Lawmakers Should Reject FDIC’s Flawed Deposit Insurance Reforms

On May 1^st, the Federal Deposit Insurance Corporation (FDIC) published a new report outlining three potential deposit insurance reforms in the wake of the failures of Silicon Valley Bank (SVB), Signature Bank (Signature), and First Republic Bank (FRB). Each of the report’s reform options include expanding deposit insurance and increasing regulation on the banking sector to a certain degree. However, the FDIC’s preferred goal is to offer a new program of “targeted” deposit insurance coverage for business payment accounts while simultaneously requiring more regulation to counter any moral hazard concerns.

The reality is the reforms would further entrench the federal government’s foothold in the banking sector, restrict businesses and households’ access to capital, significantly increase fees on banks, enfeeble economic growth, exacerbate moral hazard, and fail to fully stymie financial instability.

The growth of uninsured deposits at banks is a product of over a decade of the Federal Reserve’s (Fed) easy monetary policy that essentially created an artificial bubble of free financing for crypto and tech firms. These firms stored their excess cash in deposits at SVB and Signature. Both banks were sector-specific, and their clientele was not diversified—unlike the more mainstream banks that have yet to experience any turmoil. It is wrong for the FDIC to assume that a rise in uninsured deposits is systemic and justifies the need for excess deposit insurance.  

Business Payment Accounts

The report envisions that business payment accounts could be covered under a program similar to the Transaction Account Guarantee (TAG) program. The TAG program was originally created in response to the 2008 financial crisis using the regulator’s “systemic risk exception.” The TAG program insured non-interest-bearing accounts. In 2012, however, Congress did not reauthorize TAG because Senate Republicans opposed it for being the antithesis of free market policy. TAG also reduced market discipline, and if it had been extended, there would have been “less private sector control of bank risk-taking.” Now, the FDIC wants to introduce a new TAG program for business accounts. This program cannot be created unilaterally by the FDIC. Congress would have to pass legislation. However, resurrecting TAG, or any programs like TAG, should be vehemently opposed by lawmakers. Any legislation that would increase deposit insurance, even for business accounts, would carry moral hazard risks, and propagate future risk-taking.

Increasing deposit insurance above $250,000 for business accounts is not feasible. In the report, the FDIC points out the difficulty in defining “business payment accounts.” Knowledgeable depositors can find ways to get around a loose definition and take advantage of the insurance, such as by using bank sweep accounts. More insured deposits will mean banks will have to pay more fees to shore of the Deposit Insurance Fund (DIF), which is required to maintain a statutory ratio of 1.35 percent of all insured deposits. If bank fees go up, bank customers will face higher costs, which means taxpayers will face higher costs.

Many small business accounts are already covered under the current deposit insurance framework. Less than “one percent” of bank accounts have more than $250,000. Most small businesses are already covered by the current deposit insurance threshold. A survey of 600,000 small businesses found that their median bank balance is $12,100—far below the current $250,000 threshold. Additionally, Americans have a median savings account balance of about $5,300 while Black and Hispanic Americans have median bank account balances of approximately $1,500 and $1,900, respectively. Any new increase in coverage for business accounts would only benefit the wealthy.

The FDIC admits in its report that larger depositors are already covered because of “the presence of brokered deposits, sweeps, and reciprocal deposits.” If these techniques already allow depositors to effectively be insured above $250,000, then there is no reason extra insurance is needed. It also contradicts the FDIC’s other claim that “business payment accounts are least able to take advantage of insurance across banks in the current system.” Additionally, there are 14 different ownership categories, each of which gets insured up to $250,000 (the deposit insurance limit is $250,000 per depositor, per bank, per ownership category). Businesses can store deposits under different ownership categories and have more than $250,000 in deposits insured. Businesses already have access to insurance above the $250,000 limit.

The FDIC’s proposed insurance threshold of $2.5 million for small businesses would fail to stop runs. Footnote 129 of the FDIC report admits that even if the deposit insurance limit had been $2.5 million when SVB failed, it would not have made a material difference—a run still would have occurred. This defeats the purpose for proposing a targeted increase in the deposit insurance limit. It also further shows that increases in the limit would only benefit the wealthiest Americans.  

Regulation

The report argues for more regulation at the expense of economic growth. For example, the report wrongly proposes regressive interest rate controls on deposits. The process of repealing Regulation Q, which took place from 1980 to 2011, removed distortive restrictions on the amount of interest rates banks can pay on certain deposits. This deregulation has been a boon for consumers. The FDIC’s proposal to turn back the clock would be a mistake.

The report also proposes mandates for banks to issue more long-term debt that can be converted into equity to cover losses in the event of a bank failure. In an environment of higher interest rates, this debt, or total loss-absorbing capacity (TLAC), would increase leverage at banks, making them less stable, not more. This overreach by the Biden administration is nothing more than another avenue for the federal government to dictate how banks should finance themselves and prepare for difficult economic fluctuations.  

More regulations to restrict risk-taking is a gross expansion of government power. This will only make the U.S. banking sector more dependent on government guarantees and financial backing.

Moral Hazard

Deposit insurance weakens banks’ capital structure. According to Mark Calabria, “not only does the provision of deposit insurance reduce the cushion of equity in banks, it also increases the variance (risk) of their investments. Thus, both the asset and liability sides of the bank balance sheet are distorted in destructive ways by deposit insurance.” According to another paper, deposit insurance “reduces the marginal benefit of maintaining capital.” Moreover, Calabria points out that because of the reduced capital, “shareholders seeking greater returns on equity will shift toward banks with higher leverage.” Greater leverage leads to more financial instability, not less.

The Fed has acknowledged that insuring all depositors at SVB and Signature worsened moral hazard. According to the Government Accountability Office’s (GAO) preliminary report on the bank failures, Fed “staff raised concerns about exacerbating moral hazard and potentially weakening the market discipline of many depository institutions.” Additionally, GAO pointed out that its report from 2010 showed that regulators’ use of the systemic risk exception “may weaken market participants’ incentives to properly manage risk if they come to expect similar emergency actions in the future.” The 2010 report also states that expanded deposit insurance “could weaken incentives for newly protected, larger depositors to monitor their banks, and in turn banks may be more able to engage in riskier activities.” The GAO was incredibly prescient.

The report is an attempt to divert attention away from the FDIC’s own failures. According to the GAO’s preliminary report on SVB and Signature, as early as 2011, GAO warned the FDIC and other regulators about issues with properly escalating “supervisory concerns.” The prompt corrective action framework, “which was designed in 1991 to improve regulators’ ability to identify and promptly address deficiencies at depository institutions and minimize losses to the Deposit Insurance Fund—did not result in consistent actions to elevate concerns.”

Simple bank accounting tweaks offer more transparency and could alleviate risks of bank runs. Charles Calomiris and Phil Gramm, point out that a better alternative to expanding deposit insurance and regulatory authority is requiring “all assets held by banks to be marked to market.” This is less onerous and offers more transparency on the market value of longer-dated securities.

Conclusion

If the FDIC’s reforms were fully enacted by Congress, it would further subject the banking sector to government control and eventual nationalization. These policy proposals must be rejected by lawmakers.

New legislation and regulation will not solve future bank instability. Regulators need to come to terms with their own supervisory failures and understand they already have all the tools they need. First, they need to figure out how to properly do their job.

Fortunately, a large coalition of over 20 free market organizations have already conveyed to Congress their strong opposition to any enhancement to deposit insurance.