Earlier this month, a former Harvard business professor told CNBC that he was pulling $1 million from his accounts at Bank of America (BAC 0.90%) for fear of a run on the bank.
While I certainly commend this professor for putting his money where his mouth is, I can't help shaking my head. A leading professor from a world-renowned business school simply doesn't understand how bank deposits are protected.
Here's the low-down on how FDIC insurance actually works, and it will explain why you have nothing to worry about -- despite the misguided advice from this professor.
When banks fail, this product hasn't lost a penny since 1933
Do you remember the chaos and fear in 2008 as the real estate bubble collapsed and bank failures dominated the evening news? Or maybe the savings-and-loan crisis of the late '80s and early '90s? Or stagflation in the 1970s? Some readers may even have memories of the aftermath of the Great Depression in the 1930s.
All that pain, fear, turmoil, and financial loss, yet not a single penny has ever been lost on an FDIC-insured deposit account in a United States bank. Not a penny. Every single insured deposit has been made whole. Every single one.
FDR signing The Banking Act of 1933. Source: FDIC.
The basics
The Federal Deposit Insurance Corporation provides insurance to U.S. banks covering customer deposits up to $250,000 per depositor, per bank, per deposit category. The cost to you for this insurance? Nothing. Its totally free for the consumer.
Translated a bit, this means that if your bank fails, the FDIC guarantees your accounts up to $250,000. But that's not all; there is some nuance to the rules that can allow you to insure literally all of your cash.
Have $250,000 in a checking account? It's safe. Have $100,000 in a savings account and $100,000 in a checking account? Safe. Have another $250,000 in a joint account with your spouse? It, too, is totally safe -- you and your spouse have $250,000 in coverage each. Another $250,000 in your business' name? Its also safe.
Sometimes even Harvard professors get it wrong.
Have $500,000 in a single savings account? Well, in that case, only $250,000 is safe. Stocks, bonds, mutual funds, ETFs, and other investment oriented accounts do not qualify, either. This insurance applies to checking, savings, some IRA products, and certificates of deposit.
Have you maxed out the coverage at Bank of America? Easy -- just transfer your uninsured cash to a different bank. There were 6,812 FDIC-insured institutions in the U.S. as of Dec. 31. There are plenty of opportunities to get full coverage, not matter how fat your wallet.
The key takeaway here is that with a little planning, you can effectively have Uncle Sam guarantee 100% of your bank account deposits. Its free, and you should absolutely make sure that all of your cash is protected. Just make sure you speak with a banking pro that knows your specific situation to ensure you're covered. An experienced branch manager should be able to help you without any trouble.
A bank run in the 1930s. Source: FDIC.
This protection is awesome. Who came up with this brilliant plan?
The history of this program dates to the Great Depression. In 1933, Franklin D. Roosevelt signed the Banking Act of 1933, establishing the FDIC. The logic was pretty simple: In the aftermath of the Crash of 1929, the government sought ways to slow or end runs on banks, and to instill confidence into a financial system rattled to its core.
The solution is elegant in its simplicity. Make banks buy insurance to protect deposits and give the insurer the right to routinely examine the banks for safety and soundness. The plan worked, bank runs subsided, and 80-plus years later, the FDIC still functions in essentially the same way as it always has.
Banks pay premiums -- called "assessments" -- to the FDIC just like an individual pays premiums to receive health insurance. The amount the bank pays is calculated based on the bank's size, asset mix, and overall risk profile.
In return for the premiums, the FDIC backs customer deposits at that bank. It's a very straightforward insurance operation. And it works.
A fortress of consumer protection
Since the FDIC's inception to date, 4,060 financial institutions have failed. These failed institutions held, at the time of the failure, nearly $2.6 trillion in aggregate deposits and $4.9 trillion in total assets. These are huge numbers, but keep in mind that they have not been adjusted for inflation -- a dollar today is a lot different from a dollar in 1934. The sheer size of deposits saved is absolutely staggering.
The FDIC's track record of protecting consumers is impressive, but the impact of a massive recession does take its toll on the corporation. Commonly referred to as the DIF, the deposit insurance fund is the pool of capital the FDIC maintains to buffer the financial system from unexpected turmoil.
The DIF took some hard punches over the past five years, but it survived and is now rebuilding. As part of the Financial Reform Act, the government has implemented a plan to make the DIF even stronger in the face of potential future crises.
By 2020, the ratio of the DIF to total insured U.S. deposits must reach 1.35% -- it's currently a little below this target. And plans are currently being worked out to raise that target to over 2%. For more than 80 years, the FDIC has stood as a pillar of strength for consumers and over the next decade its going to get even stronger.
This change is critical to maintaining the FDIC's tradition of successful insurance. The data shows that over the past 20 years, the potential for losses in the fund is quite large -- but not large enough to bankrupt the fund.
What does this all mean to you and me? It means that your cash, if properly structured at the bank, is safe. It means if the stock market crashes, if there is a recession, if the Federal Reserve's monetary policy backfires, or if there is any other event short of total collapse, your cash will be safe.
There is no reason to pull your cash from your FDIC-insured bank, despite what a misguided and overly pessimistic Harvard professor may say.
