Deposit insurance maximization as a service
bitsaboutmoney.com
bitsaboutmoney.com
From the article: “We represent 1,728 insured depositors at the now-failed bank who will really need their money Monday morning. Most had precisely $250,000 on deposit. We live to serve your mission of getting these insured depositors their statutorily mandated money back and after you cut one wire to us you’re done with them; we’ll take it from here.".
What could possibly go wrong with that?
In the linked hypothetical, fintech never touches the money, but the devil is in the implementation details and shortcuts happen.
This exact issue came up repeatedly in the past few years with crypto companies whose FAQs and even executives falsely told people their deposited money was FDIC-insured simply because the company itself banked with an FDIC bank. That’s not how it works.
One of many recent sad examples: https://mobile.twitter.com/Frances_Coppola/status/1543279013...
Another one: https://mobile.twitter.com/Frances_Coppola/status/1640909892...
(Frances Coppola is a great person to follow on Twitter.)
What happens if Custodian fails? Well, ahem, plausibly the world ends in fire and blood. This is why Custodian was specifically chosen from the ranks of a count-on-your-hands number of the largest financial institutions in the world. This isn’t even the thousandth most important thing that breaks if Custodian breaks. Custodian cannot be allowed to break. Custodian is Too Big To Fail.
Realistically, Sweep customers are counting on the Custodian to properly maintain all the contracts, diligence, etc. that keep their deposits correctly segregated and protected.
Genuinely curious: How else could you mitigate risk here aside from obliging them to maintain diversified insurance, or using multiple Custodians (which puts you back at having to deal with multiple institutions)?
His thought process was basically "if Italy fails I'm gonna be screwed anyway", and it kinda worked for him.
If you’re holding millions in cash shouldn’t you be using T-Bills and lines of credit for treasury management? DIY finance at scale is dumb.
It's also not a core competency a start-up should have to focus on. For all their talk of adding value, outsourced treasury management would have been a valid one.
The goal of these products is that, to you the user, it feels like "money in your account." You don't need to think of the mechanics of brokered CDs if you e.g. want to keep $750k on deposit at Schwab. You just... keep $750k on deposit at Schwab, and Schwab does some magic you don't care about, and you're insured.
Scale up the numbers a bit and sell it to companies, and that is the fintech pitch.
This, thankfully, has never been tested in a significant way, as they are not backstopped by the federal government.
(It also suggests a rather lucrative arbitrage opportunity.)
I will say the Canadian banking system (as well as credit unions, which are regulated differently) is generally quite healthy and stable, I don't think it's imminent risk of collapse. But I would certainly not count on this guarantee, it's very silly.
I think the first is pretty likely, but not sure how many people that will hit. There are decent stress test rules so anyone who couldn't afford a 1 or 2 percent jump shouldn't have qualified. The second is less likely, I think. We've got an absolute minimum 5% down payment, and almost always more like 10%, and anything under 20% requires default insurance. So I think pretty low chances unless the housing market craters ~30% or more. Which might be what it actually should fall by, honestly, but the government will probably intervene way before that happens.
> Mortgage default insurance protects lenders in the event a borrower defaults on their mortgage. It does not protect the borrower or a guarantor. If a borrower defaults, the insurer may oversee all legal proceedings and payment enforcement. In addition, the insurer compensates the lender should there be a shortfall after the property has been sold and expenses paid. The defaulting borrower remains responsible for any shortfall on the mortgage and the lender or mortgage insurer may pursue the borrower for any deficiency following sale of the property.[1]
I just want to highlight that last part because the insurance is 100% not for the borrower, but for the lender. Just like when any other insurance policy is used, the insurance provider has a strong incentive to reduce how much of the policy's pay out it pays from its own reserves and that means going after the borrower.
