You’ve no doubt heard about last week’s meltdown of Silicon Valley Bank which, despite not being a household name, is one of the largest banks in the country and serves a substantial number of business clients, particularly those connected to VC. The bank’s collapse is already yielding widespread repercussions across the economy, including fear of bank runs throughout the world. Many are now calling for a bank bailout (even if they don’t like to use that term anymore, that’s what it is), meaning taxpayers would end up covering the losses for bank leadership’s failures. Some have even floated the idea of unlimited FDIC insurance, i.e., legislating unlimited future bank bailouts!
Problems with Fractional Reserve Banking
We aren’t going to get deep into the intricacies of banking economics, but there is something you need to understand about how this all works because it definitely affects your business whether you realize it or not. Most modern banks operate on what’s called a Fractional Reserve Banking model, where pursuant to their governing central bank’s requirements, they only retain a fraction (usually around 10%) of depositor money, under the theory that no more than that amount is likely to be withdrawn at any given time. What happens to the other 90%? It gets lent out, usually to businesses, but also sometimes for personal loans like mortgages. Of course, those borrowers often wind up depositing the borrowed money back into their own bank accounts, where it gets fractionalized and lent out again. This cycle keeps repeating.
You recognize the problem with the Fractional Reserve model: starting with the original deposit, there are now multiple claims to the same money. While there’s a lot more detail and nuance that happens within monetary policy, this is basically the mechanic through which central banks expand the money & credit supply (also knowing as lowering interest rates, increasing inflation, or in more recent years, ‘quantitative easing’). It’s also the primary reason why the economy goes through boom-bust cycles of apparent prosperity from the artificial credit expansion followed by an inevitable implosion when it becomes evident that the amount of money circulating does not reflect the value of production actually happening in the economy. If you want to study this in more detail, check out The Mystery of Banking by Murray Rothbard.
When a critical mass of depositors start fearing that their bank won’t be able to honor its deposit commitments and rush to get their money out all at once — creating a snowball effect on withdrawals — this is known as a Bank Run. If it gets bad enough, the bank might hit an inflection point where it can’t honor withdrawals and enters a death spiral towards insolvency and eventually outright failure. In some cases, banks may freeze depositor assets and prohibit withdrawals in an attempt to stabilize (these are called Capital Controls and pose a whole other type of threat to your business’ assets). FDIC insurance and its various international counterparts are intended to cover depositors in the event of a bank failure, but they have payout limits. So what you’re probably wondering is, “What can I do to protect my business from a banking crisis? How can I be sure my business’ money is safe?”
What Can You Do to Protect Your Business’ Cash?
If you’re a very small business in the U.S. and hold roughly around the FDIC-insured $250,000 USD or less in cash, then you’re probably at least relatively safe with your current bank; maybe not from potential capital controls, but at least from outright bank failure. If your business’ cash assets are in the low to middle tens of millions, then you could split it across multiple banks, each of which would offer a separate $250,000 block of FDIC insurance. You can do this as a large corporation too, but for obvious reasons the more cash you’re managing, the more cumbersome opening and maintaining all these accounts will be.
Note that the FDIC insurance cap is per client, per bank, per account type, meaning that opening multiple accounts for your business at the same bank won’t get you any additional insurance; you will need to open accounts at different banks. You could also open a brokerage account (or accounts at multiple brokerages) and hold some cash-equivalent securities; brokerage accounts are covered by SIPC insurance, which is similar to the FDIC except the SIPC will cover securities up to $500,000 in the event of a brokerage failure.
What about ‘being your own bank’ with cryptocurrency? Believe me, few people want that to be a realistic option more than I do, but as of 2023 it’s nowhere near being viable. Setting aside the extraordinary asset management challenges here for businesses users, Silicon Valley Bank’s meltdown hammered the cryptocurrency markets. The gold standard of stablecoins, Circle’s U.S. Dollar Coin (USDC), held a substantial portion of its collateral at Silicon Valley Bank. The SVB collapse and market response, along with the recent collapse of FTX, demonstrate that cryptocurrency is not even close to being a developed alternative to traditional banking; it’s still deeply, fundamentally linked to the legacy banking sector. Maybe that will change in the future, and I hope it does, but it isn’t the case today.
