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99.9% of the time banks are the most boring possible places in the world. If you work at a bank, maybe that’s not true. There are probably some exciting jobs. But to think, in ordinary times, about what your money is doing in a bank is to think about watching paint dry.
Lately we’ve been having that other .01% experience. Last week, Silicon Valley Bank in the US failed. Followed by the forced closure of another American institution, Signature Bank. Even in Canada, where no banks have failed (or been rumoured to), it felt harrowing. Worse still, it turned out a lot of clients at SVB, as it’s known, held more than US$250,000 — the maximum insured by the government. Which meant a lot of funds were uninsured. Which meant that the federal agency that is responsible for paying people back in the event that a financial institution goes under was not obligated to make sure all those clients got all their money back. (This past weekend the American government announced they have guaranteed all deposits.)
But a lot of Canadians, who have been largely spared the turmoil of the US system, are starting to ask some questions any cognizant person would wonder: how safe is my money, actually? How safe are banks? How does deposit insurance even work? And wait a minute, what about all my investments – stocks, bonds, money market accounts? What would happen if the financial companies I rely on went full SVB?
To alleviate some of those fears – and help you understand something we all should probably know anyway – we’re going back to some very basic concepts everyone should know but few think to ask about: how banks and financial companies work, where your money actually is, and how safe it is.
What’s a bank deposit?
Let’s start with: what’s a bank? A bank isn’t any place you put money. A bank is an institution that has a licence that allows it to carry out certain business activities, like accepting chequing and savings deposits and making loans. Wealthsimple, for instance, is not a bank. We don’t, for instance, print cheques.
When you put money into your savings or chequing account, that’s a bank deposit. But it’s essential to look at that dynamic from the banks’ perspective. A bank is essentially borrowing your money. In exchange for that privilege, the bank will pay you interest and provide you with services.
When my money is in a bank, where is it actually?
Regulators in Canada stipulate that all banks keep a portion of their deposits in readily available cash. The rest they use to make more money. How do banks use your money to make money? In several ways. One is by loaning it to other people for mortgages and being paid a relatively high rate of interest in return. Another is investing in securities like longer-term treasury bonds that earn interest.
What happens if I want my money back?
The reason chequing and savings accounts are great isn’t the interest you earn. The interest rates on those accounts are typically terrible. The advantage is that you can get that money whenever you want it. (And you can also write cheques and pay for things without carrying around buckets of cash.)
As long as not everyone tries to get their money out at the same time, it all works out. But remember – not all the money on a bank’s balance sheet is actually at the bank. So in the event that customers suddenly try to withdraw more money than the bank has on hand, there can be problems. That’s called a bank run and it can result in a bank going belly-up (the financial term for that is: insolvency).
What happens if my bank goes under?
First of all, it’s extremely unlikely that a Canadian bank would become insolvent. They’re closely regulated to make sure they have enough money on hand and that their balance sheets are healthy. But in the event that it happened, the Canadian created the Canada Deposit Insurance Corporation (CDIC) to provide insurance. Canadian bank accounts are generally eligible for insurance up to $100,000 at each member institution for each category.
Since Wealthsimple is not a bank, we don’t lend your money out for mortgages. Although Wealthsimple is not a bank, we are regulated by several oversight authorities such as the Canadian Investment Regulatory Organization (CIRO) and have robust risk management practices to safeguard our clients’ money. And in order to provide CDIC insurance, we keep deposits in partner banks that are CDIC-insured, so they are protected if the partner bank becomes insolvent. Wealthsimple acts as a deposit broker and holds clients’ cash in trust at CDIC member institutions.
To better understand how CDIC coverage works, please visit the CDIC website here.
Investments (stocks, bonds, etc.)
First, some general context: stocks and bonds and other similar assets are held in trust for investors. If a financial institution goes under, it doesn’t matter – those assets are still yours.
Also, investments like stocks and bonds and money market funds are protected by the Canadian Investor Protection Fund (CIPF), which covers cash and securities up to $1 million CAD per account type. It’s important to understand that the CIPF provides protection against financial companies that hold your assets going bankrupt, not against the value of what you buy going down. If you buy a stock and it goes down ten percent, sadly, the government is not responsible. If you want to know more about exceptions and details, the CIPF’s coverage policy is a good place to start.
When I use a trading platform or an investment company to buy stocks and bonds, where does my money go?
It works like any purchase. You have the money, and another party has the thing you want to buy. In this case your money goes to the party who has the stock or bond you want, and you get shares of the stock or a bond. You no longer have the money, you have the asset. All of the stock, bond and money movement is done through CDS or DTC, explained below.
Where are the actual stocks and bonds held?
Stocks and bonds are held in one of two ways: directly in your name at the transfer agent – a company that keeps track of registered shareholders for a publicly-traded corporation. In the old days this was done using paper certificates, but today it’s mostly electronic. Or, the second and more common way, in trust for you at a depository company. Take a Canadian stock you buy and hold through Wealthsimple for example: that stock is held by a depository company called CDS (Canadian Depository for Securities) in the name of Wealthsimple Investments Inc., in trust for (or ITF as it’s known) client Jane Doe. That means you have ownership of the asset and not us. CDS is the depository service for all Canadian stocks and bonds. DTCC does the same thing for U.S. stocks and bonds.
What happens if the trading platform or investment company that I used to buy my stocks and bonds goes under?
Generally speaking, stocks and bonds are not in jeopardy from things like bank runs or banking industry instability. Why? Well, as we described above, the financial company you use doesn’t actually own those assets— they’re held in trust for you. Even if one of those companies that holds assets goes bankrupt, those assets are still yours. Their creditors have no claim to them.
Same thing if the company you bought your stocks and bonds through were to become insolvent. For example, say you bought your securities through Wealthsimple Trade or held them in a Managed Investing account, and Wealthsimple went out of business. Your assets would still be held in your name at CDS. They would still belong to you.
Money market funds, high interest savings portfolios and other high interest ETFs
What are these things?
ETFs are bundles of securities you can buy and sell in markets. And they’re subject to the same set of rules we just discussed with stocks and bonds, above.
High-interest ETFs are essentially money that is held as bank deposits at large Canadian banks, and typically earns a much better rate than most savings accounts. The Wealthsimple High Interest Savings Portfolio invests clients’ money in these ETFs.
Money market funds are funds that earn yield by, essentially, making high-quality loans to the government and large companies through things like bonds, something known as commercial paper, etc.
When my money is in a money market fund or the Wealthsimple High Interest Savings Portfolio, where is it actually?
As with stocks and bonds, your money is held at a third-party custodian, just like the stocks and bonds we discussed above.
What happens if I want my money right away?
Getting your cash is just about as easy, and almost as quick, as getting it out of a savings or chequing account. With a money market fund or high-interest ETF, typically you can sell your shares and the transaction will settle by the next day (selling a stock takes two days to settle). So with something like the Wealthsimple HISP, you can get your cash in a day or two.
What happens if the investment company I used to buy my money market fund goes under?
These assets are held by custodians, just like stocks and bonds. Even if the custodian or trading platform you use goes bankrupt, your assets will still be yours.
A high interest savings portfolio does not have deposit insurance, which means fund managers tend to spread deposits among lots of banks to make sure the money is safe as well as keep close watch on the health of the banks. But any money in the fund is segregated from the fund manager’s. If the fund manager were to become insolvent, the fund’s assets would not be impacted in any way.
What happens if the money market fund itself goes under?
A money market fund does not borrow money to invest, so it can’t really go bankrupt. If the fund manager determines that the fund needs to close, assets are returned to shareholders.
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