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When the online brokerage firm Robinhood announced Thursday its plan to offer checking and savings accounts earning 3% interest and insurance up to $250,000 it got everyone’s attention. The financial sector was up in arms over the new offering, and for potential customers close scrutiny turned out to be a good thing in gaining transparency about the new product.
Robinhood has since retracted the initial offering and says it is reviewing and rebranding the potential new product. All references to checking and savings accounts have been removed from the website, replaced with something called “Cash Management”, which the firm says is ‘coming soon’ at the time of publication.
For consumers it’s important to understand the difference between banks, brokerages and the two main insurance bodies when it comes to institutions or companies that hold cash and investments for customers.
The Federal Deposit Insurance Corporation (FDIC) is a U.S. government agency that insures deposits — up to $250,000 per depositor — held with banks. Banks are financial institutions with a charter that allows them to take deposits and use those deposits to lend money. When you get a mortgage, the bank is lending the money its customers have on deposit to help you buy that new home. Banks are required to keep a certain percentage of deposits on hand in cash, but are allowed to use the rest to make consumer and commercial loans. Banks are by statute different than brokerage firms, although some do offer brokerage and wealth management services.
Brokerage firms on the other hand help facilitate the purchase of investments or securities for customers. Brokerages are not covered typically by the FDIC and have their own insurance body. The Securities Investor Protection Corporation (SIPC) provides insurance of accounts for brokerage firms. The SIPC is mandated but not funded by the US government, and operates as its own private organization supported by the brokerage industry.
The issue for the industry arises out of the fact that Robinhood is a brokerage firm — not a bank — and therefore isn’t FDIC insured. Robinhood was relying on the investment insuring body SIPC to insure the accounts for their customers.
That particular pipe dream came to a swift end when SIPC CEO Steve Harbeck said the organization would not cover the cash deposits for the new product. Harbeck said, “We protect cash that is deposited for the purpose of purchasing securities”. The key sticking point here seems to surround the fact that Robinhood was not going to require new customers of the product to hold an investment account with the firm when the product launched. Robinhood made its announcement without informing the SIPC of the new product and its claims.
It’s not uncommon for brokerage customers to hold cash in accounts at their investment firms. That cash, however, is normally held in money market accounts — or moved into a traditional bank account covered by the FDIC — from the sale or future purchase of securities. Cash for those purposes would be covered by the SIPC.
The claim of a 3% interest rate on the accounts is what got most people looking at the new product closely. That rate is well above a standard bank’s checking or savings return rates. Robinhood said it was going to meet that by investing the cash on hand in stable and reliable instruments like US Treasury bonds. The 3% once again came into play for many industry hawks because current Treasury bonds are yielding less than 2.4% on one-year notes and only 2.91% on 10-year notes.
Harbeck noted it sounds like “you are lending money to the brokerage firm, you are not investing in securities.” This seems to be the main reason that he referred the matter to the SEC.
In a blog post Robinhood stated it is “excited and humbled” by the response the new product gained and apologized for any “confusion” that the announcement had caused. The post says the company is “revamping” marketing materials and renaming the product as it moves forward. One thing is certain: the industry will be keeping a close eye on any moves that Robinhood makes in the future.
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