WASHINGTON — Regulators might have created fresh risks for the financial system when they agreed to back the uninsured deposits at two failed banks.
Both Silicon Valley Bank and Signature Bank held unusually large amounts of uninsured deposits, and their
"What we just did really is essentially implicitly guarantee all wholesale deposits," said Saule Omarova, a professor at Cornell Law School and one of the leading scholars on financial regulation. "Of course, the signal was received loud and clear, and it was meant to be seen loud and clear."
That move raises the age-old financial regulatory dilemma of moral hazard: When regulators bailed out depositors — especially wealthy tech investors at Silicon Valley Bank and crypto companies at Signature Bank — they created the expectation that they will step in to protect uninsured deposits in future scenarios, depending if the situation meets the squishy standards of "systemically risky."
Treasury Secretary Janet Yellen
Some experts worry that those comments could encourage large, sophisticated depositors — like the venture capital firms and investors who had large sums in Silicon Valley Bank — to change their behavior in unpredictable ways because of the reinforced assumption that regulators will step in and protect their deposits.
"The fear I have is the incentives, the broader incentives, for big players in the financial sector, that put their money to use, large sums of money to use every day, have changed," Omarova said. "These incentives will change, and how exactly they will change, no one can predict that right now with certainty."
How we got here
While Silicon Valley Bank and Signature's amount of uninsured deposits was unusually high, it's still indicative of a
Total deposits at domestic commercial banks rose by more than 35% from the end of 2019 to around $18 trillion by the end of 2021. That's largely been attributed to government stimulus checks hitting individuals' bank accounts throughout the pandemic. On top of that, some businesses benefited from Paycheck Protection Program loans that drove up deposit balances.
FDIC Chairman Martin Gruenberg flagged this in recent quarterly banking reports, and the agency's board voted to increase assessment fees on banks to offset the falling ratio of assets held in the Deposit Insurance Fund, which by statute pays out insured deposits on failed banks. The FDIC can cover uninsured deposits only through the authorization of a "systemic risk exception" from the Treasury secretary and a majority approval by the FDIC board.
But the share of uninsured deposits at U.S. banking institutions had been growing steadily even before the pandemic, according to FDIC data. Since 2015, the share percentage of insured domestic deposits has fallen from 59.5% to 55.3%, meaning the inverse is true of uninsured deposits: That they grew by 4.2 percentage points.
The likely answer to why this happened is a prolonged period of low interest rates, which made it easy for many companies — notably tech companies as well as firms in other more volatile sectors — to raise capital. That "easy money" was often parked in large bank accounts, where a substantial portion of it was uninsured.
"We have had almost a decade and a half of highly expansionary monetary policy," said Thomas Hoenig, former FDIC vice chairman and former president of the Kansas City Fed. "So we have an era of easy money, and the public became very used to that."
To be sure, while the share of uninsured deposits has mostly trended up, the actual value of uninsured deposits
Regulators have known about this issue for years: In 2019, Gruenberg spoke about the topic at the Brookings Institution, where he said that the failure of a large regional bank in particular could pose significant issues because of "the heavy reliance of these institutions on uninsured deposits."
"In a resolution where there is no acquiring institution, and possibly little or no unsecured debt to absorb losses, it is likely that the least-cost test would require that uninsured depositors take losses," Gruenberg said at the time. "Given the heavy reliance of regional banks on uninsured deposits, uninsured depositors' taking losses at a failed regional bank could have knock-on consequences for other regional banks, particularly in a stressed economic environment."
Morally hazardous
The deposits held by large, sophisticated financial players are mostly what policy watchers worry about when they think about the moral hazard implications of federal regulators' decision to guarantee Silicon Valley Bank and Signature Bank's uninsured deposits.
Pulling back that expectation would require either a strong effort by all those regulators, which may or may not be successful, or an acknowledgement that the risk incentives for depositors and banks have changed, and a reassessment of bank regulation from the regulators and likely from Congress.
"Regulators have sent out the smoke signal that it's going to take care of uninsured deposits," said Aaron Klein, a senior fellow at the Brookings Institution. "That's a dangerous precedent, and one where I question whether we can put that genie back in the bottle. How can you expect uninsured depositors to ever believe they'll take a haircut when Roku got bailed out?"
It's not just the depositors that benefit from that implicit guarantee, said Scott Ganz, an associate professor at Georgetown University and former special assistant to the vice chairman at the Financial Crisis Inquiry Commission, which investigated the cause of the 2008 financial crisis.
Banks use those deposits to make loans and invest in things like securities, so the more deposits they have, the more they can put those funds to work and make returns for stockholders. Deposits are a relatively inexpensive form of funding, since the reason most people put funds in a bank is for convenience, not because they expect a large return.
"Before this there was a strong incentive for banks to attract deposits of all kinds," Ganz said. "Before, it was clear — and at least through the lens of the regulatory system — that 'this is the amount that's insured and this is the amount that wasn't insured.'"
Now, if banks believe they are large enough to meet a systemic risk exception from regulators but small enough to avoid being a global systemically important institution, they could see it as beneficial to attract as many deposits as possible — and, by extension, to pile on risk.
"Uninsured deposits right now are, in effect, a subsidy to the banks," Ganz said. "They're implicitly insured, but the banks aren't paying for that insurance. And it's a source of funding that's going to be fairly insensitive to the risk profile that the bank is taking."
To a certain extent, sophisticated depositors were expected to have some degree of market discipline, meaning if a depositor believes its bank is taking a risk, it can move its money elsewhere.
Expanding the limits of deposit insurance could have other knock-on effects, including the FDIC's Deposit Insurance Fund. Before the two bank failures, the fund's ratio to insured deposits was already below the statutory minimum. Increasing the amount that's implicitly or explicitly insured would require a repricing of run risk on banks and would almost certainly result in even higher assessment fees for banks.
"That pot of money that the FDIC holds in order to pay off the potential losses associated with bank failures is way too small to cover this sort of implicit guarantee," Ganz said.
Ultimately, the long-term implications of the FDIC, Fed and Treasury's decision to extend the FDIC's guarantee to uninsured deposits in the case of Silicon Valley Bank and Signature Bank might not be known until other problems begin to surface in the financial system.
"There's broader, much more complicated implications in how the financial market actors think in how they behave, and what kind of risks they might create on top of this fully implicitly guaranteed deposit system," Omarova said. "This is the biggest question we all need to think about right now."
