DANGEROUS DECISIONS
The U.S. decision to protect all the depositors of Silicon Valley Bank and Signature Bank rendered the official ceilings on deposit insurance meaningless and put the public purse on the front line of defending the financial system.
If the world needs more deposit insurance, there ought to be a system of guarantees where customers paid for higher cover, and taxpayers shared the underwriting burden with the insurance industry.
U.S. authorities were unwilling to let SVB and Signature depositors take losses on sums above the $250,000 limit set by the Federal Deposit Insurance Corp. We don't know if the U.K. would have done the same for the local SVB subsidiary above the country's £85,000 threshold: A rescue by HSBC made the question moot.
The existing ceilings are set so that the average retail depositor has confidence in the system. Those with bigger holdings —businesses and high-net worth individuals — should either be wealthy enough to take a hit, or savvy enough to spread their cash across different institutions and products.
In practice, policymakers seem to struggle to maintain the distinction when there's a crisis. The tech industry did a good job of casting SVB's customers as deserving of support, raising the specter of startups failing to pay staff. Short-term payroll could have been met through providing emergency funds (backed by SVB collateral) so customers could have accessed, say, 50%-60% of their cash. Still, deposits were fully guaranteed. Failing to do so could have triggered bank runs elsewhere.
European regulators are quietly furious with their U.S. counterparts over the decision, the Financial Times reported. Small wonder. If banks and customers believe the authorities will bail out technically uninsured funds, large depositors will just give their cash to whichever bank pays most for it, encouraging risk taking by lenders.
And who pays for the super-sized backstop? In SVB and Signature's case, taxpayers aren't directly on the hook for any losses, as the banking sector is going to pay if SVB's assets prove insufficient to cover the tab. But this still means that well-run banks could end up covering the losses of badly run peers, and any such costs are likely to be passed onto customers.
The episode should spur the private sector to provide cover above the current limits, and to encourage depositors to buy it.
A run on a bank of SVB's size doesn't look like an uninsurable risk. Bank balance sheets may be complex but are arguably no more fiendish than the weather. There's already a mature market in insurance against banks defaulting so-called credit default swaps. Moreover, sizable bank failures are relatively rare (and might be even more infrequent with more developed deposit insurance).
Depositors could purchase cover up to a desired limit at the beginning of each year. The premium would reflect the risk of the institution and could reprice annually. That, in turn, would provide a signaling of the quality of the bank's management — contributing to nexus of checks and balances on risk taking.
The insurance industry already offers some protection for the wealth of highnet worth individuals. The Securities Investor Protection Corp. provides cover up to $500,000 in the event of a
Bank bailouts that go far past the standard FDIC limits set a precedent that puts taxpayers at profound risk.
brokerage's collapse, with "excess SIPC" insurance available privately on top.
Clearly, scaling up such products in banking is easier said than done. One worry is that increasing the interconnectedness of banking and insurance could exacerbate financial crises. Insurers would have to be ready to pay up at short notice rather than dragging their feet as is so often the case with a claim for property damage. That need for liquidity could push up the cost of policies. The same goes for the administrative expenses generated by the need for any direct-to-consumer policy to be regulated.
But it's naive to think the banking and insurance industries aren't closely linked today. Moreover, insurers already provide certain types of cover that pay out instantaneously for example, protecting small businesses from bad customers. The administrative burden could be efficiently borne by banks acting as intermediaries.
And so long as people assume they are covered anyway by the state, they won't feel the need to buy a policy. There may need to be some coercion — as with other types of insurance.
A public backstop will, ultimately, always be implicit given the scale of the issue. But as things stand, it feels like we are reverting to the idea that the taxpayer underwrites the financial system. More private-sector insurance might at least help us get back in the right direction.