Deposit Insurance and the Failures of Silicon Valley Bank and Signature Bank

Deposit Insurance and the Failures of Silicon Valley Bank and Signature Bank

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March 27, 2023
Deposit Insurance and the Failures of Silicon Valley Bank and
Signature Bank
Congress created the Federal Deposit Insurance
Assessments are calculated by multiplying a bank’s
Corporation (FDIC) in the wake of the Great Depression to
assessment base by its assessment rate. The base is defined
limit the losses depositors would face if their banks failed.
by P.L. 111-203 as average consolidated total assets minus
It did so to instill confidence in the banking system and
tangible equity. In other words, it is based on total
deter economically detrimental events such as bank runs.
liabilities. Title 12, Section 1817(1)(A) of the U.S. Code
This In Focus examines the role of deposit insurance in the
requires the FDIC to establish a risk-based system to
financial system and addresses policy considerations for the
calculate the assessment rate tied to an institution’s
118th Congress in the wake of recent turmoil in the banking
probability of causing a loss to the DIF. The way risk-based
system precipitated by the failures of Silicon Valley Bank
rates are calculated differs for larger and smaller
(SVB) and Signature Bank.
institutions. Section 1817(3)(B) requires the FDIC to set a
reserve ratio (DIF balance/estimated insured deposits) of no
Deposit Insurance
less than 1.35%. The FDIC is also authorized to impose any
When a bank fails in the United States, consumer deposits
special assessments necessary to maintain the DIF or repay
are guaranteed up to a certain amount by the government.
any amounts borrowed from Treasury to manage the cost of
This is designed to create trust in the banking system
a bank failure. Section 1824 allows the FDIC to borrow up
between consumers and institutions, and that trust is
to $100 billion from Treasury if needed to supplement the
intended to promote liquidity in banks by allowing them to
costs of bank failures. In this sense, the DIF is said to be
keep fewer reserves and make available more credit. Over
backed by the full faith and credit of the U.S. government.
time, the amount guaranteed by these insurance schemes
has increased, and today it is $250,000 per account (12
What Happens When a Bank Fails?
U.S.C. §1821).
The FDIC serves to protect depositors when a bank fails.
The FDIC typically resolves a bank by seeking an acquirer
Which Accounts Are Covered?
to purchase as many of the bank’s assets and liabilities as
A number of accounts are eligible for deposit insurance,
possible, thus minimizing the amount left in the
while others are explicitly not covered. Deposit insurance is
receivership. To do this, the FDIC uses a bidding process
limited to certain bank-offered products and accounts.
designed to end in the purchase and assumption of some or
Examples are shown in Table 1.
all of the failed bank’s assets, deposits, and certain other
liabilities. Occasionally, the FDIC will directly pay the
Table 1. Financial Accounts and FDIC Coverage
depositors up to the insured limits if it cannot find a
Examples of Types of Accounts/Products, by Coverage
reasonable purchase and assumption alternative.
Eligibility
Pursuant to Title 12, Section 1821(d)(11), of the U.S. Code,
Covered
Not Covered
the FDIC must prioritize the payout of certain claims on the
assets of the failed institutions. Similar to bankruptcy
Checking accounts, savings
Stock investments, bond
proceedings, when a payout occurs, there is a hierarchy of
accounts, money market
investments, mutual funds,
claims for the FDIC to follow, as detailed in Table 2.
accounts, certificates of
crypto assets, life insurance
deposit, and certain prepaid
policies, annuities, municipal
Table 2. Depositor Preference
cards
securities, safe deposit boxes
or their contents
By Order of Claims Paid by FDIC, First to Last
Source: FDIC.
Hierarchy of Claims
Notes: Depositors can own multiple insured accounts in different
FDIC Administrative Expenses
ownership categories, thereby protecting more than $250,000.
Insured Deposits
Who Pays for Deposit Insurance?
Uninsured Deposits
The FDIC relies on the Deposit Insurance Fund (DIF) to
facilitate deposit insurance payouts and to cover the cost of
General Creditors
resolving a failed institution. The DIF is funded in two
ways: quarterly assessments on banks and interest earned
Stockholders
on funds invested in U.S. government securities.
Source: 12 U.S.C. §1821(d)(11).
https://crsreports.congress.gov

