The stress on the financial system from the COVID-19 pandemic has just started. The Federal Reserve and the U.S. Government have begun massive new programs to support the economy and the financial system, and hopefully, that will prevent a wave of bankruptcies and bank failures. Nevertheless, as we saw after the 2008 Financial Crisis, these programs and policies can only do so much. A large number of banks still failed after the 2008 Financial Crisis. For savers, a much worse outcome than a bank failure is finding out that your savings have been in a ponzi scheme. A financial crisis often exposes ponzi schemes as we learned in 2008 and 2009 when the infamous ponzi schemes of Bernard Madoff and Robert Allen Stanford came to an end.
Over the last several years, many consumers have opened deposit accounts at financial technology (fintech) companies. These deposit accounts include both checking accounts and savings accounts. A few are hybrid accounts that combine features of both checking and savings accounts. With a potential financial crisis on the horizon, how safe is money in these fintech deposit accounts?
The issue of the safety of your money at fintechs made news in late 2018 when the fintech Robinhood announced a 3% checking/savings account with SIPC insurance coverage. SIPC is a nonprofit membership corporation that was formed by federal statute. Its insurance covers customers of broker-dealers that are members of SIPC. The insurance covers loss of investments due to failure of the broker-dealer.
Robinhood claimed that its SIPC insurance would cover its new checking/savings product. When the SIPC president challenged this coverage claim, Robinhood went back to the drawing board to redo this product. The media attention spurred Congress into action. A Senate committee looked into this Robinhood incident and sent a letter to the FDIC, SEC and SIPC describing their concerns. This excerpt summarized the letter and their concerns:
This is why Congress will continue to explore options that both encourage innovation, while protecting consumers and the safety and soundness of our financial system. In the meantime, we would appreciate an update on how the SEC, FDIC, and SIPC carefully monitor fintechs who, intentionally or not, blur financial products for competitive advantage.
I have been unable to find replies from the FDIC, SEC or SIPC addressing this letter, and I’ve seen little guidance from the FDIC to help ease consumers' concerns about banking at fintechs. With the potential of another financial crisis coming, should consumers be apprehensive about banking at any of these fintechs?
Closure of Moven Accounts
In late March, Moven notified its customers that it would be shutting down its consumer banking product by April 30th. Moven is a fintech that was offering a mobile-only bank account. This shutdown shouldn’t cause any financial loss to customers. Accounts were held at a partner bank, CBW Bank, and last week, Moven announced an agreement with Varo Money which will allow Moven accounts to be transferred to Varo.
Moven had planned to spin off its consumer banking business to another fintech, but according to this American Banker article, the pandemic made that impossible. The American Banker article included an interview with the founder of Moven, Brett King, who was asked if this product closure is “a canary in a coal mine” and if he thought “we’ll see other challenger banks forced to shut down in this pandemic.” He warned that these neobanks will have a challenge in their funding.
Fintechs that partner with a bank
One feature of Moven that reduced customers’ concerns about the safety of their deposits is that Moven partnered with a FDIC-insured bank which held the deposits. In this arrangement, Moven acted as a middleman, providing the account management software and customer support.
This banking model isn’t new. I’ve covered companies that have done this since I began blogging in 2005. There are two possible ways that these accounts may end. In one case, the partner bank can fail, and in the second case, the fintech shuts down. Based on history, depositors have held up well in both cases.
When a partner bank fails
One example of a bank that failed and had partnered with other companies that took deposits was Waterfield Bank, which failed in 2010. Before the failure, Waterfield had offered bank accounts via several companies that took deposits online. These were known as banking centers. Two popular banking centers were UFB Direct and AARP Financial Savings Center. When Waterfield Bank failed, the FDIC wasn’t able to find another bank to acquire Waterfield’s deposits. Thus, these banking center customers lost uninsured deposits. Insured deposits were made available in one of two ways. First, customers were given one month to transfer out insured deposits from their savings or checking accounts. At the end of the month, any remaining insured deposits were mailed to the customer by check. Second, insured deposits held in CDs were sent to customers by check.
When the fintech shuts down
In the case of Moven, the company didn’t shut down. They are continuing as a company focusing on other products. Thus, they can help ensure a smooth transition for their banking customers. In the past, other fintechs that were offering checking accounts went out of business. One of those was PerkStreet Financial.
I first covered PerkStreet Financial and its popular checking account in 2009. In 2013 PerkStreet Financial notified customers that they “were unable to secure more funding” and they were in the process of “closing the company.” PerkStreet Financial had partnered with two FDIC member banks that held the deposits. The account balances remained safe. One of the two banks, Provident Bank, chose not to manage the accounts after PerkStreet Financial. Consequently, those accounts were closed 45 days after PerkStreet Financial made the closure announcement. The other bank, The Bancorp Bank, assumed management of the accounts after PerkStreet Financial. Thus, these accounts remained opened.
