Look before leaping onto platforms offering elevated FDIC-insured deposits

All it took was a few high-profile regional bank implosions to refocus savers on the formerly mundane concept of FDIC insurance.

Recent government bailouts aside, the Federal Deposit Insurance Corp. protection limit is still technically capped at $250,000 per saver, per financial institution. But workarounds abound, and financial advisors would be wise not to just race toward the first neon light promoting FDIC insurance up to the sky.

It’s no coincidence that over the past week, both Betterment and SoFi announced expanded FDIC coverage up to several million dollars, with yields hovering in the 4% range.

Wealthfront bulked up its FDIC insurance coverage last fall, joining platforms including StoneCastle, Flourish, and MaxMyInterest.

To be clear, these platforms aren’t really increasing the insurance limit, they're just using networks of banking institutions to chop large accounts into insurable $250,000 increments.

This practice of so-called brokered deposits isn't really a new concept. It’s been a profit center and a mainstay of the banking and brokerage industries for decades. One big distinction is that the fintech platforms are passing most of the better yields onto savers.  

This trend will continue, and it will be interesting to see how traditional banking institutions respond, because the old model of offering savers a fraction of the potential yield with FDIC insurance limited to $250,000 is finished. Or it should be.

Even though the government stepped in to protect deposits well beyond $250,000 at Silicon Valley Bank, and even though Treasury Secretary Janet Yellen has gone back and forth on whether that will happen again, no logical person could possibly view the SVB rescue as a precedent.

One could assume anyone so cavalier about stashing a sum of cash well above the FDIC cap in a single bank, as was the case with depositors at SVB, was likely weighing convenience against the potential downside.

But it really was convenient, because unlike most of the fintech platforms offering much higher FDIC insurance through a brokered deposit system, direct bank deposits at least say they provide immediate liquidity.

And what were the odds the country’s 16^th largest bank was going to be brought down by an old-fashioned run on deposits?

Never mind. Lesson learned.

That brings us to the smart alternatives to parking mountains of client cash in banks that only insure up to $250,000.

Advisors can, of course, direct clients to open accounts at multiple banks and risk never hearing from those clients again.

Or they can start kicking the tires on the mushrooming options available across the fintech landscape. If it seems as if these firms are suddenly rolling out the red carpet to depositors, it’s because they are seizing on a near perfect confluence of events.

You’ve got the Fed keeping interest rates at elevated levels as part of its clumsy tango with inflation. The growing threat of recession has more investors moving money to cash. And the traditional banking industry is exposing cracks that look like the start of something that rhymes with the words “banking crisis.”

Anyone even tangentially supportive of capitalism would have to tip their hat to the way the various fintech platforms have pounced on the opportunity.

At Betterment, for example, where the average account size is around $50,000, it was seen as a no-brainer to scramble the jets this week to double the FDIC insurance limit to $2 million for an individual saver.

That limit goes up to $8 million for a couple by spreading the money across two individual accounts and a third joint account.

Betterment president Mike Reust said the adjustments were made in anticipation of growing demand for insured deposits.

“We looked at the assets on our platform, and there wasn’t a huge number of customers that would benefit from the higher limits,” he said. “But people are anxious about principal protection, and they will be more comforted to know that their institution knows that and cares.”

Meanwhile, at MaxMyInterest, which is the only platform so far that offers traditional banking liquidity by not employing the brokered deposit system, all the increased activity is not yet viewed as a threat.

“It’s a little disappointing to see RIAs and fintech firms adopting the same model used for so many years by brokers of selling deposits to other banks and keeping the spread,” said Chief Executive Gary Zimmerman.

Zimmerman clearly has a dog in the fight, but he does make a valid point about the distinction between brokered deposits and a platform that directly links each saver to each bank account.

For example, without knowing exactly which banks are holding assets through a brokered deposit platform, there’s a chance a saver could inadvertently exceed the FDIC limit by having money in another account at the same bank.

But Zimmerman said the bigger issue is liquidity.

“With the brokered deposit solution you don’t own the accounts, so if the bank were to collapse, you can be insured but not have liquidity,” he said. “That can be a big deal if you need that money to make payroll on Monday.”