Depositors have different banking needs, but there is one thing they all share – the need for assurance that their deposits are safely protected.

“There are few things more important to our clients than knowing that their bank deposits are secure,” said Peter Lantero, Head of Banking and Treasury Services at Northern Trust. “They want to know that their bank is financially strong, has a solid balance sheet and also has exceptional controls.”

Yet today, it may not always be clear how to make those assessments. Recent U.S. bank failures such as the collapse of Silicon Valley Bank (SVB) and Signature Bank have drawn attention to potential gaps within the industry, with depositors looking to understand how their banking partners can best protect their assets.

“Depositors are seeking additional insights into their banking partner’s balance sheet, and they want to know what their partners are doing beyond what regulators require,” said Lantero. “Recent events have reminded them that these standards may not be enough to safeguard their deposits. To gain a level of assurance about their bank’s soundness, there are certain due diligence practices that investors can follow.”

Best Practices for Sound Due Diligence

Depositors can review a bank’s credit ratings provided by agencies such as S&P, Moody’s Investor’s Services and Fitch Ratings, which grade banks and other financial institutions according to their quality, reliability, and risk of default on obligations¹, along with the FDIC’s ratings, to best understand a bank’s financial soundness. The FDIC assigns a rating based on capital adequacy, asset quality, management, earnings, and liquidity, amongst other factors. Banks that earn a rating of one or two are viewed as satisfactory or better².

The Federal Reserve’s Enhanced Prudential Standards for large banking institutions were released in 2018 to categorize banking institutions. Categories I and II, the top categories, are identified as either US global systemically important banks (“G-SIBs”) or organizations that are not classified as US G-SIBs but have a level of standards like Category I institutions. Organizations that fit in these categories are subject to the highest level of capital and liquidity requirements, offering a measure of assurance as to their safety and soundness³.

Assessing Balance Sheet Strength and Metrics

Understanding the strength and size of a bank’s balance sheet is essential to assessing risk, according to Lantero. “Measures such as the composition and size of the balance sheet, what is considered on balance sheet versus off balance sheet, as well as if the bank actively manages their duration, liquidity ratios, and credit risk are all important considerations.”

Liquidity risk management is the backbone of a bank’s business and ultimately ensures that a bank is “liquid” enough to meet the demands of its clients, which may come in the form of deposits, or, in the case of SVB, withdrawals. However, these risks are moving targets, subject to market changes caused by a variety of economic stressors. 

Banks that actively manage their duration risk will be equipped with stronger balance sheet protection than those that do not. Potential depositors should analyze the metrics and KPIs used by a bank to determine its liquidity exposure to best predict how a bank’s balance sheet may be impacted by industry-wide shifts.

Strong Resolution and Resiliency Plans

Unfortunately, market volatility and extreme tail events are unavoidable in the financial services industry, and banks that have lasted the test of time will likely have greater experience with different kinds of windfalls. To protect against these windfalls, the Federal Reserve Board requires large banking organizations to submit resolution plans that “describe the company’s strategy for a rapid and orderly resolution in the event of material financial distress or failure of the company⁴”. 

That said, it’s important for depositors to evaluate whether a prospective bank has thorough resiliency plans in place to understand how it may perform under the pressure of extreme tail events. To feel more comfortable that their deposits are protected from a future of market uncertainty, they can review a bank’s historical actions to gauge how it reacts in times of crisis.

Reviewing System of Controls

Controls are paramount to understanding how a bank manages its balance sheet, whether that be how it manages cash or the process of new client onboarding, and having tight controls in place can make a significant difference – often, well-run controls will manifest into a highly efficient process.

Anti-money laundering policies are the starting point for controls, and banks are legally required to build this into their compliance programs, starting with the first step: Know Your Customer (KYC) checks.

These checks involve banks identifying their customers and confirming their identity through a variety of facets. When it comes to the banking industry, there is perhaps no bigger differentiator than those that make the new account opening process seamless versus those that do not. Hence, banks must walk a fine line of performing adequate checks while maintaining a high level of efficiency for clients, and depositors should ask the right questions of their provider to ensure all requirements are being met.

Asking the Right Questions

Beyond understanding the best practices of choosing the right banking partner, it’s important to consider the specific questions that depositors should be asking their potential providers.

• What are the overall credit ratings of the provider? 
• What is the size of the bank (Category I or II)? 
• What are the liquidity options they offer across money markets, currency, foreign exchange, etc.? 
• How are those options different than a basic banking deposit, and how do I feel best protected? 
• Where can cash be held and what are the percentages?
• What are the bank’s requirements for liquidity and capital, and is the bank meeting or exceeding these requirements? 
• What percent of the bank’s balance sheet is highly liquid and high-quality? 
• How does the bank manage their duration risks between their loans and deposits? 
• What are the bank’s best practices for insulating cash? i.e., Different vehicles, holistic decision about your portfolio.

In the aftermath of recent failures in the banking industry, banks are facing a new level of scrutiny, at both the individual and institutional level. Depositors are increasingly seeking banking partners that are financially strong from both a credit and risk perspective, with exceptional controls in place.

According to Lantero, “in this fast-changing environment, it is important to ask: how do I know my bank deposits are sound and secure? A thorough due diligence process can help you find the right banking partner to safeguard your assets.” 

¹https://www.thebalancemoney.com/what-is-a-bank-credit-rating-4586357
² FDIC: Composite Ratings Definition List 3 Federal Reserve Board finalizes tailoring prudential standards for large banking institutions (deloitte.com)
³ Federal Reserve Board finalizes tailoring prudential standards for large banking institutions (deloitte.com)
⁴ Federal Reserve Board - Living Wills (or Resolution Plans)