What Happens If Another Bank Fails?

This article discusses “What Happens If Another Bank Fails?” in the background of the recent emergency decision made by Federal Regulators to guarantee the deposits of Silicon Valley Bank & Signature Bank, & its implications for the broader banking system. It also explores the role & mission of the Federal Deposit Insurance Corporation (FDIC), deposit insurance, & how it works. Further, this article also delves into the reasons behind the decision to guarantee all deposits & the powers that regulators have in case of another bank failure.

Introduction To What Happens If Another Bank Fails?

Earlier in March 2023, the Federal Regulators had an emergency meeting and decided to Guarantee all the depositors of Silicon Valley Bank and Signature Bank. This means all the depositors who had deposits in this bank, regardless of how much was in their accounts, will get back their money.

This decision is on the premise that it would prevent a broader run on banks – said the regulators. This intervention has raised several questions among banks, depositors, and even lawmakers. This has also prompted questions about the Government’s deposit insurance program (i.e. FDIC). One of the major questions which arise in everyone’s mind is what would happen if another bank fails. Let’s unravel more about this Deposit Insurance.

What is Federal Deposit Insurance Corporation (FDIC)?

In 1933, the Federal Deposit Insurance Corporation (FDIC) was established as an independent federal government agency. This was established in response to thousands of bank failures that took place in the 1920s and early 1930s. Then President Franklin D. Roosevelt signed the Bank Act of 1933, on 16th June, 1933. A part of which created the FDIC.

What is the Mission and Main goal of FDIC?

According to FDIC, “The main objective of the Federal Deposit Insurance Corporation (FDIC) is to maintain stability & public confidence in the nation’s financial system.”. The Main goal of FDIC is to insure deposits, examine and supervise financial institutions’ soundness and safety (for consumer protection), orderly resolution of failing banks and manage receiverships (i.e. receiver of failed banks)

From where does the FDIC get money?

There are no Congressional Appropriations for FDIC. In other words, there is no budget allocation from the Federal Government. The FDIC is funded by premiums that banks and saving associations pay for deposit insurance coverage. The FDIC insures trillion of bank deposits in U.S. Banks and thrifts.

What is Deposit Insurance?

FDIC Charges a Fee from all the banks and FDIC insures all bank accounts up to $ 250,000. For a jointly owned by a couple (i.e. Joint Account) the insurance amount is $ 500,000.

What does this mean and purpose of this insurance?

This means if your bank fails, then the FDIC will guarantee you get your money back up to a point – i.e. the insured amount. The main purpose of this insurance is to mitigate the possibility of bank runs by giving bank customers the certainty that their money is safe, even if their bank is out of business.

How many percentages of Deposits are insured?

According to FDIC, approximately 57% of Deposits are insured. Many accounts in the uninsured categories are deposits from the business which are used to make payroll and pay operating expenses.

Why did regulators guarantee all deposits in the two failed banks?

The reason why officials of the Federal Government (both the Treasury Department and the Federal Reserve), and the FDIC guaranteed is they were worried that anything short of a guarantee on all Deposits at Silicon Valley Bank and Signature Bank may lead uninsured depositors at other institutions to withdraw their money, which would result in a snowball of bank failures.

On March 22, Fed Chair Jerome Powell stated in a Press Conference that “That is why, in response to these events, the Federal Reserve, working with the Treasury Department and the FDIC, took decisive actions to protect the U.S. economy and to boost public trust in our banking system.” He further added that “These actions demonstrate that all depositors’ savings and the banking system are safe. With the support of the Treasury, the Federal Reserve Board established the Bank Term Funding Program to ensure that banks that hold safe and liquid assets can, if necessary, borrow reserves against those assets at par.”

For the question of Why did regulators guarantee all deposits above they stated that “The issue was really not about those specific banks, but about the risk of a contagion to other banks and to the financial markets more broadly. That was the issue”

When the regulators think that a failed bank is putting the entire financial system in jeopardy then they use special emergency powers to save the system.

Whether these powers can be invoked again?

Yes, these powers can be invoked again if the regulators feel that another bank failure is putting a financial system at risk.

On the 21st March, 2023, at the American Bankers Association’s Washington DC Summit, Secretary of the Treasury Janet Yellen, stated that “The steps we took were not focused on aiding specific banks or classes of banks. Our intervention was necessary to protect the entire U.S. banking system. And similar actions could be warranted if smaller institutions experience deposit runs that pose the risk of contagion. I believe that our actions reduced the risk of additional bank failures that would have resulted in losses on the Deposit Insurance Fund, which is paid for through fees levied on insured banks.”

It has to be seen how far regulators could go to protect depositors. According to the Dodd-Frank Law, 2010, if officials wanted a broad deposit guarantee, then they have to ask congress to lift the cap across all banks. In Congressional testimony, Ms. Janet Yellen said that it was soon to think about a comprehensive increase in the deposit insurance cap.

The Chairmen of FDIC, Martin Gruenberg, said in prepared remarks for a Senate Banking Committee hearing the FDIC would consider policy options for changing deposit-insurance levels among other things. He also stated that the FDIC would produce a review of the Deposit-insurance system by May 1st of this year.

Conclusion

From the above discussions, it is clear that the Regulators are now vouching for increasing the Deposit-insurance limit. However, some opponents are of the view that raising the deposit insurance limit may result in moral-hazard risks. If Banks are aware that FDIC will protect all their customer’s deposits, then Banks may take greater risks than they otherwise would.

Another issue is higher insurance caps could introduce some new costs for banks. The FDIC may need to hold more money in its Deposit-insurance fund, to guarantee more deposits. This means higher fees on banks that will be passed on to the Depositors in form of overdraft charges or higher maintenance.

Whatsoever, the Federal Government’s move towards increasing the limit of the Deposit-insurance system is welcome for the Depositors. At what costs, will be known only when the review document on the Deposit-insurance system is public. The commitment from the regulators to save the bank failures, at least so far, shows that even if there is another bank failure which threatens the Financial System then the regulators will find a solution to it.

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