One year after the failures of Silicon Valley Bank and Signature Bank, there are once again fears that a new banking crisis is on the horizon due to stress in the commercial real estate sector, along with calls to increase the FDIC deposit insurance limit.
The current FDIC limit stands at $250,000 per tax ID, per institution. It was implemented as a temporary increase at the beginning of the financial crisis, and then made permanent in 2010. To some this may seem relatively recent in regulatory terms. However, when looking at the current deposit situation, calls to modestly increasing the limit may be well-founded.
When the last FDIC insurance increase was made, there were $7.2 trillion in deposits in the US banking system of which $2.7 trillion or 36.7 percent were uninsured. Today, there are over $17.4 trillion in total deposits of which $7.7 trillion or 44.3 percent is uninsured. Depositor risk increases as uninsured deposits as a percentage of total deposits rise.
Those calling for an unlimited FDIC coverage amount are not properly considering the costs or downstream consequences of that action. First, unlimited coverage would remove the key incentives for banks to carefully manage their loan risk profile as a mechanism to protect depositors. Too many low-quality loans will lead to systemic instability as we saw during the 2008-10 crisis. Second, funding unlimited deposit insurance will overly burden all banks and render the banking system unworkable.
A very short history of FDIC limits and assessments
FDIC-insured deposits are protected via coverage from the agency’s Deposit Insurance Fund. This fund receives its income via fees assessed on FDIC-insured banks as part of their yearly assessment. Assessment rates are based on the health and safety rating of each bank — the more at risk a bank is, the higher the assessment fee. Assessment fee increases have varied over the years, based on both capitalization and CAMELS scores, and overall have trended in an upward direction.
Increased costs impact all banks. However, increased costs usually impact smaller banks the hardest. Numerous times throughout the last 25 years, debate has been had over the size of the fund as well as how assessment fees should be calculated. Inevitably, the idea of “fairness” has come out on top, with large banks arguing that there should be no difference in the way assessment fees are calculated based upon institution size. But is that the right solution?
Community banks and the Deposit Insurance Fund
The community banking system is an integral part of the overall US economy. Community banks are the backbone of many cities and towns across the US, and play a vital role in lending for small businesses in their communities which contributes to the overall success of these areas. Currently, these institutions, although smaller overall, face the same assessment fee schedule as large banks, which is based on their overall capitalization and supervisory reports.
If we are to increase the size of the DIF, we can only do that via increased fees, or mandatory “surcharges.” That is an unpopular solution across the board, but particularly with smaller banks. An alternative solution for this could be increasing assessment fees on banks over a certain size. At this point, the nation’s top institutions are functionally “too big to fail.” While this does not guarantee full protection on deposits, many could argue that it’s implied given government behavior during the financial crisis.
This perception continues to result in deposits moving away from community banks towards larger institutions during times of uncertainty. Given this, a reasonable argument could be made that the largest banks should shoulder the burden of a modest assessment fee rate increase compared to their smaller counterparts.
However, in the interest of not overburdening these banks and keeping the increases to a minimum, increased FDIC coverage could be limited to specific types of accounts — non-interest-bearing accounts, and for a specific period. This would protect depositors, and the community banks we so desperately need.
Additionally, regulators and legislators could look at increasing protection only on operating accounts for businesses, ensuring that in the event of a bank failure, employers could still make payroll and pay vendor invoices. This was one of the primary concerns during the failure of Silicon Valley Bank, with many companies spending days wondering how they were going to pay employees.
A complex solution
This is one option of many which have been hotly debated, and surely there are multiple second- and third-order consequences which must be evaluated prior to instituting additional fees. There are non-fee steps banks can take to help address the issue of a limited DIF, such as educating depositors on FDIC insurance, and evaluating deposit requirement practices that make our system less stable. It’s also important to note that increasing FDIC coverage overall creates a higher moral hazard risk and makes it less dangerous for banks to engage in risky loan practices.
This debate is sure to continue, and we must be prepared to discuss solutions that consider all the facts of our current economic climate. It’s vital to keep our community banks healthy and thriving.
Thomas is Chief Strategy Officer at deposit management services firm Ampersand.