Enforcing targeted-coverage guidelines would be difficult and likely ineffective.
Enforcing targeted-coverage guidelines would be difficult and likely ineffective.
A fter the collapse of Silicon Valley Bank (SVB) and Signature Bank in March, many analysts and politicians worried that this was a prelude to more failures. Legislators and bureaucrats hastily wrote up schemes for more stringent regulations designed to shore up other financial institutions and avoid the emergence of a systemic crisis. When that systemic crisis didn’t materialize, talk of new regulations subsided — for a time.
Two Republican congressmen are now reviving discussion about banking regulation. In late August, Dan Meuser of Pennsylvania and and Blaine Luetkemeyer of Missouri — both members of the House Financial Services Committee — sent a letter to the FDIC asking it to clarify and expand upon some of the regulatory proposals set forth in May. The FDIC had suggested increasing deposit insurance and paid special attention to insuring business accounts. In their letter, the lawmakers implicitly approve of the FDIC’s suggestions, and also propose their own rules.
But the rules endorsed by the FDIC, Meuser, and Luetkemeyer would prove useless for regulators and onerous for banks. Not only would they fail to prevent bank closures, they would destabilize the banking industry, create more red tape, cause thorny compliance issues, and cost consumers more money.
In its May report, the FDIC asserted that SVB and Signature failed because, when the banks experienced some financial difficulties, account holders — specifically businesses — with uninsured deposits panicked and withdrew their funds, causing a bank run. This would not have happened, says the FDIC, if the account holders had 100 percent insurance coverage. The agency offered a few possibilities for increasing deposit insurance, including targeted coverage for business payment accounts. Under this scheme, only qualified accounts owned by legal business enterprises would be eligible for unlimited deposit coverage.
The trouble is government-backed deposit insurance does not always make the financial sector safer. In fact, it can often make it less stable by disincentivizing depositors from monitoring their banks’ risk profiles. It also creates a moral hazard problem: If more deposits are insured, banks will take greater risks, knowing that the FDIC will cover their losses if the bank fails.
Unlimited insurance coverage might make account holders feel safer, but if they want all of their deposits to be insured, they can already do so by carefully diversifying their accounts at different banks. Most already do: According to government data, fewer than 1 percent of all accounts in the country have balances that exceed the maximum coverage of $250,000 per depositor. The FDIC offered no empirical evidence that these accounts present a systemic risk.
Yet it’s the 1 percent that the FDIC targets. In its May report, the FDIC says that business payment accounts — by virtue of the daily inflows and outflows — “are least able to take advantage of insurance across banks in the current system,” and thus are in the most need of more insurance.
Targeted coverage apparently intrigued Republican lawmakers, as they requested more information on how it would work. Representatives Meuser and Luetkemeyer also volunteered ideas about how to implement the program, suggesting that federal banking agencies should develop a “pre-certification process through either existing supervision processes . . . to confirm eligibility of business payments accounts.” Alternatively, the legislators say the FDIC could create rules that force account holders to “provide commitments and contractual warrants regarding the purpose of their accounts.”
But enforcing targeted-coverage guidelines would be difficult and likely ineffective. It’s unclear what the Republican congressmen envision as a “pre-certification process,” but like all federal bureaucracy forms, it will surely be long, confusing, and very difficult to fill out correctly. “Contractual warrants” is similarly vague. Businesses are already required to present their operating agreements or articles of incorporation. Representatives Meuser and Luetkemeyer do not provide any details on their suggestion, perhaps hoping that the FDIC could develop the idea further.
Expecting businesses to provide “commitments” about the purpose of their accounts is similarly naïve; the account holder may lie or simply change what they use the account for after the unlimited deposit insurance has been secured. The FDIC recognized this issue, warning about the probability of “regulatory arbitrage” — when businesses take advantage of legal loopholes to get some financial benefit. They note that “individuals, trusts, and estates may exploit account definitions and adopt EINs or TINs to obtain higher coverage.” Even if a “contractual warrant” were provided, demonstrating that the account had a business purpose, there is little preventing an individual owner or another non-business entity from using the account to park large, previously uninsured deposits.
Ultimately, the only way to ensure that companies are using their federally insured account for the “proper” purposes is for government bank examiners to look through their transaction histories — an enforcement mechanism that’s far too time-consuming and invasive to work.
It may seem like only the banks will have to deal with the burden of stricter government regulation, but consumers and small businesses won’t be off the hook either. In order to pay for insurance, the FDIC charges “assessments” to banks based on their total liabilities, which include current insurable deposits. Banks pass on the cost of these assessments to their customers, often by charging higher fees on their accounts. (The government frowns on banks explicitly listing “FDIC fees” on account statements, but some banks have done it anyway.) If the FDIC were to increase its deposit insurance to cover the 1 percent of accounts with balances exceeding $250,000, small businesses would disproportionately bear the cost.
Like weeds, harmful government regulations are easier to prevent than they are to repeal. If the FDIC’s reforms were put in place with Republican support, they might be impossible to eradicate. Rather than tend to misguided proposals on deposit insurance, Republicans should ignore them and allow them to wither away.