A recent speech entitled, "Remarks by Martin J. Gruenberg, Chairman, FDIC, on The Resolution of Large Regional Banks -- Lessons Learned," gives a recap of recent bank turmoil and the role of large, uninsured deposits. Gruenberg says, "Four years ago, I had the opportunity to speak at Brookings about an underappreciated risk -- the resolution of large regional banks in the United States.... [T]he speech contrasted the failures of Washington Mutual Bank and IndyMac Bank during the Global Financial Crisis of 2008. Washington Mutual, a $300 billion thrift institution, was the largest bank failure in U.S. history. Yet it was resolved at no cost to the Deposit Insurance Fund, and uninsured depositors suffered no losses. IndyMac, a $30 billion thrift, was one-tenth the size of Washington Mutual. Yet it was the costliest failure in FDIC history up to that point, at over $12 billion, and uninsured depositors suffered losses." (Note: Money fund assets jumped by $32.3 billion on Tuesday, Aug. 14, to a record $5.967 trillion, according to our latest Money Fund Intelligence Daily.)
He explains, "If we had any doubts about the challenges in resolving regional banks -- and the potential for significant adverse impact on the financial system -- they were dispelled by the failure this spring of three large regional banks -- Silicon Valley Bank (SVB), Signature Bank (Signature), and First Republic Bank (First Republic). While the FDIC resolved all three institutions in a manner that mitigated systemic risk, that outcome was by no means certain. In particular, the resolution of SVB and Signature required the use of extraordinary authority by the FDIC, the Federal Reserve, and the Secretary of the Treasury -- the systemic risk exception under the Federal Deposit Insurance Act (FDI Act) -- to protect uninsured depositors at those institutions, setting aside the least cost requirement to the Deposit Insurance Fund."
Gruenberg continues, "When Silicon Valley Bank failed overnight on Friday, March 10th, the FDIC initially established a Deposit Insurance National Bank (DINB), under FDIC control, so that depositors would have access to their insured funds on the Monday after failure. Uninsured depositors would have access to a substantial portion of their funds through the payment of an Advance Dividend. A portion of the uninsured deposits would be held back in the receivership and would experience losses depending on the losses to the Deposit Insurance Fund."
He tells us, "As it turned out, the prospect that uninsured depositors at Silicon Valley Bank would possibly experience losses alarmed uninsured depositors at other similarly situated banks, and they began to withdraw funds. Signature Bank and First Republic Bank also experienced heavy withdrawals. A contagion effect became apparent at these and other banks. There was clear evidence that the failure of a regional bank in which uninsured depositors faced losses could cause systemic disruption."
The FDIC Chair states, "In response, on Sunday the U.S. authorities invoked the systemic risk exception to the least-cost test. This allowed the FDIC to fully protect all depositors at Silicon Valley Bank and Signature Bank. They were placed into separate bridge banks under FDIC control. Signature Bank was sold a week later to Flagstar Bank, a subsidiary of New York Community Bank, and Silicon Valley Bank was sold two weeks later to First Citizens Bank of North Carolina."
He comments, "As you know, First Republic Bank also experienced large deposit outflows that weekend but managed to survive. The bank spent the next few weeks trying to raise capital, but was unsuccessful. On May 1st, the state of California closed the bank. The FDIC had time before the bank was closed to conduct a competitive bidding processs, which resulted in JPMorgan Chase submitting the least-cost bid and purchasing all of the assets and assuming all of the deposits of First Republic. The winning bid covered all uninsured depositors under the least-cost test and did not require a systemic risk exception."
Gruenberg later says, "[T]he bank failures earlier this year highlighted the vulnerabilities that can result when banks have a heavy reliance on uninsured deposits for funding. The significant proportion of uninsured deposit balances exacerbated deposit run vulnerabilities and made all three banks susceptible to contagion effects from the quickly evolving financial developments. Heavy reliance on uninsured deposits for funding carries a number of liquidity risks. First, large uninsured depositors, such as businesses, non-profit organizations, and wealthy depositors, are likely to be more sophisticated and more attuned to market developments than retail depositors, and thus may be more likely to withdraw funds quickly. Second, such deposit accounts are often concentrated in a relatively small number of depositors, also making them more susceptible to runs. Third, electronic banking services allow for the instantaneous withdrawal of large uninsured deposits. Finally, liquidity runs on uninsured deposits can be amplified and exacerbated through social media."
He explains, "For the banking industry as a whole, reliance on uninsured deposit funding has been increasing. The FDIC's report, Options for Deposit Insurance Reform, notes that in the aggregate, uninsured deposits rose from about 18 percent of domestic deposits in 1991 to nearly 47 percent at their peak in 2021, higher than at any time since 1949. The aggregate concentration of uninsured deposit funding has since come down slightly from 2021 but still remains high. Concentrations of uninsured deposit funding are more common among large banks. At year-end 2022, banks with more than $50 billion in assets were approximately one percent of banks but held nearly 80 percent of all uninsured deposits."
Gruenberg adds, "As noted previously, uninsured deposit funding tends to come from a relatively small number of depositors. At the end of 2022, less than one percent of all deposit accounts had balances above the deposit insurance limit of $250,000 but accounted for over 40 percent of banking industry deposits. At the time of its failure, Silicon Valley Bank's ten largest deposit accounts collectively held $13.3 billion in deposits.... [T]he FDIC is reviewing whether its supervisory instructions on funding concentrations should be bolstered to better capture risks related to high levels of uninsured deposits generally or types of deposits more specifically, such as business operating account deposits.... Regulators and other stakeholders may also benefit from more granular, and more frequent, reporting of deposits."
Finally, he says, "In addition, risk-based deposit insurance pricing can deter banks from relying too heavily on less stable forms of funding such as uninsured deposits and can maintain fairness by charging banks with unstable funding sources for the risk they pose to the Deposit Insurance Fund. For this reason, it is worth reexamining the ways in which deposit insurance pricing captures the risks of uninsured deposits. However, calibrating precisely the risk of uninsured deposits is a challenge."
