Understanding your bank and brokerage account protections

April 10, 2023

Previously published in The Bulletin, Bend, Oregon on April 30, 2023

The failures of Silicon Valley Bank and Signature Bank last month sparked fears about a crisis spreading throughout the banking system. Many depositors scrambled to better understand the FDIC (Federal Deposit Insurance Corporation) coverage limits for their bank accounts in case their bank suffered a similar fate. Given that the average bank account has about $41,600 sitting in it, according to Bankrate, most customers do not have to worry about ‘losing’ their savings in the unlikely event of a bank collapse. That is because the insurance protection provided by the FDIC goes up to $250,000 per account, per ownership category. If you have more than that in any single account, you should talk to your bank about your options for making sure all your deposits are covered.

The banking turmoil caused some investors to wonder about the security of their investment funds as well. Assets held at a broker or custodian (think Morgan Stanley, Merrill Lynch, Charles Schwab, etc.) are not covered by the FDIC. They are covered by a separate organization known as the Securities Investor Protection Corporation, or SIPC. This organization provides protection should a member firm ‘go under’ and client assets are missing due to fraud, theft, or unauthorized trading. In the case of SIPC, they step in to make customers whole (up to $500,000 of unrecovered securities per account type, including $250,000 of cash) if there is wrong-doing on the part of the broker-dealer firm. It’s important to note that SIPC does not protect against market declines.

It's not uncommon for larger banks to have an in-house brokerage firm or vice-versa. But there’s an important distinction between how the assets you deposit in the bank are handled versus the assets you invest through the brokerage firm. At the risk of over-simplifying this, your deposits at the bank are recorded on the bank’s balance sheet. The bank pays you interest, then turns around and uses those deposits in one of two ways. First, the bank makes loans to other customers for homes, cars, credit cards, businesses, etc. They profit by charging borrowers more interest on the loan than they pay you for your deposit. Second, they may invest your deposit in government securities. Banks fail when a large number of depositors make a ‘run’ on the bank at the same time and they don’t have the capital on hand to meet the demand of their depositors.

The money you invest through the brokerage firm, however, is segregated from other firm assets and held in your name at third party depository institutions and custodians. This prevents the brokerage firm from being able to use your assets for their own purposes. Let’s say you own a diversified portfolio of stocks, bonds, mutual funds, and/or a money market fund in an account at a brokerage firm that is struggling financially. If they become insolvent, another firm may take over, and the company name on your monthly statement may change, but the investments in your account remain invested the whole time and totally insulated from the struggling brokerage firm’s challenges. If the failing brokerage firm is publicly traded and you own shares of their common stock, well, that’s a different story…perhaps one for a future article.