Turmoil in the banking industry in early 2023 caused investors to consider the details of deposit insurance, and think about what protections were afforded to their holdings in different accounts. The Financial Pipeline spoke with Heather Mason-Wood, Canso Investment Counsel Ltd.’s President and Chief Strategy Officer, to delve into the details depositors and investors might want to consider when deciding where to park their savings. (Note: This interview has been edited for length and clarity)
The Financial Pipeline: For depositors, this whole situation raised questions about how safe their money is, and the level to which it’s insured. What kind of deposit insurance is available in North America?
Heather Mason-Wood: In the U.S., they have the Federal Deposit Insurance Corporation (FDIC), and the limit is $250,000. If you are a big company and you have $5 million that you want to keep safe and you put it in the bank, only the first $250,000 is insured. If the bank fails, you are actually not a secured creditor. In the case of U.S. (regional) banks, regulators stepped in to make sure all depositors would be made whole, but they don’t have to do that, and customers shouldn’t really rely on it. It’s one lesson that needs to come out of this: Be careful about having substantial deposits with any one bank. In Canada, we have Canada Deposit Insurance Corporation, or CDIC, coverage up to $100,000 per depositor, per eligible account, although they’re talking about raising it because it hasn’t been increased since 2005.
FP: Is there a disconnect between how safe people think their money is at a bank and what could happen if that bank runs into trouble?
HMW: People do seem to think, if they put their money in the bank, it’ll just sit there. But what happens is that generally, a bank will take that money, keep 10% aside for capital, and use the other 90% to make money by lending it out as a mortgage or a corporate or individual loan. The 10% they keep in safe, liquid investments. That was the issue with Silicon Valley Bank. They had invested their capital in safe, secure instruments – Treasury bonds – but they stretched for yield and they went for long bonds. That was fine – until they had to sell them. With interest rates going up, the value of a long bond goes down, and that led to investment losses (when they were suddenly forced to sell) to raise capital to meet the withdrawal requests from their depositors. They stretched for yield and should never have done that; this really should not have been permitted.
FP: After SVB, there was a bit of an exodus from savings and cash accounts at U.S banks and brokerages toward money market investments. Canada saw a similar shift. What exactly is the money market and why are money market investments sometimes used as a cash alternative?
HMW: A money market fund could be a mutual fund or an exchange traded fund (ETF), except their policy statement only allows them to invest in very short term fixed income securities like government bonds, corporate bonds, and maybe commercial paper – such that the investor will get a return based on that. Whatever profit they make on the investment, they take their fees and then the difference gets paid out to the investors in the form of a yield. Money market funds usually maintain a fixed NAV, usually of a dollar, but they may not always be able to keep it at that. You’re still taking some market risk because it’s a marketable investment and there’s absolutely no investor protection fund, but it’s a limited amount of risk.
FP: Are there other options for people to keep their money safe, if they’re not interested in a bank account or money market fund?
HMW: A lot of people don’t realize that they actually have a larger limit on what’s government insured if their cash is held with an investment dealer. It won’t cover investment losses, but it keeps (the initial) cash insured up to $1 million with the broker-dealer. For someone with a lot of money they want to keep liquid, a short-term government bond may be better. But it really depends on the situation, and this is where you need to seek investment advice from a professional.
FP: What do you think investors generally should think about when looking to keep their money safe?
HMW: I think it’s just a matter of understanding what the risks are that you’re exposed to and making sure that they fit your overall financial situation. If you’re trying to build capital, then you don’t want to take too much risk because you could end up losing what you already have. Once you are in a more comfortable financial position, maybe you could take on more risk with your investments. But understanding what you’re invested in is crucial. It’s really about knowing the risks of your portfolio, and it’s always best to speak with an investment professional to help you figure out what’s best for you.
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