How the FDIC Keeps US Banks Stable

When the US government announced this month that it had stepped in to take over Silicon Valley Bank (SVB) and Signature Bank, it was a 90-year-old Great Depression-era agency that took the lead. initiative to assure depositors that their funds were safe. and quell a bank run that threatened to cause wider damage to the industry.

The Federal Deposit Insurance Corp. took control of SVB on March 10 and Signature Bank two days later, moves that rendered the publicly traded shares of both institutions worthless, but preserved other assets for distribution to account holders and creditors from each bank.

In a decision that some found surprising, the FDIC announced that all deposits held at both banks would be fully guaranteed. Historically, depositors have been protected up to $250,000, a limit designed to protect the overwhelming majority of individual depositors from loss.

The agency decided, however, that to avoid “contagion” – panic over one failing bank spreading to wider panic over others – it would make all depositors whole.

The decision was also likely motivated by the fact that many companies, mostly in the tech sector, kept large accounts at SVB which they used to meet payroll and regular business expenses. The impact of so many companies unable to pay thousands of employees would have been difficult to estimate, but could have hurt the economy.

The FDIC and the Biden administration were quick to deny that the two banks had been subject to a “bailout”, pointing out that the bank’s executives had been fired, equity had been wiped out and that all the funds provided by the agency to make depositors all would come from an insurance fund financed by premiums paid by insured banks.

The FDIC, however, will need to increase bank assessments to replenish the money it spends on SVB and Signature resolution. Banks will likely pass these costs on to their customers by charging higher fees or increasing interest on loans.

FDIC History

The FDIC was created in 1933, after the United States went through years of panic during the Great Depression, which led to the closure of thousands of banks. Between 1921 and 1929, approximately 5,700 banks across the United States failed, some due to mismanagement and many because depositors lost confidence and demanded withdrawals so quickly that banks simply ran out. of cash.

Things got worse between 1929 and 1933, when nearly 10,000 banks across the country failed. During a particularly difficult week in February 1933, bank runs were so widespread that governors of nearly every US state moved to temporarily close all banks.

The FDIC was created in the aftermath of this crisis, when the federal government finally acted on a long-delayed plan to establish national deposit insurance. The agency originally guaranteed individual deposits of up to $2,500, a level that was periodically increased over the decades.

The agency is funded by the premiums that banks and savings associations pay for deposit insurance coverage. It is managed by a board of five appointed presidents. The current Chairman of the FDIC is Martin J. Gruenberg. By law, the director of the Consumer Financial Protection Bureau and the Comptroller of the Currency, whose agency oversees nationally chartered banks, are also members. Two other appointees complete the board, which cannot have more than three members from the same political party.

Over its nine decades, the FDIC has shut down hundreds of failing banks, but insured deposits have always been fully refunded.

Promote financial stability

“The FDIC’s mission is to promote financial stability,” said Diane Ellis, the agency’s former director of the Insurance and Research Division. “The FDIC does this by exercising several powers. One is to provide deposit insurance so that bank depositors can be sure that they will get their money back no matter what happens with their bank.”

In addition, the agency has the power to “resolve” bank failures, which may involve selling the bank directly to another institution, creating a “bridging” bank that provides ongoing services to depositors while the agency is working towards a resolution, or to sell the bank the bank’s assets to return as much money as possible to depositors whose holdings exceed the coverage limit.

Ellis, now senior managing director of banking network IntraFi, noted that the agency also has supervisory power over the banks it insures.

“For open banks, examiners conduct regular reviews to ensure that banks are operating in a safe and healthy manner…promoting a healthy and stable banking system, which is important for economic growth,” he said. she told VOA.

Avoiding “moral hazard”

When the FDIC was created, capping the standard amount of insurance per depositor was central to its design. The creators of the agency worried about a problem called “moral hazard”. They feared that if the federal government guaranteed 100% of deposits, individuals and businesses would not exercise due diligence when deciding which banks to entrust their money to, and that the lack of oversight would lead banks to take excessive risks. .

“Legislators wanted to strike a balance, protecting people up to a certain amount, but not everything, so that people had an incentive to make sure their money was in a safe bank rather than an unsafe bank,” he said. said John Bovenzi, who served as chief operating officer and deputy chairman of the FDIC from 1999 to 2009.

Bovenzi, the co-founder of the Bovenzi Group, a financial services advisory firm, told VOA he was initially surprised by the decision by the FDIC and other regulators to make all uninsured depositors whole.

“They weren’t the biggest institutions. Silicon Valley and Signature, they were kind of a second tier and weren’t considered ‘too big to fail,'” he said.

However, Bovenzi said, it soon became apparent to regulators that there were other banks in the country operating with similar business models as SVB, which had large amounts of low-rate securities. interest in his books, the value of which was systematically assessed. undermined by the Federal Reserve’s decision to raise interest rates significantly over the past year.

“What happened was that they saw there was too much of a ripple effect on other institutions, so they invoked what’s called a ‘systemic risk exception’ “, did he declare. If that hadn’t been the case, he said, the FDIC would have had to do the shutdown in a way that would least cost it and the government to save money, “and that would have meant uninsured losses. uninsured, the FDIC raises its own costs to cover it. And so you had to say, “We don’t want to do it for the institution, but we have to do it for the system.”

Create a precedent

The decision to protect all deposits at SVB and Signature was not unique. During the financial crisis triggered by widespread defaults in the subprime mortgage industry from 2007 to 2010, regulators shut down several hundred banks in the space of a few years and implemented a policy to protect all deposits to avoid further damage to the economy as a whole.

The decision to do so for SVB and Signature, however, in the absence of such a widespread crisis, has raised questions about whether a precedent has been set that will lead depositors to expect government relief. if their bank fails.

In testimony before Congress on Thursday, Treasury Secretary Janet Yellen warned that the treatment of SVB and Signature should not be taken as a signal that similar protection will be extended to other banks. in the future.

Such action, she said, would only take place when “failure to protect uninsured depositors would create systemic risk and significant economic and financial consequences.”