The risk of bank failure is often underestimated and can lead to Black Swan events - unpredictable, yet more frequent than we think. The consequences can be catastrophic for companies that have not diversified their bank deposits.
Therefore, diversification of bank deposits is an important strategy to protect against the unpredictable consequences of a financial crisis. The more banks one opens, the more complex the management of individual bank deposits becomes. This can lead to impaired financial processes and make it difficult to have a clear overview of liquidity. Multibanking solutions with holistic software functionalities, such as Friday Finance, allow companies to keep track of all bank accounts and efficiently manage all financial activities - all from one place.
The risk of bank failures is often underestimated
According to a study by the Federal Deposit Insurance Corporation (FDIC), a total of 556 banks were closed in the United States between 2000 and 2018. Most of these banks were small and medium-sized institutions, but larger banks were also affected. These include Silicon Valley Bank, Signature Bank, and Silvergate, which had to be rescued by the FDIC last week.
The causes of these bank failures were diverse, including a concentration of securities that lost value under the higher interest rate in 2023, as well as weak stress tests by bank regulators. In every financial crisis, banks must expect to sell part of their portfolios at a loss to strengthen their liquid funds.
Bank runs are not just a problem in the United States. In recent years, the European Central Bank (ECB) has rescued or liquidated several banks in Europe. One example is the Italian bank Monte dei Paschi, which had to be rescued by the state in 2017.
When a bank goes bankrupt, there are two options: restructuring or liquidation.
On the one hand, the bank will try to restructure. In this case, the illiquid bank borrows money from other solvent banks to pay its depositors. The alternative is to sell the bank, including all of its deposits, to another bank. If this is not possible, the bank will be liquidated. This usually happens at the last minute and requires the illiquid bank to be rescued by the banking regulator. In this case, deposits in Germany are often only paid out up to the deposit insurance limit of €100,000 per bank - anything above this limit will not be paid out unless it has been insured elsewhere.
Diversification is key
By distributing cash assets across multiple banks, a company can minimize the risk in case one bank experiences difficulties or collapses. Additionally, the payout from deposit insurance increases for each newly opened bank account.
Overall, diversifying cash deposits is crucial for small and medium-sized enterprises to protect their financial well-being. It is also an important defense mechanism against other potential crises such as inflation, currency fluctuations, and cyber attacks. During inflationary times, the real interest rate on deposits is not guaranteed. Banks have individual investment strategies that are not always protected from inflation (e.g. bonds without inflation protection or stocks). By diversifying, the risk of inflation-related losses can be spread across multiple banks.
A total failure of a bank can lead to significant operational difficulties for a company, including the failure to pay employee salaries and supplier invoices – in an emergency, this could be a reason for technical insolvency due to a lack of bank management. With diversified banks, companies remain operationally flexible.
Statistics show that diversifying cash deposits can play a crucial role for SMEs. According to a 2016 Barclays survey, 61% of surveyed SMEs diversified their deposits across multiple banks. Additionally, SMEs that diversified their deposits tended to receive better interest rates than those who deposited their money with a single bank. The report also found that companies have higher satisfaction with their banking service.
Multibanking as a control instrument for diversified deposits
Once cash deposits are diversified among banks and counterparty risk is minimized, it is essential to keep track of all bank accounts and transactions.
In this context, multibanking solutions such as those offered by Friday Finance can help effectively manage the information and data of all bank accounts in a consolidated overview. Instead of going through separate logins and authentications, multibanking solutions offer the ability to connect bank accounts, as well as payment processors such as PayPal and Stripe, through an interface and synchronize the data on one platform, providing full visibility of liquidity at all times.
Multibanking solutions can also automate a wide range of financial processes, such as liquidity control and accounting preparation. Furthermore, additional business accounts can be opened digitally, allowing companies to manage their expenses with virtual cards together with the bank overview in one place. Solutions like Friday Finance act as a control center for all financial activities.