Banks are losing money faster than a college student in Vegas, with small and midsized banks losing $260bn in deposits this year. The Federal Reserve is doing its best to stop the bleeding by lending nearly $150bn to banks via emergency schemes. But the real test is coming next year when the Fed decides whether to prolong these schemes. It’s like a game of Jenga, but with the economy at stake.
The Federal Deposit Insurance Corporation (fdic), which is currently capped at $250,000 per depositor, will produce a menu of options for Congress on how to reform or expand its backstop by May 1st. Many blame the limit for the run which brought down Silicon Valley Bank (svb). Looks like the fdic is cooking up something good, but are they serving humble pie?
As we have all learned from childhood fairytales, safety is key. Banks are inherently unstable, with deposits that are instantaneously redeemable while holding long-dated, illiquid assets. This mismatch makes even well-managed institutions vulnerable to a run that might be sparked by a misunderstanding. Banks are like Humpty Dumpty, but instead of an egg, they are balancing a stack of loans and deposits.
Despite the danger of financial institutions, governments tolerate their existence. The transformation of liquidity and maturity enables banks to provide fast economic growth and a greater provision of credit, unlike a system of “narrow banks” that only back deposits with the safest assets. It’s like choosing a wild ride that may give you whiplash, over a slow and steady horse carriage ride. Sometimes you just need to live on the edge.
Government props make the system more stable, but every leg of support requires fiddling to stop bankers exploiting the taxpayer. It’s like having a younger sibling in the house, you know they’re up to no good, but you try to stop them from doing anything too crazy. Deposit insurance, established in America under the Glass-Steagall Act after the Depression, needed to be generous, but not too generous. President Franklin Roosevelt knew what he was talking about when he warned it would lead to laxity in bank management and carelessness on the part of both banker and depositor. But who listens to FDR anyway?
Central banks are the fairy godmothers of the financial world, meant to stop self-fulfilling panics by acting as a lender of last resort. They are getting more generous with their magic wands as time goes on, valuing long-term securities at par even when the market has heavily discounted them. It’s starting to feel like a magic show, where you’re amazed at what you see, but you’re also skeptical that it’s all a trick.
Regulators could redefine the highest-quality liquid assets as bonds that are both short-dated and issued by the most creditworthy sovereign borrowers. To do so, however, would be to take a step towards narrow banking, in which every deposit is backed by such an asset. It’s like going from having a closet full of clothes to having only one outfit every day. It may be safe, but it definitely limits your fashion choices.
Technology is also forcing the government’s role in banking into the open. Mobile-banking apps and social media are to blame for the speedy run on SVB. It’s like the wild west of banking, where anything goes, and the government needs to step in to set some ground rules. Who knows how long we’ll have to wait until someone comes up with an app that allows you to deposit your paycheck by simply Snapchatting it to your bank?
The issuance of central-bank digital currencies could give the public another alternative to bank deposits. Some argue banks would work fine, as long as the central bank steps in to replace lost funding. It’s like trying a new restaurant and discovering a menu item that you never knew you needed. It’s exciting, but you’re also wary of how it will affect your usual routine. The banking industry could use a refresh, but let’s hope they don’t start adding kale to their financial portfolios.