Why Your Money May Not Be Safe in a Digital Bank, Even If It's FDIC-Insured

Last year the collapses of Silicon Valley Bank (SVB) and Signature Bank marking the second- and third-biggest bank failures in U.S. history. These events naturally raised concerns about the stability of both traditional and digital banking institutions.

For years consumers have begun turning to online-only banks and fintech platforms for their banking needs. These institutions often promise convenience, higher interest rates, and innovative features. But how safe is your money outside of traditional banks? For instance, how did the collapse of fintech middleman Synapse lock more than 100,000 Americans with $265 million in deposits out of their accounts this past May? Let's take a look at the fine print of digital banking safety and what you need to know to protect your money.

What it means to be FDIC-insured

The Federal Deposit Insurance Corporation (FDIC) is the cornerstone of consumer confidence in the U.S. banking system. The FDIC guarantees deposits on accounts up to $250,000 per depositor, per insured bank, for each account ownership category. This insurance applies to nearly all banks in the United States, providing a safety net for consumers in case of bank failure. Similarly, credit unions are insured by the National Credit Union Administration (NCUA), offering comparable protection for members' deposits.

What this means is if you have less than $250,000 in your account at an FDIC-insured U.S. bank, you don't need to live in a constant state of panic. Your money should be safe in the bank. But here's the thing: Many digital banks and fintech platforms are technically FDIC-insured. So how come consumers are getting locked out of their accounts?

Is your money really safe in a digital bank?

While the SVB and Signature Bank failures were significant, they were handled relatively smoothly by regulators. However, the recent collapse of Synapse (a fintech infrastructure provider) has revealed new vulnerabilities in the digital banking ecosystem. This event highlighted a crucial difference between traditional bank failures and the collapse of fintech intermediaries. In traditional bank failures, the FDIC steps in to protect depositors; with fintech intermediaries, the situation is more complex, as the linked banks haven't failed, leaving regulators with limited options to assist affected users.

The fintech promise vs. reality

Many consumers believed that their money in fintech platforms was "as safe as money in the bank." However, this assumption has proven to be oversimplified. While FDIC insurance does apply to many fintech-linked accounts, it's important to understand its limitations. FDIC insurance is designed to make depositors of a failed bank whole, not to address issues with third-party platforms. So, if a non-bank fintech company implodes (like Synapse), the path to recovering funds becomes much more complicated.

Here are key points for consumers to consider:

1. If a bank fails and the fintech platform has good records, customers should be able to collect their insured deposits relatively quickly.

2. If a non-bank fintech company fails, particularly one with deficient records, the recovery process can be much more challenging and uncertain.

3. Unfortunately, it's difficult for consumers to assess how responsibly individual fintechs have set up accounts promising FDIC insurance. Trusting fintech introduces a significant amount of risk.

Tips for protecting your cash savings

While digital banks and fintech platforms offer many advantages, consumers should take steps to protect their funds:

1. Verify FDIC insurance: Always make sure your funds are FDIC-insured. This protects you up to $250,000 per depositor, per bank, in case the institution fails. Here's the FDIC's bank suite for a list of FDIC-insured banking institutions.

2. Understand where you're putting your money: Research how the institution makes money. Be cautious of platforms offering unusually high returns without a clear explanation of how they generate those returns.

3. Read the fine print: Pay attention to fees, account minimums, and any restrictions on withdrawals or transfers.

4. Diversify your funds: Don't keep all your money in one place. Spread your savings across different types of accounts and institutions to minimize risk.

5. Monitor your accounts: Regularly check your accounts for any unauthorized transactions or changes in terms and conditions.

6. Be wary of high-yield promises: If an offer seems too good to be true, it probably is. Be especially cautious of platforms promising significantly higher returns than the market average.

7. Check regulatory compliance: Ensure the institution is properly licensed and regulated. In the U.S., you can check with the FDIC, SEC, or state banking regulators.

While digital banks claim to keep your money safe, it's crucial to understand the nuances of how that safety is ensured. The bottom line is that for now, individual consumers simply can't trust fintech safety the same way you can a traditional bank-assuming you even trust banks in the first place.