FDIC Insurance 2016: Still Not What You Think It Is

reasons to expatriateOver the years many people have written to us asking about the safety of banks outside the United States.  Obviously, most of these questions have come from Americans who are trying to make a comparison between FDIC, or government bank account insurance, and any similar type of insurance or bank safety programs.  While having a government insurance program in place to protect depositors is a wonderful idea, one should be very clear about exactly what kind of coverage exists (and if the government sponsored insurance company is financially solvent or capable of addressing a true banking crisis).  We only mention this because, while FDIC allows many people to sleep better at night in theory, as a solvent insurance company, in our opinion FDIC is somewhat of a sham.  In the least, it is certainly NOT what most people think it is.

You are correct if you say, It is better than nothing.  However, one should compare apples to apples when looking at foreign banks and how much is kept on reserve to cover potential bank failures.  In many countries, the Central Bank of the country is charged with this responsibility and the reserve requirement is often as high as 5% or more of each bank’s deposits.  In other words, which number is greater, 5% or 0.79%?  (See the FDIC information below, whereby in reality it has only 0.79% - LESS THAN 1 PERCENT in reserve for the entire insured number of banking deposits as of December 31, 2013).  But here is the real joke: by law, the FDIC Deposit Insurance Fund must achieve a minimum reserve ratio of 1.35 percent by 2020.  By The YEAR 2020!

But let us get away from percentage statistics for just one moment and talk about cash.  The FDIC has about US$ 47 Billion Dollars (December 31, 2013 figures) in the bank insurance fund.  It has been estimated that 90 percent of the US banks are financial institutions with less than US$1.5 Billion in assets.  However, the remaining 10 percent are banking behemoths, such as JP Morgan with an estimated US$2 Trillion Dollars in assets.  Just 5 US Banks are calculated to hold more than US$8 Trillion in assets collectively (as of 2011 figures), and among those five are: JP Morgan Chase & Co., Bank of America Corp., Citigroup Inc., and Wells Fargo & Co.  So, what that means is IF just one of those large banks go bust, the entire FDIC insurance fund is WIPED OUT.  It would take about 30 of the smaller banks (with about US$1.5 Billion in assets) to go under in order to also wipe out the entire FDIC Deposit Insurance Fund.  To put that into perspective there are in excess of 7,000 banks supposedly covered by the FDIC insurance program.  So, what that means is, IF ONLY ONE HALF OF ONE PERCENT of the small banks go under, the FDIC Deposit Insurance Fund would be kaput.  Again, LESS THAN 1 PERCENT.  Think about that for just one moment.

I know what you are thinking, that would probably not happen.  Well, what if we told you that 450 banks inside the United States have failed since 2008?  What if we also told you that right now, in 2014, there are 411 banks still on the FDIC problem banks list.  Prior to 2008 the number of banks on the FDIC troubled bank list usually totaled less than 100 on average, so these current numbers represent a 400 percent jump over the previous average.  They say the US is experiencing an economic recovery but as of June 2014 we already have 9 bank failures in the US, which puts us on track to see 20 or more by the end of the year.  One of those banks that recently failed was Columbia Savings Bank in Cincinnati, Ohio - a bank that was founded in 1892.  With that said, these numbers still represent less than one percent of all the financial institutions covered by FDIC insurance inside the US.  However, as we have stated previously, it would only take one really big bank to go deep six or a very small handful of medium sized banks to put the FDIC deposit insurance fund into insolvency.

FDIC Insurance Is Limited To The Account Owner

While the previous insurance limit of US$100,000 was increased to US$250,000 (which was made a permanent coverage limit due to the Dodd-Frank Wall Street Reform and Consumer Protection Act), most account holders with US banks probably do not realize these coverage limited apply to the person or family ONLY.  For example, someone that had 10 individual bank accounts of $25,000 each for a total of $250,000 at one bank would be fully insured up to $250,000. However, a depositor who had three individual accounts of $250,000 each for a total of $750,000 at one bank would be insured only to $250,000 and not to $750,000.  Likewise, some husband and wife joint accounts could be considered as counting towards the US$250,000 limit - so one must be careful how one structures account holding.

