The recent collapse of Silicon Valley Bank (SVB) has raised concerns about the spillover effects of the tech sector’s financial troubles on other sectors of the economy and has sent shockwaves throughout Wall Street. It has also demonstrated the fragility of the financial sector, which has been a driving force in the U.S. economy. This collapse has brought to light the importance of risk management strategies, contingency planning, and diversification for both depositors and clients of financial institutions.
It is crucial depositors and clients of financial institutions take proactive steps to manage financial risks and safeguard their assets. This process can include diversifying holdings across multiple banks and financial institutions, conducting due diligence on all financial institutions before depositing money or investing with them, and preparing a contingency plan in the event of a bank failure.
10 Lessons for Depositors and Banking Clients
By examining the experiences of the depositors and clients of SVB, those conducting business at other banks may be able to glean insight into effective protection of their assets.
Diversification is a key risk management strategy that can help depositors and clients reduce their exposure to risk from a single bank or financial institution by spreading risk across a range of institutions.
When a depositor or client holds all their deposits or investments with a single bank, they expose themselves to a range of risks, including credit risk, market risk, liquidity risk, and operational risk. If that bank fails, the depositor or client could lose some or all of their deposits or investments. Understanding that deposits up to $250,000 are insured by the Federal Deposit Insurance Corporation (FDIC) should instantly trigger concerns as to deposits above the amount covered by insurance.
However, if the depositor or client holds deposits with several different banks, then even if one of those banks were to fail, they would only lose a portion of their deposits rather than the entire amount.
Clients and depositors can achieve diversification in a number of ways, such as holding deposits in different banks or credit unions, investing in a diversified portfolio of stocks and bonds, or holding assets in different currencies. An individual’s specific approach to diversification will depend on the person’s risk tolerance, financial goals, and investment horizon.
It’s important to note, however, that diversification doesn’t eliminate all risks. Even if a depositor or client diversifies their holdings across multiple institutions, there is still a risk that all those institutions could experience financial difficulties at the same time. Therefore, they should combine diversification with other risk management strategies, such as ongoing due diligence and monitoring, to ensure that risks are managed effectively.
2. Conduct Initial Due Diligence
Conducting due diligence before depositing money or investing with a financial institution is a critical step in managing financial risks. Depositors and clients working with a large institution should not assume that other depositors or clients have done the necessary due diligence, or that regulatory agencies are ensuring that nothing disadvantageous will happen.
To properly conduct due diligence, depositors and clients should research the financial position, reputation, and regulatory compliance of the financial institution. This process can include reviewing financial statements, credit ratings, and other publicly available information about the institution’s financial position. It can also involve checking the institution’s reputation by reading reviews, feedback, and complaints from other customers or seeking recommendations from trusted sources.
In addition, depositors and clients should check the regulatory compliance of the institution by verifying its licenses and registrations with regulatory agencies, such as the Securities and Exchange Commission (SEC) or the FDIC. They can also check the institution’s compliance history and any regulatory actions that may have been taken against it.
By conducting due diligence, depositors and clients can assess the risks associated with a financial institution and make informed decisions about whether to deposit money or invest with that institution.
3. Conduct Ongoing Due Diligence
Ongoing due diligence is important because it allows individuals and organizations to stay informed about changes in the financial position, regulatory compliance, and reputation of the institutions with which they do business. Initial due diligence is a critical first step in assessing the risks associated with a financial institution, but it is not enough to ensure the ongoing safety of assets and soundness of business practices.
Financial institutions operate in an ever-changing environment, with evolving regulations, market conditions, and competitive pressures. These changes can impact the financial position of the institution, its risk profile, and its ability to meet its obligations. Ongoing due diligence allows individuals and organizations to monitor these changes and adjust their risk management strategies accordingly.
For example, ongoing due diligence may involve monitoring the financial statements and regulatory filings of the institution, tracking news and commentary about the institution in the media and among industry peers, and reviewing the institution’s compliance with regulatory requirements. This ongoing monitoring can help individuals and organizations identify emerging risks and take appropriate action to mitigate them.
4. Act Fast
Acting fast in a potential bank failure situation can be critical in protecting one’s financial interests and minimizing losses.
In a potential bank failure situation, there may be a limited window of time during which depositors and clients can take action to protect their interests. For example, if a bank’s financial position is deteriorating rapidly, depositors and clients may need to act quickly to withdraw their funds or transfer their accounts to a different institution.
Acting fast can also help depositors and clients avoid potential delays or obstacles that may arise in the event of a bank collapse. For example, if a bank enters bankruptcy or liquidation, there may be a lengthy legal process involved in recovering deposits or investments. By acting quickly, depositors and clients may be able to avoid some of these delays and obstacles.
In addition to helping them avoid delays, acting fast can help depositors and clients stay ahead of the curve in terms of monitoring developments and keeping themselves informed of their options. By staying proactive and alert, they may be able to identify emerging risks and take appropriate actions to manage those risks.
