I’m sure you know that your bank account is FDIC insured. This means that in the event that your bank or financial institution fails (goes out of business); the FDIC steps in and takes over the bank.
When we say bank we really mean financial institution. Because the line is so blurred now (for instance it seems every insurance company has a bank these days), any financial institution that is FDIC insured enjoys the same level of protection.
A bank’s product is money. It has an inventory of money. It is required to keep a only a small percentage of its total deposits as a reserve. The rest it loans out at a profit in an attempt to make money.
If the bank doesn’t make money, for instance say it makes mortgage loans to people who don’t pay back the money; the bank could go out of business. Again, because the bank's product is money, going out of business is bad news if you have an account at the bank.
This happened a lot during the Great Depression in the 1930’s so the US Government stepped in and created the FDIC. Basically the FDIC insures your deposits for up to $100,000 per bank. You can have additional accounts at separate banks but you a limited to $100,000 per account owner per financial institution.
Obviously, if you have more than $100,000 in one bank you will want to spread that money around to more than one financial institution.
Keep in mind that all financial instruments aren’t insured by the FDIC. Generally only demand deposit (checking and savings) and CD (certificates of deposit) are FDIC insured. That means that mutual funds, stocks, bonds and many other financial products are not FDIC insured. Most products will state very clearly whether they are insured by the FDIC.
In the aftermath of the subprime crisis the FDIC is expecting many banks to fail. In fact banks are starting to fail right now.
What does this mean and how can you protect yourself?
If you have less than $100,000 and you bank at a large nation wide financial institution, you probably have very little to worry about. Usually the smaller banks are at more risk of failure. Also bank failure is rare. The banking industry is tightly regulated by state and federal officials. I recall several teams of auditors descending upon the bank that I worked each year.
The FDIC will go out of its way to keep a bank failure secret. The don’t want to cause a bank run, a situation where everyone tries to get their money out of the bank at the same time. Bank runs will actually cause a bank failure if one wasn’t eminent. This happened a great deal during economic downturns in the past (most notably during the Great Depression). However, modern bank runs, like bank failures, are a relatively rare occurrence.
In the end, it’s not something you should worry a whole lot about. Just make sure you divvy up your money between banks if you are in the enviable position of having a large bank account.
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