We recently addressed the FDIC insurance limits on various types of bank accounts. Not all accounts with banks are FDIC insured. Many don't need it - that is, some assets are effectively owned by the client so they are not impacted by a failure of the institution itself.
The American Bankers Association has issued a memo that addresses deposit accounts, fiduciary accounts, and custody accounts, and the general operation of such accounts in the event of a financial institution failure. The memorandum provides:
Assets held in deposit accounts become liabilities of the bank. As such, deposits create a debtor-creditor relationship between the bank and the depositor. In exchange for the money deposited, a liability of the bank is created which is the bank’s contractual promise to repay the amount on deposit plus, where applicable, interest. Deposit accounts are insured by the Federal Deposit Insurance Corporation (FDIC) up to $100,000 per individual per bank.
Assets held in trust and fiduciary accounts do not become assets or liabilities of the bank and are, indeed, segregated from the bank’s assets. The bank acts as trustee or fiduciary to the account and, in this connection, provides investment management, investment advice and other services to the account. Account ownership remains vested in the individuals or entities for whose benefit the bank is acting as trustee or fiduciary and the assets are not subject to the claims of creditors.
Assets held in custodial accounts in the trust department of a bank do not become assets or liabilities of the bank and are segregated from the bank’s assets. The bank’s role as custodian is to hold the assets for safekeeping, to collect dividends and interest and provide other similar services. Account ownership in the assets remains vested in the individuals or entities for whose benefit the bank is acting as custodian and the assets are not subject to the
claims of creditors.
What happens if a bank fails?
Since deposit accounts become liabilities of the bank, it follows that the depositor would become a creditor in the event a bank failed. However, the FDIC insures depositors for up to $100,000 per individual per bank.
Since assets held in trust, fiduciary and custodial accounts do not become assets or liabilities of the bank (title is held by the account’s owner(s)), it follows that none of this property is subject to the claims of the bank’s creditors. As a result, a failure of a bank will have no adverse effect on trust, fiduciary or custodial accounts: they remain the property of the account’s owner(s).
In the event that a bank with trust, fiduciary or custodial powers fails, the FDIC will seek to transfer responsibility for administration of the accounts to a successor trust institution as quickly as possible. Provided this effort is successful, the account beneficiaries would need to either accept this new arrangement or make provisions with the successor bank for alternative arrangements. Should the search for a successor trustee to the failed bank be unsuccessful, the FDIC will then promptly notify all affected beneficiaries to either personally reclaim their property or designate an alternate institution to which the trust, fiduciary or custodial property may be conveyed.
Therefore, the safety of trust, fiduciary and custodial assets is not dependent upon whether the bank has assets greater than its liabilities. Property held in these accounts belongs to the owner(s) of the accounts and would be unaffected by a bank failure.
One area of failure that has not been widely explored is what happens to securities in a brokerage account held in street name, if the brokerage house goes under. As many readers are already aware, securities held in a brokerage account these days is typically held in "street name," and not registered with the issuer in the name of the client. There are some questions as to who is the legal owner of such securities (the client or the brokerage house) and whether the client will always receive back all of such securities.
Thanks to Tim Peters at Key Private Bank in North Palm Beach, Florida for providing the materials which this post was based upon.