In the past week, two notable banks suffered a major collapse. Silicon Valley Bank and Signature Bank were subject to bank runs by depositors after reported losses triggered panic. Notably, both of these banks served tech startups and venture capitalists as their primary clients. Due to declining tech stocks, as well as venture capitalist caution, banks have seen fewer deposits and more withdrawals. Combined with unfavorable interest rate shifts and a lack of diversification, banks like these were highly vulnerable. Perhaps it shouldn’t be surprising that they quickly got into trouble.
(The climate was already unfavorable for startups seeking capital–read up on why in this Bold story.)
Of course, while these aspects of the current banking system demise are important, they certainly aren’t the biggest part of the story. The more intriguing, and concerning, aspect involves the decision for the FDIC insurance for banks to provide bailouts. As it turns out, roughly 90 percent of the deposits in both Signature and Silicon Valley were uninsured. In other words, a small portion of these bank’s deposits fell under the FDIC insurance coverage cap limit of $250,000. As such, the FDIC had little obligation or responsibility to step in and guarantee these deposit excesses. But they did, and now one of the bigger questions we’re left with is: should we rely on the government for bailouts all the time? There short answer is no!
“By insuring all deposits at SVB and Signature, regulators judged the risk of cascading effects to other regional banks and the broader economy to be more significant than the moral hazard of increasing FDIC limits.” – Rich Falk-Wallace, CEO, Arcana
The Government, Banks, and the FDIC
The Federal Deposit Insurance Corporation, or FDIC, has provided deposit protections for banks since 1933. It was then that Congress established a cap of $250,000 for the amount that the FDIC insurance coverage would guarantee. At the time, most believed such policies would protect small depositors and leave larger companies to care for themselves. But since then, times have changed as has the number of unprotected deposits that exist in American banks today. Roughly, 43% of all domestic deposit balances lack government protection. This adds up to about $7.7 trillion that exceeds the FDIC’s $250,000 cap. And as a result, whenever a major bank gets into trouble, the potential economic consequences are dire.
The FDIC insurance for banks was not only created to protect deposits but to also prevent panics and runs on banks. The assumption was that the guarantees offered would prevent depositors from collectively withdrawing funds in the wake of bad news. But while this may have been effective in the 1930s, this philosophy no longer holds true. With the volumes of unprotected deposits present today, and large deposits linked to a low number of companies, panic does occur. Based on this, it is clear that initial FDIC insurance coverage protections are no longer effective in achieving its purposes. Not only are FDIC policies and parameters outdated, but they also create a volatile and unjust financial system.
Taking Advantage of a Bad System
The recent debacles involving Signature Bank and Silicon Valley Bank demonstrate the lack of accountability that now exists for banks. In both cases, these banks took extremely large deposits that they knew were uninsured. Silicon Valley Bank had deposits worth over $173 billion, of which 88% were beyond the FDIC insurance coverage guarantee. Signature Bank had $79 billion unprotected. This was not by accident or due to negligence. Instead, both banks intentionally and aggressively sought these deposits. And they did so from startups and VC firms when economic climates were favorable. In other words, when times were good, they rode the wave. And when they weren’t, they relied on FDIC insurance for banks as a backup.
As the saying goes, all good things must come to an end. And both banks have now been brought under federal government control in the aftermath of major losses. But precisely what consequences have these banks suffered in the process? Treasury Secretary Janet Yellen cited system risk exception and has chosen to bail these banks out. The potential for serious adverse effects to the economy and financial system justified these actions. So, both Signature and Silicon Valley will effectively suffer little. And depositors who failed to oversee these banks’ practices will have their funds reinstated thanks to the FDIC insurance coverage. Hardly a just system in terms of accountability.
Options and Solutions to Consider
Clearly, the current system and FDIC insurance coverage protection cap is not working for modern times. It’s therefore not surprising that potential solutions are being considered. Many are naturally calling for greater government oversight of banks and financial institutions. This was the solution imposed after the 2008 recession when the last major government bailouts took place.
While a consideration, the track record of such a solution has not proven very effective. At the same time, others are calling for an increase in the FDIC cap limit on deposit guarantees. This would certainly reduce the burden of unprotected deposits, and it would discourage bank runs to a greater degree. But these policies continue to place the burden in depositors and taxpayers. Depositors would still need to monitor bank practices, and taxpayers would have to support larger FDIC insurance for banks. This solution alone once again lets banks escape responsibility.
While a combination of government oversight and FDIC insurance coverage changes could provide improvement, other options do exist. Solutions that place the burden of responsibility on banks should be those considered first. In this regard, banks should be required to guarantee and protect 100% of their deposits regardless of their size. Rather than acquiring these protections from the government, however, banks should obtain private insurance to cover their balances. This would relieve taxpayers of paying for deposit protections and assign it instead to banks as a cost of doing business. At the same time, with more skin in the game, banks would be more responsible with deposits and banking strategies. This would relieve depositors of the burden of having to closely monitor bank behaviors. Of the options available, this is the one that’s fair and just. For too long, banks are enjoying a free ride via the government. It’s time for this to come to an end and require banks to finally be accountable for their choices.
