The writer is a former chair of the US Federal Deposit Insurance Corporation and a senior fellow at the Center for Financial Stability
In times of financial turmoil, big banks get bigger. Their massive balance sheets let them gobble up troubled competitors. Uninsured depositors flock to the safety of their perceived too-big-to-fail status. This happened during the 2008 financial crisis when I chaired the Federal Deposit Insurance Corporation. It is happening again today as America’s largest bank, JPMorgan Chase, grows through both deposit inflows and the acquisition of a failed bank.
The FDIC is legally required to sell a failed bank to the highest bidder, but during the 2008 crisis we had emergency powers to stem deposit flows to the mega banks. We provided targeted, temporary increases in deposit insurance caps that helped healthy regional and community banks retain their most valuable business accounts. Regrettably, under the Dodd-Frank Act, Congress must now authorise the FDIC to take such action. Given persistent, if unwarranted, hysteria around the health of regional banks, it should act quickly to do so.
To be sure, today’s turmoil is overblown. Accounts that depict three recent bank failures as larger than those in 2008 are misleading. In 2008, it was huge banks like Citigroup that were in trouble. The government did not let them fail. These three recent failures total $532bn in assets in a $23tn system comprised of over 4,000 banks. There is no crisis, unless media hype and short selling pressure undermine confidence so that depositors flee otherwise healthy banks. Polls show they are nervous.
Insured depositors have traditionally kept confidence in the FDIC’s perfect, 90-year record of protecting them. The problem is with the $7tn deposits above the $250,000 deposit cap. But universal coverage for all accounts is not the answer. We need wealthier, more sophisticated depositors to monitor banks and exert market discipline on those that are badly managed. With universal coverage, reckless banks could offer high yields to attract large depositors who would ignore the risks, knowing the FDIC would protect them. It could also distort capital flows away from money market funds and short-term Treasuries into bank deposits which can offer quicker access to funds.
It does make sense to provide unlimited coverage for transaction accounts used by businesses and other organisations to receive and make payments. These typically pay low or zero interest because they are used by depositors to support operations, not generate returns. Protecting these accounts ensures that employers with uninsured deposits at a failed bank can continue accessing funds for payroll and other expenses. However, transaction accounts cannot always be moved quickly. During uncertain times, business depositors assess whether they should pre-emptively transfer their business to a too-big-to-fail bank even if their own bank is not in distress.
To address this problem, we launched the Transaction Account Guarantee (or TAG programme) during the crisis. It successfully reassured depositors that their transaction accounts were safe. We did not cap coverage because with little, if any, yield on the accounts, depositors had incentives to maintain only the balances required for operations. Moreover, a key goal of TAG was to stem increasing deposit concentration in the mega banks. With caps, larger employers would continue to move their accounts away from the smaller banks.
While the Dodd-Frank Act now requires Congressional authorisation for TAG, there is a fast track. During the Covid emergency, the Trump administration secured temporary reinstatement of the FDIC’s TAG authority, which fortunately the FDIC never had to use. But today, given political polarisation, the Biden administration has not asked for a Congressional go-ahead. Instead, it is working with regulators to implicitly guarantee uninsured accounts using special emergency powers unsuited to that purpose. Each time a bank fails, two-thirds majorities of both the FDIC and Federal Reserve Boards must approve use of those powers. It is highly questionable whether Republican appointees will keep providing votes to bail out the uninsured.
Regional banks have a target on their backs — and perhaps deserve some comeuppance for their 2018 lobbying to weaken oversight. Nonetheless, the vast majority are sound, well managed and play an important role in providing credit. They and community banks were heroes during the 2008 crisis, continuing to lend even as many mega banks pulled back. To promote banking competition and mitigate concentrations of power, we need to help them protect their core business accounts. Congress needs to reinstate TAG.
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