In a bid to contain the damage to the banking system, regulators over the weekend invoked the “systemic risk exception” for Silicon Valley Bank and another failed lender, Signature Bank.
The designation means the Federal Deposit Insurance Corp., or FDIC, can guarantee uninsured deposits.
And as we’ve learned in the past few days, there were heaps of those at SVB. But how does the designation work, and why is it drawing so much scrutiny?
When a bank fails, the FDIC is supposed to resolve it while minimizing costs, according to Steven Kelly, senior research associate at Yale’s Program on Financial Stability.
“FDIC takes it over. It sells the assets, pays out insured depositors. It’s required to protect its own pot of money to the best extent possible,” he said. That’s the so-called least cost resolution. But the systemic risk exception allows the FDIC to avoid that.
“What it basically said [Sunday] was, ‘If we try to do this “least cost,” it risks systemic contagion to the banking system or to the economy,’” Kelly explained.
But he and others aren’t so sure these banks were a systemic risk. Silicon Valley Bank had assets of $209 billion and Signature had around $100 billion — not actually huge in the era of megabanks.
With the systemic risk exception, the FDIC’s Deposit Insurance Fund can cover deposits that exceeded $250,000, which are usually uninsured. The decision sends mixed messages, per Itamar Drechsler, a professor of finance at Wharton.
“It is just raises kind of an existential banking question,” Drechsler said. “Do we have uninsured deposits or don’t we?”
In granting these banks the systemic risk exception, regulators panicked, said Matt Stoller, director of research at the American Economic Liberties Project.
“We just decided that when banks have a problem, we’re going to do whatever we can to help highly capitalized entities who have mismanaged risk. And we keep doing that,” he said. “We should stop doing that, but we keep doing it.”
What’s more, a few years back, SVB successfully lobbied Congress to exempt it from enhanced regulatory scrutiny. It’s time to reexamine that, argues Hilary Allen, a professor at the American University Washington College of Law.
“If we’ve concluded that these particular banks are deserving of this kind of government backstop, then they also need the heightened regulation that they lobbied to get rid of a few years ago,” she said.
Otherwise, she added, the optics of this intervention aren’t great.
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