After the recent collapses of Silicon Vally Bank parent SVB Financial and Signature Bank, there have been calls for some form of blanket insurance on all U.S. bank deposits. After all, one of the things that prompted the runs on SVB and Signature was the realization by their customers that so much of the money they had deposited with those institutions was not insured by the Federal Deposit Insurance Corp. (FDIC). The Mid-Size Bank Coalition of America has already asked regulators to insure all U.S. deposits for the next two years in an effort to prevent additional bank runs.
While I don't know what the best solution to this problem would be, the decision over whether to insure all U.S. deposits has political, social, and economic ramifications. Let's take a look at some of the pros and cons of blanket deposit insurance, and weigh what steps regulators and lawmakers should take next, if any.
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Pro: It would level the playing field
The desire for blanket insurance is perfectly understandable if you look at it from the perspective of America's community and regional banks. During the Great Recession, the largest banks played a much bigger role in blowing up the economy than the community and regional banks did -- not that those smaller players were blameless.
But regulators realized that allowing too many of these large banks to fail could destroy the financial system and cause a gigantic depression. So a lot of the most-troubled lenders were forced to merge with other large banks, making the survivors even bigger and even more insulated against failure because the U.S. and global economy simply can't afford to have them fail.
People know this now, so when SVB and Signature failed, the top 25 U.S. commercial banks saw $67 billion in deposit inflows while smaller banks saw a record $119 billion of outflows. People and companies that have patronized smaller institutions are worried about losing their money or not being able to access it for a period of time if there's a run on their bank. Many of them are responding by moving their money to a bank that simply can't fail.
This is really quite unfair because the large banks tend to be at the heart of most bank crises, yet arguably, their competitive moats increase in strength every time a crisis occurs because people perceive them as being the safer choice.
Con: The potential unknown consequences
Big policy moves made to solve one pressing problem can sometimes put wheels in motion that lead to behaviors that eventually trigger an entirely different crisis down the line. Government and central bank policy decisions have certainly contributed to the conditions that produced past bank crises, and this is really an issue in other industries as well.
But an obvious concern about blanket deposit insurance is that it could encourage bank executives to be overly aggressive with how they deploy deposits and make them more willing to stretch for profits, knowing that even if they mess up, the depositors are safe. Now, I am sure a raft of new regulations are coming, and banks are already limited from investing any significant amount of customer deposits into riskier places like venture capital or hedge funds, but this is definitely a valid concern, and one that should be examined closely.
There's also the question of who would end up paying if all deposits needed to be covered. Currently, all banks pay annual assessment fees to the FDIC to insure deposits of up to $250,000 per depositor. The FDIC's Deposit Insurance Fund only had $128 billion in it at the end of 2022, and there's expected to be a $23 billion drawdown from it to cover the failures this year.
A logical next move
In my opinion, economists and regulators need to spend more time studying the potential impact of blanket deposit insurance. It's not a solution that should be rushed into.
I also believe confidence will rebound in the smaller and regional banks, which are really a necessity for the U.S. economy considering all of the lending they do, their niche expertise that allows them to better serve certain industries and markets, and the fact that under the current regulatory regime, it's hard for the "too big to fail" banks to get too much bigger too quickly.
But one thing lawmakers and bankers should seriously consider is raising the FDIC deposit insurance threshold from $250,000 per depositor, which was set in 2010, to at least $500,000 per depositor, or maybe even $1 million. While the costs would be higher for banks, they would likely be manageable, and I'm sure more bankers would be open to the idea, especially if it helps shore up depositors' confidence in most of these institutions.
Take a look at First Republic (FRCB), which recently experienced deposit outflows of $70 billion, according to news reports. In an investor presentation at the end of 2022, the bank said the average business deposit balance at First Republic was $490,000, and business deposits made up 63% of total deposits. A sizable portion of the bank's deposit run might have been avoided if the FDIC covered balances up to $500,000. I also think it makes sense to revisit deposit insurance every so often and make sure it keeps up with the country's increase in disposable wealth, income per capita or some other metric -- not to mention inflation. Just for perspective, it takes almost $350,000 today to buy what $250,000 bought 13 years ago.
There are also private industry solutions that could help the cause. For instance, IntraFi operates a network of financial institutions to help depositors access multimillion-dollar FDIC insurance through one banking relationship. Perhaps more private insurance solutions will pop up. In Massachusetts, a private industry association called the Depositors Insurance Fund covers deposits in excess of $250,000 at 74 community banks across the state.
While blanket insurance will likely be an ongoing topic of debate, I do think there are plenty of actions that could be taken in the near term to shore up confidence.