But let’s say your business has a lot of cash, maybe multiple tens of millions or more, and dividing it up into a bunch of different banks under the insured limit isn’t realistic or desirable. Or maybe you don’t have that much cash but you just don’t trust the deposit insurance mechanism itself, or you are concerned about capital controls impeding your ability to access your funds. What then?
Your best bet is to start using safe, well-capitalized offshore banks to store the bulk of your business’ cash. The fact is, if you want to access the world’s safest banks, you’re probably going to need to look outside your home country (especially if you’re in the United States). You can always keep what you need for upcoming working capital or major expenditures in your domestic bank. While this sounds scary to many people, it is actually a normal thing to do, doesn’t have to be particularly complicated, and is perfectly legal in most jurisdictions provided you go about it the right way.
Unfortunately, many banks located outside of the United States will not even work with U.S. citizens or companies due to the compliance requirements imposed by U.S. regulators, but there are still plenty that will. Many will still even open an account remotely without you ever even needing to travel to a branch. Having said that, there’s a few very important things of which you need to be aware if you go this route:
Things to Know Before You Bank Offshore
First, just because a bank is offshore doesn’t make it safe. For example, many banks outside the U.S. are not at all safe, and you’d be much safer even with a mainstream U.S. bank. So if you do this, you need to find a bank that is highly-capitalized (look for a high proportion of what bankers call Tier I capital), has low debt, and doesn’t engage in much (or ideally any) risky lending or investing activities such as derivatives trading or subprime loans. Preferably it also practices 100% reserve banking, meaning they actually keep your full deposit and don’t lend out your money at all, though it’s becoming hard to find banks that do this.
Also, know that the reason many modern banks are able to offer you ‘free’ accounts is because of the precarious lending and investing practices they take with your funds, so expect to pay a service fee in exchange for holding accounts at more conservative, safe banks. In addition, you should know that many offshore banks don’t carry any deposit insurance from their home government, but that likely won’t be a problem if the other safety criteria are met. Well-capitalized, conservative, high reserve banks in jurisdictions with no deposit insurance typically know that their reputation is everything and no bailout is coming. As a result, they tend to be much safer than many deposit-insured banks. Nevertheless, there is no such thing as 100% bank safety, so you should still exercise caution and potentially diversify even among offshore banks.
Second, there are compliance issues you need to address. For example, if you’re a U.S. citizen (and that includes a U.S. company, or a company with U.S. citizen control persons or major shareholders), then opening any offshore financial account introduces new compliance requirements like the Foreign Account Tax Compliance Act (FATCA) and Foreign Bank and Financial Accounts (FBAR) reporting. The fines for messing up these reports can be steep, so ensure that you work with a CPA or tax advisor who understands the requirements in your home country and will make sure your forms get filed correctly and on time.
But don’t let that scare you away; the process is actually pretty well-developed and straight-forward, so as long as you find an accountant who regularly works with these types of reports for clients in your home country, it should be both simple and affordable. It’s also perfectly fine to hire a specialist accountant who only handles your foreign reporting requirements and then provides the relevant information to your primary, domestic accountant to synthesize into your overall taxes. In short, if your business’ cash assets are large enough for you to be concerned about bank safety in your home country, then a few thousand dollars a year in extra accounting and bank service fees is obviously a common sense ROI.
Notice I’m not recommending any specific banks in this article. In addition to your unique business requirements, this topic is highly-specialized and there are others who are much more knowledgeable on the details and changing landscape than me. It’s recommended that you consult with an offshore banking expert to help you choose a bank that will work for your business’ specific needs. As a starting point, you can check out this resource from Simon Black.
Contrary to popular belief, the banking sector in many industrialized countries is not very stable. As a leader, don’t let your company get caught in a bank liquidity crisis. If your business has large amounts of cash assets, moving most of them into safer, conservative, well-capitalized banks is just good business sense, even if those banks are outside your home country.