Silly fintechs, federal deposit insurance is for banks

Silly fintechs, federal deposit insurance is for banks

Few things are as American as mom’s apple pie and the Federal Deposit Insurance Corp. While most Americans understand the healthy goodness that comes from a steaming crust containing baked apples, the same level of understanding cannot be said about the protection provided by the FDIC.

In short, the FDIC is one of the key reasons why the US banking industry is a world leader in safety and soundness. Insured deposits in financial institutions are protected in case of financial problems in the bank. That’s the big difference between US banks (technically insured depository institutions): the FDIC protects customers in the unlikely event that the bank experiences difficulty.

FDIC sticker

Fintech companies are not as safe for customers as FDIC-insured depository institutions because the FDIC does not protect customer deposits if the fintech fails.

Fintech companies commonly place commingled customer funds in a single bank account, and this type of account may be known by various names: “suspension”, “custodial accounts”, “aggregate accounts” or “in favor” accounts. Regardless of the name, a fintech company is responsible for maintaining beneficial ownership information.

If the fintech fails or for any reason the total funds customers should have on deposit does not match what the fintech deposited into the account, the FDIC insurance will not be triggered.

Only if the bank failed, and if the bank and fintech set up the account structure to meet pass through insurance requirements, would customers be covered by FDIC insurance.

In other words, customer deposits in fintechs are generally at risk of fintech financial performance. Customers should be concerned about this, and for their own protection, customers should avoid fintechs and seek the safety and security of insured depository institutions.

The digital asset industry has recently seen the collapse of some of the industry’s larger non-bank deposit-taking companies and customers have been cut off from accessing their funds. Voyager Digital and Celsius Network had billions in customer deposits, and both firms filed for Chapter 11 bankruptcy protection in July 2022. Whether customers will eventually have access to those funds and whether they will be whole is uncertain at best.

There is no such thing as “too big to fail”, and large investments in a company from well-known venture capital firms are no guarantee that the company is managed prudently. Unlike most of the fintech industry, transparency and good governance are hallmarks of the US banking system.

I don’t know many people who would say they like their bank, but in general, people in the United States trust their banks to protect their funds. According to the agency, in the nearly 90-year history of the FDIC, no one has ever lost a single penny on an insured deposit.

The fintech industry has a number of participants looking to borrow from this source of credibility, and perhaps the leaders in this effort are from the cryptocurrency industry.

Founders and startups with limited financial services experience are trying to bolster their flimsy credentials as safekeepers of other people’s money by touting that customer dollars are deposited in FDIC-insured institutions.

Guess what? Of course they are! The phrase isn’t much different than simply stating that the funds are held in a bank, but the reference to the FDIC can be misinterpreted, and perhaps that outcome is what some firms were looking for.

It is very rare to find a bank in the US that is not FDIC insured, and if there is one, it is not a member of the Federal Reserve System. The most frequently cited non-FDIC bank is Bank of North Dakota, which is fully supported by the state of North Dakota and is the only government-owned general service bank in the country.

The FDIC works with banks, and despite offering some similar products and services, fintechs are not banks. It is a serious violation for an uninsured institution to claim FDIC coverage. There is at least one cryptocurrency lender that, with its mix of products, is almost impersonating a bank that may have played fast and hard with its coverage claim. It will be interesting to see if the FDIC and the Consumer Financial Protection Bureau continue to pursue enforcement actions. Cleaning up bad actors is good for the industry and good for consumers.

The FDIC is an independent agency created by Congress and supported by the full faith and credit of the US government. It is important to note that the FDIC does not receive public funding, but is instead funded by premiums paid by banks and credit unions to insure deposits.

The FDIC does more than just provide deposit insurance. The agency investigates and oversees the safety, soundness and consumer protection of financial institutions; makes large and complex financial institutions solvable; and manages emergency messages.

The agency is an active and important member of the interconnected network of financial regulators in the US that ensure the safety and soundness of banks. In the rare event that an insured institution runs into financial difficulties, it is the FDIC that steps in and directs the receivership process. The FDIC protects customer deposits and the strength of the entire industry.

Fintech may have some advantages in terms of flexibility and speed of change, but it is never a level playing field for consumers. Only insured banks have the protection of safety and soundness that comes with oversight by the FDIC and other regulators, and one should never have to worry about the stability of the institution holding their money.

For years, an ad ran on American television in which a cartoon rabbit wanted to eat a bowl of children’s cereal, but was told he couldn’t because it was only for children. When it comes to Federal Deposit Insurance, many fintechs need a similar reminder: “Stupid fintechs, the FDIC is for banks.”

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