Sweep up my money, there is a bank run: Sweep networks for banks and fintech

FinTech and banks typically have a lot more money in their bank accounts than the $250,000 insurance limit set by the FDIC. This puts them in a bit of a pickle. That pickle can sometimes be the size of the SVB debacle. 

As the dust settles on Silicon Valley Bank’s 48 hour downfall, many fintechs are crawling out of the woodwork offering solutions that can help companies avoid losing their funds to an unforeseen bank run. 

One popular solution is sweep networks. The solution is the single point of failure issue that occurred with SVB and allows companies to split their deposits across a network of partner banks. 

For example, if a company has $1 million dollars, it can divide its deposits to four partner banks, with each split being equal to the FDIC insured limit of $250,000. This insures 100% of the money whereas depositing it all in one bank would have only gotten 25% insurance coverage. However, this doesn't mean that the company then has to liaison with 4 different institutions. Instead it can depend on the sweep network chosen to handle the banking relationships in the background.  

Who's who of sweep networks:

IntraFI is a popular sweep network, with a network of 3000 banks across the country, where companies can store their money in demand deposit accounts, money market deposit accounts, or CDs. Similar options for companies and banks alike to get more of their deposits insured: 

• Mercury: Mercury is a next generation neobank that competes with SVB for venture-backed startups’ banking business. It works with two partner banks, Evolve Bank & Trust and Choice Financial Group. At the moment its network can offer up to a $5 million FDIC insured deposit limit. Their bank partner network includes Goldman Sachs and Capital One, with 12 banks in total. Mercury clients can omit a particular bank(s) when it comes to their deposits, but this may impact the total amount of insurance that is available to them. 
• Wintrust’s MaxSafe: Similarly with a network of 15 community banks, MaxSafe allows  FDIC insurance of up to $3.75 million.
• Depositors Insurance Fund: This network can help banks protect deposits beyond the FDIC insurance limit.  Note that the DIF is not a government owned organization but an industry sponsored insurance company. In the 1990s, it paid out more than $50 million to protect more than 6,500 depositors in 19 failed member banks. 
• StoneCastle: For banks in its FICA network, the company offers up to $25 million in FDIC insurance.
• Rho: With its Treasury Management Account, the commercial startup offers up to $75 million in FDIC deposit insurance. This product is built on a network of 400 banks, where money can reside insured and earn interest at the same time. 

The rub:

The catch? Redundancies cannot help with system-wide failure. So if there is a widespread crisis (think 2007-2008), there is very little chance these distributed risk strategies will help.

Sweep networks allow companies to build redundancy into their deposits, which negates any chance of a single point of failure like SVB. Rather than managing bank accounts and relationships with 14 banks themselves, businesses can offload this responsibility to the companies mentioned above. Which is great.

Omid Malekan, an adjunct professor at Columbia Business School, has a slightly different take on what the recent SVB downfall and its consequent bail out from the government means. “The depositors at SVB and SBNY who were above the FDIC limit should have suffered impairment. But did not, sending a powerful message to the market. If the government backtracks on this now it would erode credibility,” he told Tearsheet. He believes this shows that the government is unwilling to let depositors lose any money.

This doesn’t mean that everyone is now safely out of the woods. Malekan wonders whether introducing more counterparties into the system would introduce greater risk. What if they are fraudulent or make a mistake in routing money? And what if they go out of business?

Understand the fineprint:

Moreover, companies should note that providers of sweep networks like Mercury retain the right to move their funds. This may be done in a manner that helps make the provider more money.

Consider the following two statements from Mercury’s disclosure statement about its network with Evolve Bank & Trust:

• You understand and agree that Evolve, as your agent, may place any or all of your funds on deposit with Evolve at one or more Program Banks in an amount determined in Evolve’s sole discretion based on available capacity at the Program Bank or other criteria, including rates paid on deposits by the Program Bank or fees paid to Evolve.

• You understand and agree that Evolve has no obligation to place funds into Program Banks to maximize the amount of deposit insurance available on your funds or to maximize the interest rates that your funds may earn. Evolve may place your funds without regard to whether such funds may exceed the Deposit Limit at one or more Program Banks, even if your funds could be placed in one or more Program Banks in an amount less than the Deposit Limit.

Companies need to tread carefully when it comes to using sweep networks to insure their accounts. It is prudent not to place all your eggs in one basket. However it is also important to read the fine print very carefully.