I was recently asked whether a client could lose investment assets because of a bankruptcy of the asset custodian.
For example, if you have your investments in a Charles Schwab investment account, can you lose that money if Charles Schwab goes out of business? Is it the same as when a bank goes out of business?
The short answer is “no,” but it got me thinking about balance sheets, banks and how banks are fundamentally different from other businesses.
Whose balance sheet are you on?
Say you have an investment account and own shares of Coca-Cola. Where is your risk? Just ask yourself, “whose balance sheet am I on?” In other words, your money is actually on some company’s books. So where is it?
In this case you are on Coca-Cola’s books as stockholder’s equity. If Coke goes out of business, you lose your money. But you aren’t on the balance sheet of the company holding your investments. You are simply their customer – technically the equivalent of someone who buys coke at the supermarket. You use their services, but your money isn’t on their balance sheet.
Whose on a bank’s balance sheet?
This got me to thinking about banks. They are different because when you make a bank deposit (and become a customer of the bank) your money is actually on the bank’s balance sheet as both an asset of the bank and a liability (money owed back to you on demand).
This is fundamentally different from any other business because you can be on the bank’s balance sheet simply by being a customer. When you buy a six-pack of coke, you don’t put yourself on their balance sheet. This is one reason why banking regulation is such a high profile topic and why banking crises effect the economy at a deeper level than a downturn in any other industry.
The balance sheet is the key
Virtually every investment is on some institution’s balance sheet. Do you own a bond? You are on a company or government balance sheet as their liability. Own a stock? You are on a balance sheet as stockholder’s equity. Have a bank account? You are on their books as a liability.
When thinking how your investments might be at risk, all you have to do find the balance sheet they are on.
Photo by Ricardo Diaz