Protecting Your Cash: Understanding Canadian Deposit Insurance

With some banks recently failing in the United States, Canadian investors may be wondering if this is a risk that requires more attention. So, this post will describe the Canadian deposit insurance market and how investors may protect themselves.

Canadian Bank Deposits

90% of Canadian deposits are held with the five biggest Canadian banks: RBC, TD, BMO, Scotia, and CIBC. These banks are considered “too big to fail” and the Canadian government will likely find ways to keep these banks alive at any cost (to taxpayers). This may include buying assets from the banks (such as Canada Mortgage Bond qualifying mortgages) using CMHC and/or the Bank of Canada, making loans to these banks, and otherwise changing regulations to promote solvency.

What is CDIC?

The Canadian Deposit Insurance Corporation (“CDIC”) is a federal Crown corporation that provides deposit insurance to protect eligible deposits at member financial institutions in the event of their failure.

CDIC deposit insurance covers eligible deposits up to a maximum of $100,000 per insured category at each member institution.

What is CIPF?

The Canadian Investor Protection Fund (CIPF) is a non-profit organization that provides insurance protection to investors in case of a member firm’s insolvency or bankruptcy. CIPF covers most types of investments including stocks, bonds, mutual funds, and segregated funds, among others.

The protection provided by CIPF is different from the deposit insurance provided by CDIC. CIPF provides coverage for investment losses in the event a brokerage fails, while CDIC provides coverage for deposit losses in the event a bank fails.

The coverage limit provided by CIPF is $1 million per account category per member firm.

How Much Cash?

With limits of $100,000 for CDIC and $1 million for CIPF, its easy to see how wealthy investors can quickly blow past any deposit insurance limits. So, here are some strategies that wealthy investors can use to protect themselves from the risk of bank or brokerage failure.

• Keep cash deposits as low as practical
• Diversify
• Act strategically

Hold Less Cash

Holding cash deposits is not a productive investment in the long-run. Simple logic tells us that banks will only offer interest rates that are profitable for the bank. This means the bank taking your deposits must have a better place to invest your cash to make a profit. So, instead of holding large cash deposits, think like a bank and search for more productive places to invest your capital.

After putting your cash to its best use, a good rule of thumb is to keep enough cash on deposit to satisfy your day-to-day spending requirements. For most of us, this might mean a year’s worth of personal spending. This should not be more than $100,000 unless you’ve living a materially lavish lifestyle. Doing so will keep you under the CDIC insured limit.

If you feel like holding more than $100,000 of cash, then you should consider buying some cashable or short term GICs for your emergency fund. Diversify those GICs between several banks to spread your risk and stay under the $100,000 CDIC insured limit. Practically speaking, this may mean holding accounts at 2 to 3 different banks (and also diversifying between various GICs from multiple issuers within the same bank/brokerage account).

Diversify

Let’s say your investment policy calls for 10% cash, and your portfolio is worth $100 million. This means your cash position at anytime will be around $10 million. Obviously, this is far more than either the CDIC and CIPF insured limits. So, a way to reduce the risk of bank/broker default is to diversify between insured deposits within an account.

This means rolling insured deposits purchased from several different issuers within brokerage and bank accounts. Canadian private banking accounts will usually allow this, as will most brokerage accounts will too. Investors can usually choose from a lineup of CDIC insured GICs from more than 10 issuers in the same brokerage account. Place $100,000 into 10 different GIC issuers within the same brokerage account. This gets you to $1 million, but if you want to place $10 million, you’ll need to get more creative.

Act Strategically

Another way to place large amounts and diversify your risk of bank failure is to use money market funds. While they might not be insured by CDIC or CIPF, holding a money market fund that in turn holds Canadian t-bills is a way to avoid holding deposits directly. Even though the interest rate paid on t-bills is usually lower than the rate paid on CDIC insured bank deposits (or High Interest Savings Accounts: “HISAs”) investors receive greater safety in return.

Overall, the most important way for wealthy Canadian investors to reduce the risk of bank failure is focus their dealings with the “too big to fail” banks. This means only holding deposits and brokerage accounts with the five biggest banks.  If you have a brokerage account with more than $1 million, best to hold it at a big bank owned brokerage.

Wealthy investors might also consider annuities with Sunlife and Manulife. These institutions are also considered “too big to fail” by the Canadian government.

There are other ways wealthy investors can insure various risks related to their large cash positions, but more importantly, re-examining why an investor wants to hold more cash and then re-positioning a portfolio away from holding cash is usually more productive in the long-run.

Our Family Office

The first way our family office will help protect you from banking failure is by documenting your investment policy. This will outline your asset allocation and show us how much cash you’re planning to hold. From there, we can search out the best rates at the preferred risk for your cash.

Cash management is sometimes administratively cumbersome since lots of documentation is required (account opening and KYC maintenance). Since holding cash on deposit involves paperwork and account documentation, our family office service includes doing this paperwork for you to make the transfer of cash more secure and easy.