However, many people do not realize that not all touted by the bank is covered by FDIC insurance.  With the advent of banks getting into the brokerage and insurance business, and allowing sales people from these other businesses into the bank for solicitations from banking customers, depositors may not understand they are often NOT putting their money into an insured product.  Insurance policies, annuities, mutual funds and even certain kinds of IRA accounts will not be covered by the FDIC insurance even though the bank was seemingly patronizing the sale or investment of these products.

Banking Abroad: Better Or Worse?

Truth be told there are more than 200 countries in the world and we certainly cannot comment on all of them individually, with respect to banking issues in each one.  However, the question of FDIC insurance and or banking insurance in general usually comes up when clients are asking us about banking in the Dominican Republic.  In this regard, we can of course offer our insight.

To begin with, as we have mentioned before, the term Offshore Banking has been used in conjunction with so-called tax haven countries, but in reality in can be generically applied to banking in any country other than your own home country.  In terms of Canadians that might be banking in the US for example, we can certainly say that the US bank account is an Offshore Bank Account for the Canadian.

With regards to banking in the Dominican Republic, there is in fact a very solvent banking insurance fund that ALL banks must pay into (unlike in the US whereby some banks have been exonerated from paying because they are supposedly too big to fail – or in our opinion, they are too broke to pay).  However, we are even more concerned about general banking practices and government banking supervision because in theory and in practice, if everyone is doing their job correctly, there should not be any bank failures.  And this applies equally to the government banking regulators and the management at the banks alike.

One very notable difference between banking in the US and banking in the Dominican Republic is the attitude and practices of the bankers themselves.  Unlike in the US, Dominican Banks keep the loans they make on their own books and are responsible to manage them.  As a result, they are very cautious about lending practices.  In order to qualify for a home mortgage, applicants must demonstrate anywhere from a 20 to 30 percent down payment, aside from being able to prove they can support the monthly mortgage payments with verifiable income.  For this reason, there are very few cases whereby secured borrowers are going to walk away – they have too much invested, literally.

With regards to banking regulations, the banks in the Dominican Republic are required to secure both side of their balance sheets – both assets and liabilities.  The reserves that need to be deposited with the Central Bank can range anywhere from 2 percent up to 7 percent for items such as unsecured credit card debt the bank might be carrying on it's balance sheet.  And local banks in the Dominican Republic are audited with a requirement to top up or increase any reserve deposits IF their balance sheet has grown (new banking deposits and or new loans that were made since the last audit).  We put this in contrast to the current state of affairs in the US banking system whereby the US banks can borrow their reserve requirement from the Federal Reserve – how ridiculous is that? If the US bank cannot come up with cash or acceptable real collateral (such as government bonds) to meet the reserve deposit requirement, how is borrowing it going to help them?

Getting back to the mortgage and related housing market in the Dominican Republic, it is important to note that the problems that have occurred in other countries, such as the US, Ireland, and Spain – have NOT happened in The Dominican Republic.  Why?  Simply because aside from the down payment or equity of the borrower, and aside from the fact mortgages issued by the local banks in the Dominican Republic stay on the books of the bank that issued them, interest rates for mortgages have typically ranged from a low of 12 percent up to 20 percent or so.  In other words, consumers in the Dominican Republic are going to think twice about borrowing money and about paying it back as well.  Banks in the Dominican Republic are not stuck with Liar Loans, abandoned properties and similar shenanigans that have occurred elsewhere because they utilize sound and conservative practices.

In summary, this is not meant to be a complete primer on the subject by any means, but we do think it important to understand what is really going on in terms of banking insurance, banking regulations and conduct of the bankers themselves in how they manage their own respective banks.   As such, is the FDIC banking insurance program from the US the holy grail of safety it is made out to be?  We think not.  And likewise, banking practices in other countries are not wild and unregulated as some would have you believe as well.  After all, local citizens bank in the very same institutions you might be considering and they have no desire or interest to see their money at risk either.