Even though no money was lost, there was concern that customers would lose rewards they had accumulated. Instead of paying interest, PerkStreet Financial paid cash back rewards based on the amount of debit card purchases. Those rewards could be exchanged for gift cards. At first, it appeared that some PerkStreet Financial customers would lose some of their accumulated rewards. Later PerkStreet Financial announced it was able to provide full value of the remaining accumulated rewards of its customers.
Two important things to note in this PerkStreet Financial case are: 1) the deposits in the FDIC-insured accounts were safe and no money was lost, and 2) reward points or other perks are not protected by FDIC insurance. There’s no protection on points/rewards if the fintech shuts down.
Fintechs that offer FDIC-insured sweep accounts
A more complicated arrangement has evolved in which fintechs are offering accounts with checking and/or savings account features without a direct partnership with a bank. These accounts are often called sweep accounts and/or cash management accounts. The fintech manages these accounts and transfers or “sweeps” the cash balances into deposit accounts at FDIC-insured banks. These banks are often called the program banks that participate in the network.
The Insured Network Deposits (IND) service is a popular FDIC-insured deposit sweeps service. This service is managed by the Promontory Interfinancial Network, the same company that operates CDARS. This IND page describes the benefits that fintechs can obtain by using IND:
Fintechs can use IND to offer an attractive cash management option. With IND, Promontory Interfinancial Network can help fintechs place customer funds in insured deposit sweep accounts through a seamless integration with one or more participants in its bank network—a network that is ~3,000 strong and the largest of its kind.
Robinhood is one of the fintechs that are using IND for its deposits sweeps program, called Cash Management. I reviewed this product, a reboot of its 2018 product, last October. At that time, you could only sign up for a waiting list. That is still the case as of April 13, 2020.
Other fintechs have similar deposits sweeps programs which don’t appear affiliated with IND. These include SoFi, Aspiration, Betterment and Wealthfront. All of these four define their accounts as either cash management accounts or cash accounts that are considered to be a brokerage product. All of these fintechs describe how deposits that have been moved into the program banks are FDIC insured. The coverage that exists while the deposits are in transit into or out of the program banks is complicated. Most state that the funds are covered by SIPC. For example, the following is part of Wealthfront’s small print:
While funds are at Wealthfront, before they are swept to the program banks, they are subject to SIPC’s protection limit of $250,000 for cash.
However, SoFi Money’s small print does not claim this SIPC protection:
The deposits in SoFi Money or at Program Banks are not covered by SIPC.
The issue of SIPC protection of cash is more complicated than FDIC protection. When Robinhood first announced its “Checking & Savings” product in late 2018, it proved to be a failure due to confusion over SIPC coverage. Robinhood had described the “Checking & Savings” product as deposits that were intended for saving and spending rather than for investing. In this December 2018 Bloomberg article, here’s how the president and CEO of SIPC, Stephen Harbeck, described why Robinhood’s Checking & Savings would not be covered by SIPC insurance:
“The statute that we administer says that we protect money with a brokerage firm that is used for the purchase of securities,” he added. “On Robinhood’s help page, it says that you don’t need to invest to use Robinhood checking and savings, that statement is wrong. If you deposit money for any other purpose, it is not protected.”
After these comments, Robinhood stopped promoting its “Checking & Savings” account, and replaced the mention of this account with the message “Cash management, coming soon.”
It should be noted that there’s no guarantee that SIPC will cover a cash management account if the SIPC determines that it’s being used for banking purposes. Below is a relevant excerpt from the SIPC FAQs:
I have a securities account. Isn’t everything in my securities account protected by SIPC?
Not necessarily. In general, SIPC protection is determined on an asset-by-asset basis and extends only to: (1) cash in a customer’s account that is on deposit for the purchase of securities; [...]
The SIPC’s website reminds me of that last line from the Senate committee letter excerpt that asks the regulators about how they are monitoring “fintechs who, intentionally or not, blur financial products for competitive advantage.” I don’t have confidence from the SIPC that they will cover these products from these fintechs since the fintechs appear to be marketing these products as checking and savings accounts rather than cash accounts to be used to purchase securities.
Another risk when banking at fintechs
One thing that has been common at fintechs that offer bank accounts is that they often change the partner banks. One risk is that a new bank partner happens to be a bank at which you already have accounts. FDIC insurance will combine deposits in accounts held directly with that bank with the deposits in accounts held indirectly with the bank via the fintech. That could put you over the FDIC coverage limit. It’s important that you keep track of the banks that hold your deposits at these fintechs.
Rate advantages have diminished
The appeal of many of these fintech accounts have diminished with the fall of the federal funds rate. A number of these fintechs have agreements with the program/partner banks that set rates based on the federal funds rate. When the federal funds target rate was in the range of 2.25% to 2.50%, these accounts had competitive rates compared to the online banks. Now with the federal funds rate near zero, these cash management accounts no longer offer competitive rates. These cash management accounts may be useful if you’re planning to use the investing services of these fintechs, but if you’re just looking for a safe deposit account with competitive rates, it makes more sense to go with the standard online banks (like Ally, Discover, Synchrony, etc.) where you can have a direct relationship with the bank that’s actually holding your account.