Stupid fintech, federal deposit insurance is for the banks

Few things are as American as Mom’s apple pie and the Federal Deposit Insurance Corporation. Although most Americans understand the utility that comes from a steaming crust containing baked apples, the same level of understanding cannot be said for the protection afforded by the FDIC.

In short, the FDIC is one of the main reasons why the American banking industry is a world leader in safety and soundness. Insured deposits in financial institutions are protected if there are financial problems at the bank. That’s the big difference for American banks (technically, 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 depository institutions because the FDIC does not protect customer deposits if the fintech fails.

Fintech companies typically place commingled client funds in a single bank account, and this type of account may be known by various names: “pass-through,” “trust accounts,” “omnibus,” or “beneficiary” accounts. Regardless of the name, the fintech company is responsible for maintaining information about the beneficial owners.

If the fintech fails, or for whatever reason the total funds customers are required to have on deposit does not match what the fintech has placed in the account, FDIC insurance is not triggered.

Only in the event that the bank fails, and if the bank and fintech set up the account structure to meet pass-through insurance requirements, will customers be covered by FDIC insurance.

Put another way, fintech customer deposits are generally at risk for the fintech’s financial performance. This should concern customers, and for their own protection, customers should avoid fintech and seek the safety and security of insured depository institutions.

The digital asset industry has recently seen the collapse of some of the larger non-bank deposit-taking firms in the industry, and customers have been cut off from accessing their funds. Both Voyager Digital and Celsius Network had billions in customer deposits, and in July 2022 both firms sought Chapter 11 bankruptcy protection. At best, it is uncertain whether customers will ultimately have access to those funds and will be healed.

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 is being managed wisely. Unlike most of the fintech industry, transparency and good governance are hallmarks of the US banking system.

I don’t know many people who will say they like their bank, but generally in the United States, people trust their banks to keep their money safe. According to the agency, never in the FDIC’s nearly 90-year history has anyone lost a penny on an insured deposit.

The fintech industry has numerous players willing to borrow from this source of trust, and perhaps the leaders in this effort are the cryptocurrency industry.

Founders and start-ups with limited financial services experience seek to bolster their meager credentials to hold other people’s money by promoting that customers’ dollars are held in FDIC-insured institutions.

Guess what? Of course they are! This phrase is not much different than simply stating that the funds are held in a bank, but the reference to the FDIC can be misinterpreted, and perhaps that result is what some businesses are looking for.

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

The FDIC works with banks, and although they offer some similar products and services, fintech companies are not banks. It is a serious offense for an uninsured institution to claim FDIC coverage. There is at least one cryptocurrency lender, almost masquerading as a bank with its mix of products, that may have played fast and loose with its coverage claims. It will be interesting to see if the FDIC and the Consumer Financial Protection Bureau take enforcement action. Cleaning up the bad actors is good for the industry and good for consumers.

The FDIC is an independent agency created by Congress and supported by the full trust and confidence of the U.S. government. It is important to note that the FDIC does not receive public funding, but instead is funded by premiums paid by banks and savings associations for deposit insurance coverage.

The FDIC does more than provide deposit insurance. The agency inspects and supervises financial institutions for safety, stability and consumer protection; makes large and complex financial institutions solvent; and manages the syndicate.

The agency is an active and important member of the interconnected network of U.S. financial regulators that protect the safety and soundness of banks. In the rare event that an insured institution experiences financial difficulties, it is the FDIC that steps in and manages the receivership process. The FDIC protects customer deposits and the strength of the entire industry.

Fintech may have some advantages in terms of flexibility and speed of change, but for consumers it is never a level playing field. Only insured banks have the safety and soundness protections that come with oversight by the FDIC and other regulators, and one never has to worry about the soundness of the institution holding their money.

For years there was an ad on American television 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 fintech companies need a similar reminder: “Stupid fintech companies, the FDIC is for the banks.”