“The hard-earned savings of the majority of our people who are only able to deposit in one bank must be protected”. These were the words of US Representative Henry Steagall in hearings preceding the creation of the Federal Deposit Insurance Corporation in 1933. With depositors losing about $1.3bn over the Depression, consensus towards providing insurance — then at $2,500 per depositor — grew to help rebuild confidence in banks. Few would disagree with Steagall’s general sentiment today. Yet, even a promise to make depositors whole, above the latest $250,000 limit, was not enough to save Silicon Valley Bank and Signature Bank in March. It is clear that deposit insurance needs rethinking.
Bank runs are different today. Social media posts spread news of bank frailty — whether true or speculative — at a fingertip. The same fingertip can then shift deposits into another online account via mobile banking. This is not just a difference from 90 years ago when the FDIC was founded. In 2008, it took Washington Mutual nine days to lose about 9 per cent of deposits. SVB lost $40bn in deposits, 23 per cent of its total, in a day. Deposits have also grown. The portion of uninsured deposits in 2021 reached its highest since 1949; around $7.7tn of uninsured deposits sit at institutions covered by the FDIC.
This means deposit insurance remains an important part of regulators’ anti-contagion arsenal. It has generally served well in making the banking system less vulnerable to deposit flight. And it helps protect smaller depositors from poorly managed banks, which they are unable to audit on their own. But it should not be made universal, as some argue. The incentive for banks to manage risks effectively would then be stunted. It would also require banks to fork out considerably more to the FDIC’s kitty, which could have knock-on impacts for bank customers.
The FDIC last week set out options for reform. Its recommendation to raise the threshold on a targeted basis is a sensible intermediate step. This is particularly true for business accounts used to meet payments, such as payroll. It would help reduce any contagion effects and assuage corporate depositors who may otherwise look to move their money to larger banks in uncertain times.
The FDIC’s statutory requirement to resolve bank collapses in a manner that imposes “least cost” on its insurance fund also needs review. It is a fair goal, but the policy tends to lead to the absorption of smaller banks by larger and more able purchasers during times of crisis, as with JPMorgan’s acquisition of First Republic. The best solution for the economy in the long run may not be the cheapest. Mergers need to consider the system-wide impacts on competition and banking diversity, which fall under the purview of other agencies. Consolidation of America’s 4,000-plus banks may be a good thing, by raising robustness. But it would be best achieved by determining what is optimal for the merging business models, rather than a rushed acquisition by a large bank during a crisis.
Ultimately, deposit insurance should be considered a last line of defence to avoid a loss of faith in the banking system. Former Bank of England deputy governor Paul Tucker has called for lenders to keep enough collateral with central banks to cover all their short-term deposits in a single day. His proposal merits further study.
Above all, if regulators think midsized lenders are significant enough to warrant more deposit protection, as the recent crisis has conveyed, then they should face the same scrutiny that large banks face. This means stronger capital and liquidity buffers and broader stress tests. That will go some way towards fostering renewed confidence — before deposit insurance even comes into play.
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