Following the announcement by the Federal Deposit Insurance Corp. that uninsured depositors at the failed Silicon Valley and Signature Banks would be made whole, Treasury Secretary Yellen said in a speech on Tuesday that "similar actions could be warranted if smaller institutions suffer deposit runs that pose the risk of contagion."
Secretary Yellen's comments come on the heels of the Mid-Size Bank Coalition of America's plea for the FDIC to insure all deposits at all banks for the next two years so that deposits do not flee smaller and midsize institutions, and news that Treasury Department officials are evaluating whether the government can unilaterally do so. In addition, some have called for permanently providing FDIC insurance to all deposits at U.S. banks, while others have renewed calls for a public alternative.
While these proposals have merit, maintaining some deposit insurance ceiling brings market discipline to banks. As a result, more modest changes to the ceiling with more stringent bank regulation is appropriate. Congress should consider removing the ceiling for non-interest-bearing accounts while keeping the $250,000 threshold for yield accounts. And because some market discipline will certainly be removed as a result of such a change, Congress must also act to ensure banks are as safe and sound as possible by stopping banks from acting like venture capitalists by preventing them from holding equity interests or warrants in borrowers, preventing banks from engaging in business advisory services, and requiring bank directors be independent of their holding companies.
The fundamental purposes of deposit insurance are to allow banks to engage in maturity transformation without runs and to allow depositors the use of banks without regard to credit risk. With insurance, depositors have access to their assets when needed while those funds are simultaneously put to use in productive activities, and depositors are not required to analyze the balance sheets and management of banks, which many cannot feasibly do.
Despite these twin benefits, deposit insurance creates moral hazard by permitting banks to extend loans to risky borrowers that they would not make with their own capital, allowing banks to reap the rewards of these bets while the deposit insurer bears the losses. The FDIC's $250,000 ceiling therefore allows small, unsophisticated depositors to easily utilize the banking system for savings while requiring larger depositors to conduct the due diligence necessary for market discipline.
As seen with SVB, that ceiling does not always work as intended. Over 90% of SVB's deposits were uninsured and many were used for depositors' everyday operating expenses. Depositors were not looking for profit; if they were, they would have put their cash in instruments with higher interest rates. It's also unlikely that most had reviewed SVB's call report data. After SVB customers ran, uninsured depositors at other banks also began running, indicating that they had not reviewed their banks' call reports either.
To ensure deposit insurance fulfills its core purposes, Congress should remove the insurance ceiling for accounts that are unlikely to bring market discipline to bear on banks: those non-interest-bearing accounts whose owners are simply looking for a means of safekeeping their cash. Unlimited deposit insurance for these accounts would allow depositors to avoid conducting due diligence and make them unlikely to run. At the same time, large account holders making deposits as a form of investment and capable of reviewing call reports are not those for whom deposit insurance is intended, and would be left to bring market discipline to bear.
While removing the insurance ceiling for non-interest-bearing accounts, Congress should retain the $250,000 ceiling for interest-bearing accounts. Banks are an important source of investment income for Americans, as only 58% of households reportedly invest in securities, whereas 95.5% of households reportedly have a checking or savings account. This status quo allows individuals to earn yield while keeping their assets safe for the future.
If Congress were to provide an even greater backstop to banks, it should at the same time limit insured institutions to core banking activities by preventing insured institutions from taking equity interests and warrants in borrowers or providing business advisory services. Taking equity or warrants in borrowers has the result of turning bankers into venture capitalists: In Silicon Valley, that meant looking to invest in many startups with the hope that one will become the next Google or Apple. This type of lending requires different types of analysis than traditional loans, requiring bankers to evaluate the likelihood that borrowers will make it big or be acquired by larger firms rather than whether borrowers will have the ability to repay their loans within a set period of time. Similarly, advising borrowers on how to grow in their industry is also different from core banking proficiencies. Accordingly, Congress should prevent banks from investing in borrowers or offering business advisory services, requiring that those activities be pushed out to uninsured affiliates.
Finally, Congress should require bank directors to be independent of their holding companies. In 1999, Gramm-Leach-Bliley allowed bank holding companies to engage in non-banking financial activities. These activities — including securities underwriting, asset management, support with mergers and acquisitions, and more — are important, but can threaten the health of holding companies' insured subsidiaries by exploiting banks' insurance coverage and access to the Federal Reserve's discount window through preferential loans, asset sales, or other intra-company transactions, putting the public on the hook for losses.
Unfortunately,
The fact that uninformed depositors' fear of losing access to their cash caused Silicon Valley Bank and Signature Bank to collapse demonstrates the need to reform the deposit insurance system in the United States. Congress should consider lifting the ceiling only for non-interest-bearing accounts so that yield-bearing accounts maintain market discipline and enacting regulatory changes to ensure that insured banks operate soundly.
