Maximizing FDIC Insurance: Cash Sweeps and Partner Banks

FDIC insurance coverage wasn’t on the mind of most founders until SVB collapsed in March 2023 and their deposits were at risk. Had Federal regulators not stepped in, depositors with balances over $250k would’ve lost the excess cash. Since the bank’s collapse, Fintechs have been locked in an arms race to increase their FDIC coverage by partnering with and sweeping their customer deposits across other banks. In addition, FDIC coverage has recently become a focus of several members of Congress, who are pushing for tighter regulations and higher limits. In this post, we break down what cash sweeps are, how they work, why Fintechs are leveraging them, and what the future holds in store—let's dive in!

An overview of the FDIC and the limits of FDIC insurance

The FDIC is a government agency that is responsible for backstopping or insuring deposits if a member institution becomes insolvent. When this occurs, the FDIC insurance kicks in and pays depositors up to the insurance limit. Then the FDIC and other federal regulators take over the institution and begin liquidating its assets to settle its debts, including claims by its depositors for the amount they held with the institution exceeding the claim limit.

The current FDIC insurance limit, as of March 2023 is $250,000 per depositor, per insured bank, for each account ownership category. This means that if one depositor has multiple deposit accounts of the same type at the same bank, e.g. multiple checking or savings accounts, they’re still only insured for $250,000. This detail is crucial because roughly 94% of all the deposits stored with SVB were uninsured. That said, if a startup has a checking or savings account at four separate FDIC-insured banks, then up to $1M is insured—this is the impetus behind partner bank programs and cash sweeps. Check out this guide for a more in-depth look at how bank deposits are protected through FDIC insurance.

Partner bank programs and their relation to cash sweeps

A partner bank program is simply a formal partnership or venture, between different banks, that enables them to store and move funds between one another. This enables a depositor to interact with a single bank, but have accounts at multiple banks, which increases the FDIC coverage. Cash sweeps simply enable the transfer of funds to take place seamlessly, through RTP, ACH, and Wire transfers.

Cash sweeps in a treasury management program

Treasury management is the process of managing a startup’s finances, to minimize capital risk while maximizing returns. It involves financial management, forecasting, cash flow management, capital allocation, risk management, and so much more. Treasury management teams and platforms leverage cash sweeps to ensure that the company has enough liquidity to meet its short-term and long-term needs while generating returns through interest-bearing accounts and the purchase/sale of securities. Check out this guide for a more in-depth look at treasury management.

The logistics behind how cash sweeps work

Cash sweeps can be initiated through manual triggers or can be automated with the help of technology. Funds are transferred from an interest-bearing account to operating accounts or vice versa to satisfy short-term working capital or generate returns on funds that are not needed for daily operations. Cash sweeps can be done within the same banking institution or from one bank account to another. Here’s how that works in practice for a cash-burning startup.

At the end of the month, the finance team runs a projection of how much they expect to spend over the next month. They pull or ‘sweep’ those funds from their interest-bearing, or investment accounts into the primary account. As obligations are satisfied, the primary balance drops. If the balance runs low prematurely, or the organization faces an unexpected cash crunch, they sweep more funds into the account.

For businesses that generate a profit, the opposite occurs. They still forecast their needs for the month and keep some percentage of it in their primary account, but as outstanding accounts-receivable balances are satisfied, the bills are paid. At the end of the month, the teams transfer the excess funds from their operating account to their interest-bearing or investment accounts to generate returns.

Why Fintechs love partner bank programs and cash sweeps

Fintechs, as the name suggests, are financial technology companies, not banks. As such, they must leverage the banking charters of actual banks, to provide depositors with a banking experience. Since these Fintechs, also called “neobanks”, do not have banking charters, they cannot legally touch or lend out their customer’s deposits. They also cannot hold the deposits in their name or store them on their balance sheet, rather, funds must be held by the partner bank.

Rather than building the banking infrastructure, or having an in-person presence, Fintechs focus on providing best-in-class experiences, which manifests themselves in a few different ways.

• Reduced Fees: due to their low overhead, Fintechs typically don’t need to charge fees on banking products and services: money movement, scheduled payments, debit cards, and spending controls.
• Easily Integratable: Fintechs typically don’t have tech debt. As such, they can easily integrate with and connect to other technology providers like accounting, payroll, subscriptions & billing…etc.
• Feature Rich: Fintechs typically offer a wider range of services and features than traditional banks, such as embedded financing, budgeting tools, and financial insights.
• Account Variability: Fintechs typically offer a host of different accounts such as money market accounts and money market funds.
• Increased Returns: Again, due to their lower overhead, Fintechs can pay out significantly more interest, and APY than traditional banks. Arc, for example, pays out 4.00%+ APY in its Reserve account, 60x more than traditional banks (0.03%). 
• Increased FDIC Coverage: Fintechs leverage partner bank programs to increase their FDIC coverage. Depositors that have Arc Platinum, for example, receive up to $5.25M FDIC insurance¹ - 11x the standard coverage amount.

So while some may see the lack of banking charters as a drawback, Fintechs leverage it to their advantage. They not only abide by the same banking regulations as traditional banks but leverage them alongside their partner banks and cash sweeps to provide depositors with best-in-class experiences that come with higher levels of FDIC protection. Check out this guide for a more in-depth look at the differences between traditional banks and neobanks.

Why traditional banks aren’t as safe as you might think they are

Admittedly, this is a tangent, but we thought it was important to note.

As mentioned, traditional banks can touch their customer’s deposits. SVB, which was a traditional bank, not only touched their customer deposits but also invested a large percentage of them in long-duration government bonds.

When interest rates rose, the par value of the bonds dropped, which meant they were underwater. This wouldn’t have been an issue, as they were simply paper losses, but when depositors started withdrawing their assets in droves (e.g. bank run), SVB was forced to liquidate these holdings at a loss. In short order, the withdrawals exceeded the cash SVB had on hand and could access from liquidating the securities, and the bank went under.

Because Fintechs are not allowed to touch the deposits, and because Fintechs often diversify depositors’ cash across multiple partner banks through cash sweeps, the probability that this would’ve happened to them is virtually non-existent. That’s the real reason why so many startups and founders ran to Fintechs for shelter in the aftermath, not other traditional banks.

The future of cash sweeps and partner bank programs

We’ve spoken with hundreds of software founders over the past few weeks—from those conversations, one trend shined through: founders are now banking with multiple providers to minimize their cash risk. They’re leveraging Fintechs, and traditional banks side-by-side, as well as partner bank networks to maximize their FDIC insurance coverage. With congress pushing for higher FDIC limits, it's only a matter of time before cash sweeps and nationwide partner bank programs become the norm. Until then, the arms race between fintechs building their partner bank programs will continue, which ultimately, is in depositors’ best interests anyway.

If you’re looking to leverage cash sweeps and partner bank programs to maximize your FDIC coverage, check out Arc Treasury. It comes standard with 24/7 support, and embedded working capital and venture debt—more importantly, it provides up to $5.25M¹ of FDIC coverage.