There is also a vague idea that because one of the major mortgage insurers is a government corporation (CMHC), they will pay out and not pursue the borrower. This is not true, and if Canadians know anything it's that no one loves taking other people's money as much as the government. To get out of paying you have to declare bankruptcy, much like the US. [2]
So in short, the Canadian system is set up to have the borrower pay for the lender's ability to expeditiously be made whole in the case of default, and for the insurer to then pursue compensation from the borrower if the asset price is below the loan value. It's the most Canadian thing ever: the borrower is getting screwed but thinks it's a good thing.
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[1] https://www.scotiabank.com/ca/en/files/12/07/Mortgage_Defaul...
[2] https://rates.ca/resources/does-declaring-bankruptcy-get-you...
Interest rates were incredibly low, but they still weren’t just handing out mortgages like we saw in the States in the previous collapse.
Of course nothing is impossible.
Know nothing about Canadian law. But that doesn't sound like an obligation.
Practically the fund doesn't have sufficient funds to bail out a big bank failure - let alone multiple - and everyone expects a government bailout.
In BC, how would the government fund a bailout if several Credit Unions collapsed at the same time?
Can you imagine the fallout of a bank run on all credit unions? The federal government would find a way to prevent that.
What is this lucrative arbitrage opportunity we have to make money with this setup?
Of course, if you actually pitched someone on this, their first question would be, "who insures you?" At which point you either didn't tell them (and lose their trust and they don't give you their money), tell them and they don't trust the coops (in which case you don't get their money), or tell them and they do trust the coops (in which case, they'll cut you out as a middle man and bank with these coops).
All the insurance does is make sure you get your money back if the credit union ogoes under.
If I put $500,000 of my own money in the credit union I can't see how I can sell my "insurance" to someone else as I need it to protect my own money.
If someone else wants the insurance they have to put their own money into the credit union. I can't sell my insurance to someone else unless I hand them my money but I cant see why i'd do that as it wouldn't make any sense and its certainly not an arbitrage opportunity as the OP suggested.
The arbitrage is that in some places, universal deposit insurance costs >$0 but these banks are giving it out free. So there is a difference here that's exploitable on paper, but presumably the reason it exists is that it isn't in practice.
It fits the strict definition of an arbitrage opportunity in that there's a difference in pricing that you could exploit without taking on market risk, in a frictionless vacuum where wires clear instantly and carry no transaction fees and a bunch of other unrealistic assumptions.
I don't view it as real, but it gave me a chuckle, like when people turn DNS into an ersatz file system or similar hackery. Like a pun in the financial system.
It's not an opportunity for an individual, it's one for a bank.
You start SVB2, and say "we charge significant fees and insurance premiums, but also offer 100% deposit insurance, no cap". And then your entire existence as a bank is just as a front-end to those credit union deposits.
edit: and yah, maxbond hit the nail on the head, it's not a real suggestion, it's a joke.
Was it 2.5% 30yr mortgages for founders? Was it liquidity, in the form of loans against illiquid pre-IPO stock?
Were the interests of the companies aligned with those of the people who were getting the perks? (At 4-5% for parking excess cash in simple T bill it seems like a pricey perk)
Sometimes the issue is that there is nothing better, that is known to be available.
I can't recall being in a treasury management meeting where the CFO or VP of finance raised a concern about maxing coverage by FDIC insurance. In fact, many transactions that even a $2-3M per year company does require pooling more than FDIC covered amounts in a bank account just to cover receiving payments or making payments.
Incidentally SVB did have very comparable treasury management feature to other banks.
Finally, to address the perk part of the post, at no time did I see SVB offer anything other than market rates for mortgages - the difference is that they would not reject founders immediately because they were a business owner with no W-2 income.
This is standard issue for corporate America. People who cut their teeth in the last decade's tech boom didn't learn it. But managing counterparty risk is one of the core jobs of corporate treasurers.
But the interest rate spread ... Seems like a lot now? Wasn't, for a long time?
"Sometimes the issue is that there is nothing better, that is known to be available."
Where SVB customers money in a money market fund that failed, or was it simply a "bank deposit" ?
There are plenty of money market funds that are ungated and that are based on very short term treasuries that can be used as cash: write checks,ue credit cards, wire money, schedule payments, use autopay, etc, etc.