5. Understand Deposit Insurance Options
Deposit insurance is a type of financial protection that provides a safety net for depositors in the event of a bank failure. There are several types of deposit insurance available to depositors, each with its own unique features and limitations.
For depositors, the most widely known and relied upon deposit insurance in the United States is that provided by the FDIC, which insures deposits of up to $250,000 per depositor, per account type, per insured bank. The FDIC insures deposits at nearly all banks and savings associations in the United States, and it is backed by the full faith and credit of the U.S. government.
For legal entity depositors, such as businesses, the FDIC states that it “provides separate insurance coverage for funds depositors may have in different categories of legal ownership. The FDIC refers to these different categories as ‘ownership categories.’ This means that a bank customer who has multiple accounts may qualify for more than $250,000 in insurance coverage if the customer’s funds are deposited in different ownership categories and the requirements for each ownership category are met.”
However, while the FDIC provides a significant amount of protection for depositors, it may not be sufficient in all cases. For example, if a depositor has more than $250,000 in deposits at a single bank, the excess funds may not be covered by FDIC insurance. Similarly, if a depositor has deposits at multiple banks that are affiliated with each other, those deposits may be aggregated for purposes of FDIC insurance coverage, which could mean a depositor has less coverage than they may have expected.
There are other types of deposit insurance available to depositors. For example, the National Credit Union Administration (NCUA) provides deposit insurance for credit unions, with coverage similar to that provided by the FDIC. The Securities Investor Protection Corporation (SIPC) provides insurance for securities held by broker-dealers, with coverage up to $500,000 for each separate account.
In addition, some states have their own deposit insurance alternatives, which may provide further protection for deposits held at state-chartered banks and credit unions. These state-level plans may provide coverage in excess of the federal deposit insurance limits, but they may also have their own limitations and exclusions.
Overall, while depositors are most familiar with (and most often rely upon) the FDIC, it may not provide sufficient coverage for all depositors in all circumstances. Depositors should be aware of the deposit insurance plans available to them and should ensure that they hold deposits with insured institutions to minimize their risks in the event of a bank failure.
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6. Monitor the Markets
Depositors and clients should stay informed about the financial institutions with which they do business by monitoring news to stay abreast of any potential risks. Monitoring short-seller activity, publicly disclosed records of insider buying and selling, credit default swaps (CDS) spreads, and other market indicators can provide depositors and clients valuable insight into potential risks and vulnerabilities and help them take appropriate actions to protect their financial interests.
The activities of short sellers, for example, can indicate the financial health of an institution to depositors and clients. Short sellers are investors who bet against a company’s stock by selling borrowed shares in the hope that the price will fall. They often conduct in-depth research into the financial health and reputation of the company, looking for potential vulnerabilities that could cause the stock price to fall.
However, short-seller activity is not publicly disclosed, so monitoring it requires alternative methods. One way to monitor short-seller activity is to subscribe to financial news and analysis services that track short-seller activity across financial institutions. Another way to monitor short-seller activity is to pay attention to market rumors and speculation. While depositors and clients should always take rumors with a grain of salt, they can sometimes provide early indications of changes to an institution’s risk profile. Deposit and investment account holders can also monitor the stock prices and trading volumes of financial institutions to identify potential trends or anomalies that may indicate short seller activity or other market concerns.
Perhaps a better course of action than monitoring short selling is to monitor the activity of insider buying and selling, an indicator of what those on the inside, who know the bank the best, are doing. However, it’s important to note individuals may sell their shares for various personal financial reasons, so it’s crucial to examine the number and magnitude of insider buying and selling to gain a better understanding of the situation.
CDS spreads, which are a type of financial derivative instrument, can also provide valuable insights into the financial health of an institution. CDS spreads represent the cost of insuring against a default on a company’s debt, and increasing CDS spreads can indicate increasing market concerns about the company’s financial health.
Lastly, depositors and clients can consult with financial professionals, such as investment advisors or brokers, who have expertise in the markets and can provide insights into potential risks and vulnerabilities of financial institutions.
7. Monitor Regulatory Reports
Monitoring regulatory reports is another important part of staying informed about financial institutions and can help depositors and clients identify potential risks and take appropriate actions to manage them.
When it comes to regulatory reports, there are several types of reports depositors and clients can monitor to stay informed about the financial institutions with which they do business. These reports are filed with regulatory agencies, including the Federal Reserve, the FDIC, or the NCUA.
Some of the regulatory reports depositors and clients can monitor include:
- Call reports: These reports are filed quarterly by banks and contain financial information, including balance sheet and income statement data, loan and deposit information, and other financial metrics.
- 10-K and 10-Q reports: These reports are filed annually and quarterly by publicly traded companies, including banks, and provide detailed financial information, risk factors, and other disclosures.
