Bitcoin nodes are constantly verifying Bitcoin’s ledger which is open, transparent, and immutable.  By holding a private key any individual or business can be its own bank and guarantee the ownership of its bitcoin without any reliance on a trusted third party or government.  Holding bitcoin instead of United States dollars may be a viable, if not the preferred, option in a world where individuals and entities cannot trust that the bank can actually pay back deposits above the FDIC guarantee.

An example may help illustrate the point.  If a user has 100 bitcoin held in a wallet, Bitcoin’s public ledger fully guarantees the user has 100 bitcoin so long as the user has control of the private key.  At the current price of 25,000 per bitcoin, the 100 bitcoin would be worth2,500,000.  If instead a person or business held 2,500,000 in United States dollars at an FDIC insured bank, the person or business would be guaranteed250,000 and the remaining $2,250,000 the person or business would hold as an unsecured creditor should the bank fail.  If the government is not going to fully insure amounts above the FDIC guarantee, entities must explore alternative options and be acutely aware of the balance sheet of the banks in which the entity holds its deposits in excess of the FDIC guarantee.

Oddly, the FTX collapse illustrates the problems that could be facing banks if trust is lost in the banking system and the federal government does not fully insure deposits.  FTX was a crypto exchange where users could purchase and sell a number of cryptocurrencies.  Instead of using self-custody to secure the crypto asset, FTX held its customers funds, or at least that’s what FTX customer’s assumed FTX was doing.  When FTX collapsed in late 2022, FTX customers learned a tough lesson regarding the value of Bitcoin’s public ledger.

After a thorough examination of the FTX assets, bankruptcy documents revealed that FTX held 6 million worth of bitcoin while it owed its clients1.6 billion in bitcoin.  FTX created $1.594 billion in paper bitcoin.  Paper bitcoin is a phrase used by the bitcoin community to signify bitcoin IOUs.  The risk of purchasing and holding bitcoin on any exchange is the exchange may not hold the bitcoin it says it does for the customers.  While this was not a problem for users who bought and sold cryptocurrency on the exchange prior to the collapse as FTX serviced buy and sell orders, eventually the FTX scheme collapsed.  This became painfully real for FTX customers who thought they had their bitcoin safely secured by a trusted third party.  In all likelihood FTX bitcoin holders are going to be receiving pennies back on the dollar (or maybe satoshis back on the bitcoin is more apt here).  Fortunately, Bitcoin’s public ledger allows anyone to self-custody bitcoin and know with absolute certainty through verification on the Bitcoin network that their private key holds the bitcoin.

Similar to paper bitcoin, amounts held above the FDIC guarantee at a bank could be viewed as paper money.  Unlike, bitcoin which is securely stored by Bitcoin’s public ledger, banks do not hold all of a customer’s deposits.  Instead, almost all banks participate in a practice known as fractional reserve banking.  Fractional reserve banking allows the bank to only hold a fraction of a customer’s deposits as reserve while using the remaining portion for lending and investing in an attempt to make the bank money.  Banks are subject to many rules surrounding fractional reserve banking, but, as the past week has illustrated, these rules do not always prevent bank failures.  If a bank fails, any customer deposit amount above the FDIC guarantee is paper money which is similar to paper bitcoin.  As the chart of failed banks above illustrates, in some instances this paper money was worth less than 40 cents for every dollar above the FDIC guarantee.  That’s scary.

While widespread bank failure may seem far-fetched, it was only a little more than five years ago when Janet Yellen stated that she believed that there would not be another financial crisis in her lifetime.  Twelve banks have failed since then including a top 20 bank in SVB that melted down in less than 48 hours.  Had the government not intervened and fully insured all deposits at SVB, the United States financial system would have once again been on the brink of total collapse for the first time since 2008

Since SVB failed it has been disclosed that US banks are holding assets with unrealized losses of $620 billion. Exacerbating the problem is the stubborn inflation rate which appears to be more than just transitory as originally claimed.  To combat the stubborn inflation the Federal Reserve rapidly raised the interest rate by more than 400 basis points in less than 12 months!  This created an issue for SVB’s large position in bonds in which the bank invested when the interest rate was lower in an effort to find higher-yield.  A rising interest rate is inversely correlated with the price of a bond.  Consequently, when the interest rate rises, the value of a bond decreases.  Once customers got word of potential trouble at SVB, withdrawal requests came in quickly.  This created the downward spiral for the bank as it needed to sell its bonds at a loss in order to cover the withdrawal deposit requests which only sparked more fear, more withdrawal requests, and more selling at a loss until the FDIC, along with the State of California, finally shut the bank down.

While the Federal Reserve strongly believes it needs to continue to raise the interest rate, doing so could endanger more banks, particularly banks who have positions in assets with an inverse relationship to the interest rate.  Unfortunately, some banks mismanaged the bank’s portfolio of assets, in part due to the interest rate increasing at a faster rate than has been seen in 40 years, leaving more banks potentially in peril.  Thus, the Federal Reserve options appear to be record inflation or potentially a collapse of large segments of the financial system.  That’s a precarious situation to say the least.

Conclusion

Entities who hold amounts above the FDIC guarantee need to rethink those positions with banks.  Bitcoin may be an alternative strategy for a portion of an entity's holdings previously stored at a bank above the FDIC guarantee.  Prior to making such a decision, an entity should try to determine what portion of the deposits the FDIC plans to guarantee (the current FDIC guarantee is $250,000) and the risk of the bank failing where deposits are stored above the FDIC guarantee.  Those two factors should be balanced against bitcoin’s price volatility as well as the potential for the bitcoin price to rise as it has every halving cycle to date.

Once the price of bitcoin matures, and possibly even before then if the banking crisis is bad enough, or bank failures occur with customer deposits greater than the FDIC guarantee being treated as unsecured credit and not backstopped by the United States government, holding bitcoin through self-custody could become a best practice for businesses.  Holding cash above the FDIC guarantee limit is equivalent to holding bitcoin on an exchange.  Any amount held in excess of $250,000 has the possibility of being paper money just like any bitcoin being held on an exchange has the possibility of being paper bitcoin.  Paper money and paper bitcoin are not the same as hard cash (or cash that is fully insured by the FDIC ) or bitcoin verified by the blockchain.  We may be coming into an era where control over one’s assets is paramount.  Bitcoin was built for such a moment.