April 11, 2023
Bank Failures: The FDIC’s Systemic Risk Exception
When Silicon Valley Bank (SVB) and Signature Bank
depositors would spread to other banks, causing a broader
failed, the Treasury Secretary, the Federal Deposit
crisis that could be detrimental to the real economy.
Insurance Corporation (FDIC), and the Federal Reserve
(Fed) announced on March 12, 2023, that the FDIC would
Under the 1991 law, LCR can be waived under the systemic
guarantee uninsured deposits at those banks under the
risk exception when five statutory requirements have been
statutory systemic risk exception to least-cost resolution
met: (1) The Treasury Secretary, in consultation with the
(LCR; 12 U.S.C. §1823(c)(4)(G)). (See CRS Insight
President and upon a written recommendation of at least
IN12125, Silicon Valley Bank and Signature Bank
two-thirds of the boards of the FDIC and Fed, determines
Failures.) The FDIC insures deposits up to a statutory limit
LCR “would have serious adverse effects on economic
of $250,000. (See CRS In Focus IF12361, Deposit
conditions or financial stability” and the FDIC’s actions
Insurance and the Failures of Silicon Valley Bank and
would avoid or mitigate those effects. (2) Any loss to the
Signature Bank.) Currently, the FDIC projects that the two
FDIC must be repaid through a special assessment on banks
resolutions will cost the FDIC $22.5 billion. The two
by the FDIC. In levying this assessment, the FDIC need not
banks’ combined estimated uninsured deposits were $231.1
follow normal deposit insurance assessment rates and may
billion in 2022. Under LCR, at least some of these losses
consider who benefited from the action and the effects on
would have been borne by uninsured depositors.
the banking industry (as amended by P.L. 111-22). In
testimony, FDIC Chair Martin Gruenberg confirmed that
FDIC Least-Cost Resolution
the FDIC will be levying a special assessment in this case.
When a bank fails, it does not enter the bankruptcy process
(3) The Treasury Secretary must document the decision. (4)
like other businesses to resolve creditors’ claims. Instead, it
The Government Accountability Office (GAO) must review
is taken into receivership by the FDIC, which takes control
the incident. (5) The Treasury Secretary must notify the
of the bank and resolves it through an administrative
congressional committees of jurisdiction within three days.
process. Costs to the FDIC associated with a resolution are
funded by drawing on the FDIC’s Deposit Insurance Fund,
Before 1991, the FDIC considered several goals, including
which is funded through assessments on banks and backed
cost, in determining how to deal with a troubled bank. As
by the U.S. Treasury. (See CRS In Focus IF10055, Bank
such, LCR, even with the exception, represents a constraint
Failures and the FDIC.)
on its pre-1991 authority. The FDIC can take a number of
actions under the exception, but it can be used only in an
A banking crisis in the 1980s was more costly to the FDIC,
FDIC receivership.
and ultimately the taxpayer, because of the frequent use of
regulatory forbearance—allowing troubled banks to stay
Previous Uses of the Exception
open—which in many cases increased the losses that they
Before 2023, GAO reported five planned uses of the
suffered before they were ultimately shut down. In some
systemic risk exception since 1991, all occurring between
cases, the FDIC used open bank assistance to provide funds
September 2008 (in the depths of the financial crisis) and
or guarantees to troubled banks to keep them going rather
March 2009.
than taking them into receivership.
1. Wachovia. The FDIC sought a buyer to prevent the
Following the crisis, Congress reformed how the FDIC
imminent failure of Wachovia, the fourth-largest U.S.
resolves banks in 1991 (P.L. 102-242). This act introduced
bank. Citigroup made an offer to acquire Wachovia
prompt corrective action and LCR requirements as
under which the FDIC would partially guarantee $312
cornerstones of resolution. These two principles are
billion of Wachovia’s assets using the systemic risk
intended to minimize resolution costs by ensuring that
exception. The FDIC initially accepted this offer but
banks are resolved as quickly and inexpensively as
subsequently rejected it in favor of a competing offer
possible. As such, uninsured depositors and other creditors
from Wells Fargo that required no FDIC assistance.
can be repaid in a resolution only insofar as it is consistent
2. Citigroup. Concerned that Citigroup, the third-largest
with LCR, unless the systemic risk exception is invoked.
U.S. bank, would fail and exacerbate the financial
What Is the Systemic Risk Exception?
crisis, policymakers decided to provide an assistance
package involving the Fed, the FDIC, and the Troubled
Systemic risk is financial market risk that poses a threat to
Asset Relief Program (TARP). As part of this package,
financial stability. (See CRS In Focus IF10700,
the FDIC used its systemic risk exception to provide
Introduction to Financial Services: Systemic Risk.) In the
open bank assistance in the form of a partial asset
case of SVB and Signature, the FDIC, Fed, and Treasury
guarantee for $306 billion of Citigroup’s assets. This
Secretary were concerned that a run by uninsured
guarantee (joint with the Fed and TARP) never paid
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Bank Failures: The FDIC’s Systemic Risk Exception
out, and the government received compensation in the
potential risks. This way, financial conditions can be
form of stock and warrants.
stabilized before a crisis spirals out of control. In this case,
3. Bank of America. A similar partial asset guarantee for
guaranteeing uninsured deposits may have prevented a
$118 billion of assets was offered to Bank of America,
broader deposit run that could have caused other banks to
the second-largest bank, for similar reasons but was
fail. Broad, discretionary powers come at a cost, however.
never finalized. Bank of America paid the government
Policymakers may have “itchy trigger fingers” and
a termination fee to cancel the guarantee when
intervene before the need has been proven. In this case, the
financial market conditions stabilized. Unlike with
failure of two mid-sized banks, in isolation, posed little risk
Wachovia and Citigroup, the exception was invoked in
to the economy or financial system. It may be that other
anticipation of market pressure on Bank of America
banks could have fended off the pressure of withdrawals on
before it occurred.
their own and conditions could have stabilized.
