Stupid fintechs, the federal deposit insurance is for banks

Stupid fintechs, the federal deposit insurance is for banks

Few things are as American as Mama’s apple pie and the Federal Deposit Insurance Corp. While most Americans understand the wholesome goodness that comes from a steaming baked apple crust, the same level of understanding cannot be said of the protection the FDIC offers.

In short, the FDIC is one of the main reasons the American banking industry is a world leader in safety and soundness. Insured deposits at financial institutions are protected if there are financial problems at the bank. That’s the big differentiator for US banks (tech-insured depository institutions): The FDIC protects customers in the unlikely event that the bank runs into trouble.

FDIC sticker

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

Fintech companies typically place mixed customer funds in a single bank account, and this type of account may be known by a variety of names: “pass-through accounts”, “escrow accounts”, “omnibus” or “for the benefit” accounts. Regardless of the name, the fintech company is responsible for maintaining beneficial ownership information.

If the fintech fails, or for whatever reason, the total balance customers should have in the account doesn’t match what the fintech deposited into the account, the FDIC insurance will not trigger.

Just in case the bank fails and if the bank and fintech set up the account structure to meet the requirements for pass-through insurance, customers would be covered by FDIC insurance.

In other words, customer deposits in fintechs are generally at risk for the financial performance of the fintech. This should worry customers, and for their own protection, customers should avoid fintechs and seek the safety of insured custodians.

The digital asset industry has recently witnessed the collapse of some of the larger non-bank depository firms in the industry and customers have been denied access to their funds. Voyager Digital and Celsius Network both had billions of dollars in customer deposits, and in July 2022 both companies filed for Chapter 11 bankruptcy protection. Whether customers will eventually access those funds and recover is uncertain at best.

There is no such thing as too big to fail, and large investments in a company by well-known venture capital firms are no guarantee that the company will be 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 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 cent on an insured deposit.

The fintech industry has numerous participants looking to capitalize on 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 meager credentials for keeping other people’s money safe by promoting customer funds being held in FDIC-insured institutions.

Guess what? Of course they are! This phrase isn’t significantly different from simply saying that funds are held in a bank, but the reference to the FDIC can be misinterpreted, and perhaps that outcome is what some companies were seeking.

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

The FDIC works with banks, and while fintechs offer some similar products and services, they are not banks. It is a serious violation for an uninsured facility to claim FDIC insurance. There is at least one cryptocurrency lender that almost masquerades as a bank with its product mix and may have played fast and loose with its claim for coverage. It will be interesting to see if the FDIC and Consumer Financial Protection Bureau take enforcement action. Cleaning up the bad actors is good for the industry and good for the consumer.

The FDIC is an independent agency established by Congress and fully endorsed by the US government. It is important to note that the FDIC does not receive any public funds, but is funded by premiums paid by banks and thrifts for deposit insurance coverage.

The FDIC does more than just deposit insurance. The agency checks and monitors financial institutions for safety, soundness and consumer protection; makes large and complex financial institutions resolvable; and manages bankruptcy administrations.

The agency is an active and key member of the interconnected network of financial regulators in the United States that protect the safety and soundness of banks. On the rare occasion that an insured entity encounters financial difficulties, the FDIC steps in and manages the receivership process. The FDIC protects customers’ deposits and the strength of the entire industry.

Fintechs may have some advantages in terms of flexibility and speed of change, but it’s never a level playing field for consumers. Only insured banks have the safety and security protections that come with oversight from the FDIC and other regulatory agencies, and one should never have to worry about the stability of the institution holding their money.

For years, American television ran a commercial 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, FDIC is for banks.”

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