Multibanking as a Financial Control Instrument

November 23, 2024

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 allow companies to keep track of all bank accounts and efficiently manage all financial activities – all from one place.

How does a so-called Black Swan event, the bank collapse, occur?

Companies deposit their money in banks as deposits. These deposits are invested by banks in loans or bonds to earn returns on customer deposits.
In a financial crisis, a bank can become illiquid if the book values of the bank’s investment portfolio quickly fall into negative territory. This means that the bank’s investments are worth less than its customers’ deposits.
If the failing bank cannot pay its depositors, a bank panic can occur. Customers rush to the bank to get their money back – a classic bank run.
This can further worsen the situation for the failing bank as its liquid funds shrink when depositors withdraw their money. This is particularly critical when customers want to withdraw funds that the bank has further invested in time-bound investments that are not immediately liquid.
Such bank panics occur every few years, most recently with Silicon Valley Bank, which almost wiped out the payment ability of technology companies within a week.

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.