Can CDIC insurance fail?
You may be watching our neighbours to the south look at FDIC terms and conditions for the first time in a long time. It may be prompting you to research “Canadian FDIC” or maybe you’re wondering “what does CDIC do again?”. I know I am. In the wake of a few USA banks collapsing (for the second time in as many decades) it is good to know what the financial policies and institutions do to protect their depositors. It’s your money afterall!
CDIC insurance is widely understood to cover the majority of Canadians. Most people understand it to insure their deposits up to $100,000 should anything happen to their bank.
Some historical CDIC information
In Canada, this is often taken for granted as we haven’t been exposed to the same level of banking meltdown that our neighbours to the south. In fact, as far as I can tell CDIC insurance hasn’t been used in Canada since the 90s.
During the financial crisis of the early 1990s, several Canadian financial institutions failed and CDIC was used to pay back depositors. The institutions that failed and were covered by CDIC at that time included:
Canadian Commercial Bank
Northland Bank
Principal Group
Confederation Life Insurance Company
Mutual Life of Canada
Since then, there are significantly fewer banks and the Canadian financial landscape is significantly more resilient. So what does this mean for CDIC, and does it do what it’s supposed to?
What exactly is CDIC?
First, let’s go to our trusty robot and ask it to explain CDIC:
Adam 💁🏻♂️: Explain CDIC to me
ChatGPT 🤖: CDIC stands for Canada Deposit Insurance Corporation, which is a Canadian federal Crown corporation that provides deposit insurance to eligible Canadian banks, credit unions, and other financial institutions.
The purpose of CDIC is to protect eligible deposits held at member institutions in case of their failure or insolvency. The insurance covers up to $100,000 per eligible depositor, per insured category, at each member institution.
The insured categories include savings accounts, chequing accounts, term deposits, and certain investment products like guaranteed investment certificates (GICs). Deposits held in foreign currency are also eligible for insurance, subject to the exchange rate at the time of payment.
CDIC is funded by premiums paid by its member institutions and does not receive funding from taxpayers. It also works closely with member institutions to monitor and promote sound banking practices to help prevent bank failures.
In summary, CDIC provides deposit insurance to eligible Canadian banks and other financial institutions, which protects depositors in case of their insolvency. The insurance covers up to $100,000 per eligible depositor, per insured category, and is funded by premiums paid by member institutions.
ChatGPT: Explain CDIC to me
This is a pretty good explanation, I might take issue with “CDIC is funded by premiums paid by its member institutions and does not receive funding from taxpayers.” CGPT is showing its bias here. Everything is indirectly paid by the taxpayers as the banks raise their fees to accommodate for these premiums. I think what the robot was trying to say was that the government doesn’t pay for it directly with taxpayer dollars. And fair enough.
Comparing CDIC to other types of insurance
Like most insurance models, CDIC takes these premiums paid by the banks and invests it until the funds are needed. This works really well for retail and corporate insurance, but maybe not so well for CDIC.
In retail and corporate insurance, it’s quite typical for the “insurable assets” (everything the insurance company is responsible for replacing in the event of a loss - we’ll call these liabilities) to vastly out measure their “premium assets” (the sum of all premiums collected and invested).
While in practice this seems scary, let’s walk through this scenario. If Insurance Company A insures 100 vehicles that cost $25,000 each to replace and collect $3,000/year in premiums they would receive $300,000 in premiums each year. These $300,000 in assets would be responsible for replacing $2,500,000 in “liabilities”. Not even close to enough! However, the likelihood of 100% of their insured vehicles being lost is very low. In fact, it’s likely that most auto insurance or adjacent organizations have a claims rating of < 5%.
With a big enough portfolio, spread out amongst enough categories you can see how that claim rating could even decrease and you have yourself a nice business! Your success comes from:
Appropriately gauging the risk of your liabilities; and
How well you can invest the premiums you don’t have to pay out as claims
The more industries and diversification you have, the less exposed you are to chaos and the more successful you will be.
Let’s compare this to CDIC, on the other hand.
They have $1T (that’s trillion, we should get used to seeing that letter… it’ll continue popping up as the money is devalued) in liabilities with $7.03B (billion) in assets.
For those of you trying to do quick math, that’s less than 1%.
If this doesn’t ring alarm bells for you off the start, it should. But, if I give you the benefit of the doubt because “they haven’t had a claim in 30 years” or “the Canadian financial industry is robust” ’or even “we have to balance banks’ fees against the risk”. Let’s run down a scenario of what happens in the event of a collapse.
Why would CDIC fail?
Unlike in a diversified insurance model, if 1 bank collapses in Canada, multiple will collapse. The consolidation and barriers to entry that have popped up since the last Canadian banking crisis in 1990 have only made the industry smaller. Granted, it’s stronger, but smaller. But stronger doesn’t mean bullet-proof. It just means more time between collapses and bigger collapses when they come.
We’re entering an era where bank executives weren’t around for the last collapse. They have the log books and faxes from the chaos and panic that ensued, but the historical learnings will vanish as that generation of leaders exit the workforce. This, coupled with an unstable national economy and monetary policy, start adding some crack to the large, consolidated financial sector.
So, when interest rates rise, deposits naturally tighten up. When deposits tighten up, liquidity gets thin. When liquidity gets thin, it’s akin to adding full heat to defrost your windshield with a small rock chip when your car has been sitting outside in -30 temperatures (a joy my Alberta readers can understand). The cracks grow. Fast and ugly. The house of cards begins to tumble.
Suffice it to say that CDIC insurance is not the same as auto insurance. It is the epitome of boom and bust. Auto insurance will have a steady 5% yearly claim (or whatever it may be). Some years might be a little less. Some more. But over the course of a decade or two it’ll average out.
CDIC on the other hand will go decades without claims, but when it rains it will pour. Much like we’ve seen across the world, and more recently in the USA, a run on the banks starts and doesn’t stop until depositors get their money. And my concern is the 0.5% asset to liability ratio won’t cut it.
What is the alternative?
So, the next time someone tells me their deposits are insured and that’s why they have their money sit in the bank, I’ll tell them to buy and self custody bitcoin instead.
