Boosting deposit insurance would make banks safer

OPINION:

When the Trump administration and Sen. Elizabeth Warren agree, a skeptical eye is warranted. However, sometimes they are onto something, and raising the ceiling on Federal Deposit Insurance Corp. coverage is a prime example.

After the 2008 global financial crisis, the ceiling on individual and business checking accounts was lifted from $100,000 to $250,000. Since then, the cash needs of startups and smaller businesses have increased.

Silicon Valley Bank, which failed in 2023, primarily served high-tech startups and other niche groups, such as wineries. The former often raise capital through major equity rounds and bank the proceeds to shell out as needed to meet expenses.

About 94% of SVB deposits exceeded the $250,000 limit.

SVB clients required lots of specialized services but didn’t often seek large bank loans. Consequently, 35% of SVB assets were loans, and more than half were invested in secure Treasury and government agency bonds.

As the Federal Reserve raised interest rates in 2022, the market value of long-dated, high-quality securities fell even though they pay out in full at maturity. This phenomenon is known as interest rate risk.

Sens. Bill Hagerty, Tennessee Republican, and Angela Alsobrooks, Maryland Democrat, have introduced a bill to increase the FDIC limit on non-interest-bearing checking accounts, where many small businesses keep their working capital, to $10,000,000 at all but the largest banks.

The latter are globally systemically important banks that were made essentially too big to fail by regulatory reforms imposed in the wake of the 2008 global financial crisis and include familiar names such as Citigroup and J.P. Morgan.

Those are subject to annual stress tests and to larger capital requirements, and they maintain resolution plans to wind down operations should they become insolvent. Through this framework, the federal government implicitly acknowledges that globally systemically important banks are too big to fail, making them more attractive to large customers than regional banks.

In mid-October, Zions Bancorporation and Western Alliance Bancorp reported losses on loans owing to alleged fraud by borrowers, and their stocks fell significantly.

Regional banks generally took a big hit. The Dow Jones Select Regional Bank Index fell nearly 7% from Oct. 14 to 16.

The individual stocks and the overall index rebounded, but investors remain nervous about conditions in credit markets after the bankruptcy of private lender Tricolor.

Similarly, after Silicon Valley Bank experienced a run and failed, a contagion spread to Signature Bank and First Republic Bank.

Had SVB deposits been insured at a much higher level, it might not have failed.

SVB had a solid loan book. Apollo, Blackstone and others expressed interest in purchasing it.

Ultimately, the SVB was merged into First Citizens Bank & Trust Co. with assistance from the FDIC. Similarly, most of the assets, deposits and branches of Signature Bank were acquired by Flagstar Bank, and J.P. Morgan absorbed most of First Republic Bank

Deposits were honored in full by the FDIC and financed by a special assessment on member banks.

Critics of a higher ceiling for deposit insurance assert it would encourage large depositors to be careless in choosing banks. It would cause banks to take imprudent risks — so-called moral hazards. A higher insurance ceiling would require more regulations for regional and community banks with attendant higher compliance costs.

That’s foolish.

We can’t expect retirees with perhaps $2 million in savings — $500,000 in bank deposits and the balance in a ladder of bonds and stocks — to scrutinize balance sheets. The same applies to startups in the technology sector or entrepreneurs establishing, for example, a vineyard.

It’s beyond the expertise of those whose careers are outside finance or economics.

The Hagerty-Alsobrooks proposal would be much improved by including interest-bearing accounts and CDs where ordinary investors stash their cash.

Similarly, the stockholders and officers of insolvent banks get wiped out and lose their jobs too.

Treasury Secretary Scott Bessent supports a higher insurance ceiling to level the playing field between regional and globally systemically important banks, as well as a lighter regulatory burden.

SVB did not fail because it was run by lousy bankers.

SVB failed because the federal government undertook massive deficit-financed COVID-19 relief spending, and the Federal Reserve printed money to purchase the resulting new bonds.

Those set off the first rush of terribly high inflation in more than a decade. When the Fed responded by raising interest rates in 2022, it depressed the market value of SVB’s longer-term Treasury securities.

An alert bank examiner should have seen that SVB was at risk and needed to rebalance its portfolio.

In the wake of the SVB contagion, bank oversight has decidedly improved.

What is needed and hasn’t been proposed is establishing a Federal Reserve facility that would permit banks to borrow against the face value of their federal government and agency bonds. These are safe and will pay out in full at maturity.

• Peter Morici is an economist and emeritus business professor at the University of Maryland, and a national columnist.