4. FDIC’s Temporary Liquidity Guarantee Program.
The downside to intervening is the cost to the government
To help banks remain liquid during the financial crisis,
and moral hazard—the concept that when individuals or
the FDIC created this two-part temporary program—
businesses are protected from losses they will act more
the Debt Guarantee Program (DGP) and the
recklessly. In this case, SVB and Signature and their
Transaction Account Guarantee Program (TAG). Both
leadership and shareholders were not “bailed out,” as the
programs were voluntary but automatic unless banks
banks were closed, but uninsured depositors were. Congress
opted out. Under DGP, the FDIC guaranteed certain
set a deposit insurance limit in part because there is an
debt issued by banks between October 2008 and
expectation that depositors above the limit should be
October 2009. Under TAG, the FDIC guaranteed non-
financially sophisticated enough to monitor their banks’
interest-bearing deposit accounts (primarily owned by
riskiness (i.e., impose market discipline). By using the
businesses and local governments) above the deposit
systemic risk exception, policymakers have signaled that
limit. Both programs charged participating banks fees
uninsured depositors and their banks need be less concerned
to cover potential costs.
about risk taking going forward. (The systemic risk
5. Public Private Investment Program (PPIP).
exception was not used to protect the banks’ debtholders or
Treasury created the Legacy Loan Program within
shareholders, so debtholders at other banks arguably still
TARP’s PPIP. Under this program, the FDIC would
have an incentive to monitor risk taking.)
have partially guaranteed “legacy loans” acquired by
PPIP. The program never progressed beyond a pilot
Guaranteeing uninsured depositors also shifts the costs of
phase.
the resolution to banks that did not fail. In a counterfactual
Of the five cases, only the TAG program resulted in net
where all deposits had been insured, banks including SVB
costs to the FDIC. Assistance to Citigroup, Bank of
and Signature would have pre-funded the deposit insurance
America, and the DGP resulted in positive net income to
fund ex ante to a size sufficient to absorb the costs of
the FDIC or the government as a whole. (A special
guaranteeing all deposits. Instead, those costs must be
assessment was not levied for TAG because its net income
recouped ex post. But the FDIC is required to consider who
was considered jointly with the DGP.) In the cases of
benefited from the intervention when levying assessments.
Wachovia, Bank of America, and PPIP, the proposed action
never occurred. (See CRS Report R43413, Costs of
A long-standing moral hazard concern is that some banks
Government Interventions in Response to the Financial
are “too big to fail,” meaning that their failure could result
Crisis: A Retrospective.)
in financial instability, which would result in government
bailouts to prevent them. Although SVB and Signature
None of these five episodes involved a bank in FDIC
were taken into receivership, the use of the systemic risk
receivership. (Wachovia would have been an FDIC-assisted
exception at two institutions that few previously believed
open bank transaction.) Although the exception was clearly
were TBTF supports those concerns. In addition to moral
intended to be a bank resolution tool, policymakers used the
hazard concerns, TBTF could potentially put small banks at
authority at the time to justify two crisis programs that were
a competitive disadvantage if uninsured depositors believe
open to all banks, including healthy ones. In 2010, the
their deposits are safer at large banks because the systemic
Dodd-Frank Act (P.L. 111-203) limited the systemic risk
risk exception would be invoked only for a large bank.
exception to receiverships to rule out its future use for
broadly based programs. It provided separate authority for
The first use of the systemic risk exception since it was last
future debt guarantee programs and temporary authority for
amended in 2010 raises questions about whether additional
a TAG program that was not renewed when it expired.
legislative changes are warranted. Policymakers’ discretion
could be narrowed, but it might impede their ability to
Policy Issues
quickly and flexibly respond to a crisis. Nevertheless, the
The systemic risk exception is a recognition by Congress
Dodd-Frank Act added more parameters to the Fed’s
that financial stability concerns sometimes trump the desire
emergency lending authority (12 U.S.C. §343) concerning
to minimize potential costs to the taxpayer. Financial crises
when and how that authority should be used—and what
impose economic costs that can far exceed resolution costs
should be reported to Congress—compared to the FDIC’s
to the FDIC. Because systemic risk is unpredictable and fast
exception. Those changes did not prevent the Fed from
moving, emergency tools such as the systemic risk
responding aggressively to the COVID-19 pandemic or
exception have been crafted to give policymakers broad,
from creating a new emergency program following the
discretionary powers to respond quickly to a range of
failures of SVB and Signature. Legislative changes to bank
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Bank Failures: The FDIC’s Systemic Risk Exception
regulation or deposit insurance could also change the
Marc Labonte, Specialist in Macroeconomic Policy
likelihood of the systemic risk exception being used again.
IF12378
Disclaimer
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https://crsreports.congress.gov | IF12378 · VERSION 1 · NEW