- CAMELS ratings: These ratings are assigned by regulatory agencies and represent an overall assessment of a bank’s financial health and risk management practices. The rating system evaluates a bank’s capital adequacy, asset quality, management, earnings, liquidity, and sensitivity to market risk.
By monitoring these regulatory reports, depositors and clients can develop an understanding of the financial health and risk profile of the institutions with which they do business. For example, if a bank’s call reports show declining capital levels or rising loan delinquencies, depositors and clients may infer that the bank is experiencing financial difficulties. Similarly, if a bank’s CAMELS rating is downgraded, it may be an indication that regulatory agencies have identified weaknesses in the bank’s risk management practices.
8. Communicate Downstream Effects to Clients
When a bank fails, the impact can often extend beyond the depositors and clients of the bank. For instance, if the bank has issued loans to businesses or individuals, the failure can have downstream effects on those borrowers, potentially impacting their ability to repay the loans and causing financial difficulties for them.
In such situations, it’s important for the depositors and clients of the failed bank to communicate any downstream effects to their own clients or stakeholders immediately. This early communication can help mitigate the potential impact of the bank’s failure on others and minimize any further financial losses.
Communication is key in managing such situations, and the depositors and clients of the failed bank should be transparent with their clients and stakeholders about the impact of the bank’s failure. They should provide timely and accurate information about any potential risks or disruptions and work proactively to address any concerns or issues that arise.
9. Seek Professional Advice
In the event of a bank failure, depositors and clients may find themselves facing complex financial and legal issues that can only be resolved through professional expertise. In such situations, it’s important to seek advice from qualified professionals who have experience in dealing with bank failures and related issues. By seeking professional advice, depositors and clients can ensure that they are managing risk and taking appropriate actions to protect their financial interests.
Qualified professionals who may be able to provide depositors and clients assistance include lawyers, financial advisors, and accountants. These professionals can help depositors and clients to understand their rights and options in the event of a bank failure and can provide them guidance on how to recover lost funds, file claims against the bank, or take other appropriate actions.
When seeking professional advice, it’s important to choose qualified professionals who have experience in dealing with bank failures and who are licensed and regulated by relevant regulatory bodies. Deposit and investment account holders should do their research and seek recommendations from trusted sources before engaging with any service providers.
10. Prepare a Contingency Plan
Preparing a contingency plan to manage the fallout from a bank failure is another important lesson many SVB customers have learned the hard way from the bank’s failure. Depositors and clients may experience difficulties in accessing their funds and may be at risk of losing some or all of their deposits. That process can take up to one week for insured deposits and up to six weeks for uninsured deposits. By taking proactive steps to have this plan in place, depositors and clients can help mitigate the impact of this type of crisis. These are some potential steps they may take:
- Contact the bank: Deposit and investment account holders should contact the bank to confirm the status of their accounts and to find out what options are available to them. They may be able to retrieve some of their deposits through the bank’s liquidation process.
- Check deposit insurance: Deposit account holders should check if their deposits are covered by deposit insurance. If the deposits are insured, they may be able to recover some or all of their deposits through the insurance plan.
- Contact regulatory agencies: Deposit and investment account holders should contact relevant regulatory agencies to find out what assistance is available to them. These agencies may be able to provide them with guidance on how to recover lost funds.
- Seek legal advice: Deposit and investment account holders should seek legal advice to understand their rights and options in the event of a bank collapse. Review counterparty relationships and contractual obligations to determine whether they involve affected accounts or banking relationships and assess the need for action to avoid or mitigate potential disputes. These options may include filing claims against the bank, its directors, or its auditors.
- Monitor developments: Deposit and investment account holders should monitor news and developments related to the bank collapse, including any legal or regulatory actions being taken. This monitoring can help them to stay informed about the status of their accounts and any potential recovery options.
- Emergency funds: Ensure access to emergency funds or have a backup bank account with a different institution.
While these steps overlap with some of the lessons above, the separate point here is that depositors and clients should prepare a contingency plan prior to any indication of a problem with the financial condition of the bank.
The Bottom Line
In the aftermath of the SVB collapse, depositors and clients of financial institutions have learned valuable lessons about risk management, due diligence, and contingency planning. The collapse has highlighted the need for individuals to take proactive measures to safeguard their assets and manage financial risks.
To protect themselves from the fallout of a potential bank failure, depositors and clients should consider diversifying their holdings, conducting ongoing due diligence, and preparing a contingency plan. They should also stay informed about the financial institutions with which they do business by monitoring market and regulatory reports and seeking professional advice when necessary.
At Arootah, we understand the challenges of navigating financial uncertainty and the importance of being prepared for the unexpected. Our team of experienced professionals can provide you with guidance and advise you on steps you need to take to manage risks and protect your financial interests. Contact us today to learn more about our business advisory services and take the first step toward mitigating risks and securing your financial interests in these uncertain times.
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