Managing Cash Risk in the Face of Bank Failures
Small business owners nationally are waking up to the idea that the risk of bank closure is real and could have a huge impact on their ability to operate, make payroll and keep their doors open.
Bank failure is an unusual event; so the fact that several banks have been closed by The U.S. Treasury in the past few days should not be a mass call to alarm.
However, there are a few actions that business owners can take to protect the cash assets of their business (and their personal accounts) in the face of disruption.
With any risk there are three possible actions:
Accept the risk: Acknowledge that the risk is real and monitor the situation
Mitigate or eliminate the risk: Lessen the probability that the risk will actually occur or lessen the effect of the risk on your business
Create a contingency plan: Decide in advance what actions you will take if/when the risk becomes real.
For the risk of bank failure in the current environment, I recommend using all three of these responses.
First: Accept that Bank Risk is Real
One week ago, very few people had the possibility of their bank closing as a top concern on their business bingo card. Today it’s on everyone’s mind.
Knowing that several banks are in crisis entrepreneurs can’t help but wonder if our bank and our deposits are at risk.
Here is what you need to know:
The Federal Deposit Insurance Corporation explicitly protects checking and savings deposits up to $250,000 per entity or individual in each bank. (Personal accounts are totaled separately from business accounts).
The Treasury indicated on 3/12/2023 that it would 100% cover all deposits at Silicon Valley Bank and Signature Bank. This means that everyone would have all deposits returned to them by The Treasury even if their total deposits are more than the $250,000 FDIC insurance cap. This is meant to stem the movement of cash out of smaller banks, and reassure anyone with more than $250,000 in a particular bank.
If the worst-case scenario comes true and your bank is closed by regulators, you will lose access to your checking and savings accounts for a number of days. And then have to scramble to open new accounts at another bank.
Actions: breathe deeply and when you are calm move on to mitigation!
Second: Mitigate or eliminate the risk that bank failure will stop your business cold.
As noted above, there are two downstream effects of bank failure on you and your business.
The top issue is whether you would get 100% of your cash back.
The second issue is how long you would lose access to all or some of the funds.
Either could be catastrophic to a business.
The best way to eliminate or mitigate these risks is to structure your cash so that you keep the total amount of funds at any one bank below the $250,000 FDIC Insurance limit. That is the only way to guarantee that you would get access to all of your funds, even if the bank is closed.
If that is not possible, or you want to lower the impact of a potential problem — make sure to have enough funds at a separate banking institution so that you can operate smoothly for several days or weeks in the case of a bank failure.
Note: This is just one more reason why we work with clients to build a reserve fund to cover 3 months of operating expenses as a cash cushion for the business. Yes, this may take time; it is 100% worth the effort!
Here are two ways to move funds and reduce the risk of exposure due to bank failure:
Option One: Move reserve funds to a different bank with a High Yield Savings Account
If you have reserve funds that aren’t needed for day-to-day operations, one of the easiest steps is to move your reserve funds to a different bank. While you are doing this, shop for banks that provide high-yield savings accounts. One of the best things about this approach is you get to directly control where your money is going. You can ensure that your money is at banks that align with the values of your business. Because, the truth is, not all banks are created equal when it comes to how they invest your money!
Click here for more insight on banks and choosing the best one for your small business.
One of my clients shopped to find a high-yield account with an interest rate that comes closest to the interest they are paying on their largest loans. Eventually, they are planning to use these funds for growth. In the meantime, keeping cash in an account that earns as much as the interest of their largest loan essentially means that keeping this capital for eventual growth is cost-neutral.
For recommendations for high-yield accounts that are vetted and continually updated, you can check out the Best Business Savings Accounts from NerdWallet.
Pros & Cons of High Yield Savings as the Solution for Managing Cash Risk
The Pros
You have complete control over where your money goes.
You can shop around for the best interest rates and other services.
The Cons
Managing your money falls completely on your shoulders.
Option 2: Set Up a Cash Sweep Account
An Insured Cash Sweep (ICS) — also commonly referred to as a “sweep account” — is a service provided by your primary bank that moves money from your account over a certain amount to demand deposit accounts or money market deposit accounts at other ICS Network banks. You can set the threshold for sweeps at $250,000 (the FDIC cap) or higher, depending on your cash needs.
Sweep accounts are secure and protected by the FDIC, so you know your money is safe when it is moved from your account.
One of my clients used this option when they had raised a large amount of cash. They moved excess cash through their Sweep Accounts. Their bank, Amalgamated Bank, is a B Corp and agreed to place their cash with banks that fit their values and criteria.
The Pros & Cons of Choosing an ISC as Your Solution:
The Pros
Simple, safe, and straightforward
The Cons
You don’t control what banks your money goes to.
You may or may not get the highest interest rate.
Create a Contingency Plan for managing the cash risk related to banking failure.
Regardless of how you diversify your banking choices, now that you have reserve funds separated from your operating accounts and protected by FDIC insurance you’re ready to create a contingency plan.
A contingency plan clearly articulates the steps you or your team members will take if or when your business loses access to its primary business accounts for any reason. This could be due to a bank failure or closing; or it could be the result of a climate disaster, national emergency or terrorist attack.
Your contingency plan should include:
Who is authorized to access the reserve funds and exactly how they can be used
Any controls or approvals required to access the funds
How to communicate with staff, vendors, investors or others who may be concerned or affected in the event of an emergency
Review and Update your risk plan as needed
The final step in any risk management plan is to make sure that it is up to date.
On a quarterly basis take a few minutes to review the plan and make sure that any of the specifics within the plan are up to date. Update your staff, communications plans, and banking details as these things change. And make sure that the key people on your team that would be expected or required to act know about the plan and how to implement it.
“Never let a good crisis go to waste.”
– Winston Churchill
Once the current crisis is over, the risk that your business could lose access to your bank and savings accounts probably won’t seem like the most pressing issue of the day. So even if your bank seems secure now is the right moment to take steps to lessen this risk and create your contingency plan.
And if you need help navigating your cash management quickly, you can get free help from one of our CFOs by requesting a 30-minute CFO session HERE