This is what I do - I keep $0 in the "bank", have almost all the services a bank can provide, and all my "cash" is guaranteed by the federal government.
Maybe I am misunderstanding something here. I am not, and never have been, a CFO.
Talk to your accountant (Most of you here on HN probably make enough to warrant having one of these), Talk to your banker, and if you have more that 50 people working for you then you have a firm or a CIO...
You don't call a plumber to fix your electrical wiring... Get advice from a professional and rest easy at night. Take this article and the comments here as you being an informed consumer when you go to your accountant or CFO... speaking their language and understanding what they have to say will benefit both of you.
For example
> Many financial service providers have so-called treasury management solutions which they sell against these needs.
What does "sell against" mean?
Fractional reserve banking was a known quantity. Risk management of your cash matters in a system like that. Full stop. Whether you think fractional reserve banking is dumb idea is a different discussion, but to willfully pretend that the depositors weren't at least partially culpable for this collapse is something else.
Tech has no humility.
or self-awareness
It has really made me believe that a lot of tech is just grifters reinventing wheels everywhere, but with great marketing.
Nobody has humility. Everyone trying to build a business fakes it. Your HVAC guy is highly likely to be a bozo (and overcharging besides). This isn’t “bad” it just is.
Tech is people. People suck.
Banks cut sweetheart deals with large depositors to keep their deposits with them. A sweep account is less lucrative than one you can YOLO into long-term Treasuries. I'm not surprised most start-ups didn't have a treasurer; I am surprised e.g. Roku or Circle didn't.
For some banks brokered deposits subsidize all other deposits because their customers otherwise are more expensive. Many small banks that serve underprivileged communities are in this category.
For SVB it seems this was decidedly not true! They had low cost to acquire large depositors and had no market pressure to engage with a deposits network.
AIUI regulators do not allow this due to systemic risk: https://www.bloomberg.com/opinion/articles/2019-03-08/the-fe...
To be clear, I’m not suggesting this is a good idea. I’m just trying to clarify if this is allowed. Because at face value the idea that keeping all deposits liquid is a systemic risk seems counter intuitive. It only begins to make sense with the specific context of parking that money at the Fed.
In our current system, every bank or bank-like institution does fractional reserve banking. The systemic risk posed by a narrow bank or a full reserve bank is that during any potential banking crisis, there is a strong prisoner's dilemma style incentive for depositors to "defect" by withdrawing all of their money from normal banks and moving it to narrow or full reserve banks all of a sudden. This is broadly why regulators won't let you run one.
Now, to answer your core question AIUI: "what stops me from running a full reserve bank [equiavalent]?"
In theory, you could offer a secure storage service like safety deposit boxes etc and not be subject to finance regulatory controls. In fact, most cities do have businesses that offer secure storage facilities that you can rent space in to store your property and retrieve it as needed. This is perfectly legal and honestly such a business doesn't usually know or even need to know the contents of such storage lockers etc.
The problem comes when you want to integrate with the larger financial system. Finance regs are far reaching in a "viral" sort of way; they don't just restrict how you do business, they also typically restrict whom you can do what business with based on how and what kind of business they do. The result of this is that you end up under the purview and subject to the approval of regulators one way or another, at which point they disallow your business.
As a simple example, if you want to make it so your customers can easily send or receive money, you'll probably want to be able to process ACH and wire transactions, at which point you fall under extensive regulation administered primarily by the Treasury and the Federal Reserve. I imagine the same will be true for things like debit cards on the standard networks since they're already subject to regulation of a viral nature and so on and so on.
Tldr: narrow banks could break traditional banking and monetary policy so the fed doesn't let it exist.
Deposit insurance is a useful tool to manage the orderly unraveling of a bank independent of how it goes bust.
They don’t state that the fraud caused the failure and perhaps fraud would be harder in a fully reserved bank, but the incidence level is high.
[0] https://www.fdic.gov/analysis/cfr/2017/wp2017/cfr-wp2017-06....
They either paint an inaccurate picture of the situation or try to frame something old as new.