In times of financial turmoil, it is crucial to know what financial products/instruments you are holding and whether they will be protected from bank failure. Over the last decade, the products and services offered by banks and brokerage firms have become more similar, but there are important differences in the regulatory and insurance protection offered for different products. This article will explain the similarities and differences between the two bodies that provide this protection: the Federal Deposit Insurance Corporation (FDIC) and the Securities Investor Protection Corporation (SIPC). Will one of these bodies step in and repay your losses if your bank fails? Read on to find out.

Bank Accounts and the FDIC

To get a sense of what’s protected by the FDIC, let’s think for a moment about the primary functional difference between banks and brokers. The function of banks is to take deposits and use those deposits to make loans. Through the reserve mechanism of the Federal Reserve. banks can actually lend far more than the deposits they take in (also known as the multiplier effect ). Deposits are held in the form of cash. Of course, one can also purchase a certificate of deposit (CD), but this is essentially a loan by the purchaser of the CD to the bank issuing the CD.

The Federal Deposit Insurance Corporation (FDIC) insures deposits (cash and CDs) up to $250,000 (principal and interest) for each account holder in a federally insured institution. (For IRAs. the insured amount may be $250,000.) These amounts cover shortfalls in each account in each separate bank. For example, if Mrs. Jones has an individual account at XYZ bank as well as a joint account with her husband, both accounts would be covered separately. Furthermore, if she has an FDIC-insured CD with yet another bank, that CD will also be covered separately.

The FDIC is an independent agency of the U.S. government, but its funds come entirely from insurance premiums paid by member firms and the earnings on those funds. However, the FDIC is backed by the full faith and credit of the U.S. government. Since its creation in 1934, there has never been a loss of insured funds to a depositor of a failed institution. (For more information, go to FDIC.gov or check out Are Your Bank Deposits Insured? )

Brokerage Accounts and the SIPC

While banks deal mostly with deposits and loans, brokers function in the securities markets, primarily as intermediaries. (Brokerage firms also wear other hats, but we will limit this discussion to their most simplistic function within the securities markets.) Their primary purpose is to buy, sell and hold securities for their clients. In this function, they are heavily regulated by the Securities and Exchange Commission (SEC) and the various securities markets in which they operate. Some of the most important regulations relate to net capital requirements. the segregation and custody of customer assets and record keeping for client accounts.

The Securities Investor Protection Corporation (SIPC) was created by Congress in 1970, and unlike the FDIC, it is neither an agency nor a regulatory body. Instead, it is funded by its members and its primary purpose is to return assets, which are usually securities, in the case of the failure of a brokerage firm.

Most stocks, for example, are not actually held in physical form at a brokerage firm. They are held by SEC-approved depositories or trust companies. Most commonly, they are held in electronic form by the Depository Trust Company (DTC). The purchase and sale of Treasury bonds. for example, is entirely electronic and ownership records are actually held at the Treasury. The old days of issuing physical certificates for bonds and/or stocks to individuals are rapidly coming to an end because it’s easier and safer to hold these securities in electronic form. It also facilitates the settlement of trades among brokerage firms when securities are bought and sold. (To find out more about physical certificates, read Old Stock Certificates: Lost Treasure Or Wallpaper? )

The SIPC covers shortfalls in customer accounts up to $500,000, including $100,000 in cash. This coverage kicks in only when customer securities are missing when the brokerage firm fails. In addition, most large brokerage firms maintain supplemental insurance for much more than the $500,000 insured by the SIPC. The excess coverage maintained by each brokerage firm is different, so it is worth asking about when opening a new account. (To learn more, read Are My Investments Insured Against Loss? )

Caveats to SIPC Insurance

There are certain things the SIPC does not cover. Unlike the FDIC, it is not blanket coverage. Some of the things not covered include:

• Commodities and futures contracts. as well as options on these
• Foreign-exchange contracts
• Insurance policies
• Mutual funds held outside the brokerage (these are the responsibility of the mutual fund sponsor )
• Investment contracts not registered with the SEC (private equity investments, for example, which are the responsibility of the general partner of that fund)

Although technically the SIPC does not protect against fraud, most large brokerage firms carry stockbrokers’ blanket bonds that do. (Single, limited instances are usually covered in the ordinary course of business without reliance on the bond.)

SIPC insurance becomes complicated in instances where a failed broker is the counterparty to a number of uncompleted trades to a solvent broker, or in cases where the failed broker did not maintain adequate records. In these situations, the actual settlement of claims can be delayed as the correct information is obtained. (For more on how to resolve a problem without getting the lawyers involved, see Broker Gone Bad? What To Do If You Have A Complaint .)

Similarities Between Bank and Brokerage Accounts