Deposit Insurance and the Failures of Silicon Valley Bank and Signature Bank
How Are Banks Supervised for Deposit Insurance?
Recently, there have been a number of proposals for raising
Because the FDIC wants to minimize losses to the DIF and
the deposit insurance limit further. (Pursuant to Title 12,
prevent failures from disrupting financial stability, the
Section 1821(a)(1)(f), of the U.S. Code, the FDIC is
banking agencies supervise banks routinely to try to ensure
required every five years beginning in 2010 to assess
that they are operating in a safe and sound manner. With
whether an inflation adjustment to the limit is necessary and
respect to deposit insurance, assessment rates are
to report to Congress if it is. The next revision date is April
determined in part by how a bank is evaluated in its
2025.) One possible basis for this is that many of the
examinations process. In the 1970s, the banking agencies
accounts that are uninsured are business accounts, which
adopted a “Uniform Financial Institutions Rating System”
are used for a number of things, such as payroll.
to evaluate banks. This system has been updated several
times over the years and comprises six elements that bank
While P.L. 111-203 restricted the FDIC from reinstating
examiners assess: capital adequacy, asset quality,
TAG, Congress could establish a similar guarantee on
management, earnings, liquidity, and sensitivity to market
transaction accounts. Because businesses use these accounts
risk (abbreviated as CAMELS). Bank examiners assess
to manage cash for purposes such as payroll, it is feasible
each component and derive an overall rating for the bank
that guaranteeing all of these types of accounts could
(from 1 to 5, with 1 being the best), and that rating is used
protect payroll operations and limit moral hazard, since
to determine the total assessment rate.
these accounts do not offer interest rates that incentivize
depositors to move funds.
Policy Issues
The recent failures of SVB and Signature Bank have raised
Another option is to raise the entire limit or even make it
a number of policy questions, which are explored below.
unlimited. It is reasonable to expect something like this to
reduce the risk of bank runs. However, it would erode
Is the Current Deposit Insurance Limit Sufficient?
market discipline from depositors, and it could be costly to
The typical bank customer holds much less than $250,000
banks. The FDIC would need to adjust its assessment base
in a covered bank account. Thus, runs among banks that
to provide substantially more funds to the DIF to guarantee
mostly provide traditional checking account services is
all deposits. As of December 2022, around 50% of the $19
unlikely. However, larger institutions, particularly those
trillion deposit base was insured.
with a concentration of corporate and business accounts,
may hold a significant portion of deposits that exceed the
The DIF reserve ratio dipped below its statutory minimum
$250,000 limit. This was the case with SVB and Signature
in June 2020 due to a spike in insured deposits during the
Bank. Around 90% of both banks’ deposit base was
pandemic. The FDIC, subsequently, enacted a plan to
uninsured. Because of the swift nature of the banks’
restore the ratio to 1.35% by 2028. In October 2022, the
deterioration, their size, and the fear that a run would spread
FDIC raised assessment rates in part to restore the DIF.
to other banks, the federal banking agencies decided to
While this action was taken to meet a statutory requirement,
protect all of the banks’ depositors, both insured and
some banks opposed it on the basis that deposit levels were
uninsured, by invoking its systemic risk exception to least
normalizing, and thus the DIF ratio would return to its
cost resolution.
minimum without a change in assessments. In addition,
special assessments might be needed to replenish the DIF if
Some have asked: What is the point of a deposit insurance
losses from resolution were sufficiently large.
limit? The FDIC’s statutory requirement is to protect the
DIF from loss, not to prevent banks from failing. Thus, a
Regardless, if the FDIC were to provide insurance coverage
key question is which poses a more likely loss to the DIF:
to all deposits, it would need to increase the DIF
protecting uninsured deposits in the short run or the
sufficiently to cover another $9 trillion or more in deposits.
potential for further bank runs. The flip side of this policy
Moreover, if uninsured depositors were to be made whole
tradeoff is at the heart of the economic debate around the
in any failure going forward (based on the response to SVB
virtues of market discipline (whereby depositors incentivize
and Signature Bank), at least for large banks, then
banks to operate in a safe way by removing deposits in
increasing the size of the DIF before—instead of after—
response to banks’ reckless behavior) in preventing moral
another bank fails would reduce the chance that the DIF
hazard (whereby banks are free to take more risks, because
would be exhausted. This approach could also be more
they do not bear the downside of those risks).
equitable for healthy banks and small banks, as uninsured
depositors may shift to large banks in the belief that the
Historically, quelling a bank crisis has motivated
FDIC will rescue only large bank customers in a failure.
policymakers to protect both uninsured and insured
depositors. During the 2007-2009 financial crisis, the FDIC
Another option is to eliminate or narrow the FDIC’s
implemented a temporary unlimited guarantee on certain
systemic risk exception, which would reduce moral hazard
transaction accounts (called the TAG Program). The FDIC
and increase market discipline but would increase the
also temporarily guaranteed certain debt products to shore
incentive for bank runs, which pose systemic risk.
up liquidity at the banks. Additionally, before the deposit
limit was permanently raised to $250,000 (P.L. 111-203),
CRS Resources
Congress temporarily expanded the limit from $100,000 to
CRS Insight IN12125, Silicon Valley Bank and Signature
$250,000 in an attempt to calm depositor fears.
Bank Failures, by Andrew P. Scott and Marc Labonte
https://crsreports.congress.gov

Deposit Insurance and the Failures of Silicon Valley Bank and Signature Bank
CRS In Focus IF10055, Bank Failures and the FDIC, by
Andrew P. Scott, Analyst in Financial Economics
Raj Gnanarajah
IF12361

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