Introduction
Good afternoon. I would like to thank Mike Hanson for that kind introduction.
I am grateful for the opportunity to speak with you today at the 22nd Annual Conference of the International Association of Deposit Insurers (IADI). I am delighted to be back in person with my IADI friends and colleagues.
I would like to thank IADI and IADI’s outstanding President, my friend Alejandro López, for inviting me to share some thoughts this afternoon, and the Massachusetts Credit Union Share Insurance Corporation (MSIC) for being such gracious hosts. I would also note that this is our first annual meeting with our new Secretary General, Eva Hüpkes, with whom I have had the pleasure of working closely through my involvement in the Financial Stability Board (FSB), and for whom I have the highest regard.
From 25 founding members in 2002, IADI now has 124 affiliated organizations, including 95 member deposit insurers, 12 associates, and 17 partners.1 This growth speaks to the increasing recognition of the importance of effective systems of deposit insurance for financial stability and depositor protection, and the importance of IADI as the international standard setter for deposit insurance and the repository of global experience and expertise in this crucial area of banking regulation.
In my remarks today, I will discuss the FDIC’s experience earlier this year with three large bank failures in the United States, considerations for changes to deposit insurance in light of that experience, and some thoughts on IADI’s role in global financial leadership. I am honored to join a number of distinguished speakers and panelists at today’s conference, and I commend IADI for organizing such an outstanding program.
Recent Events
As many of you probably know, on March 10, 2023, Silicon Valley Bank (SVB), with $209 billion in assets at year-end 2022, was closed by the state banking authority, which appointed the FDIC as receiver. The events that led to its failure began on March 8, when SVB announced a $1.8 billion loss on sale of securities, and a concurrent plan to raise $2 billion in capital to shore up its balance sheet. Then on Thursday March 9, shares of SVB fell 60 percent and it experienced a run by depositors. By that evening, $42 billion in deposits had left the bank with an additional $100 billion staged to be withdrawn the next day. To put this in perspective, nearly 30 percent of deposits left the bank in a matter of hours, with another 50 percent set to leave. Of great relevance, over 90 percent of SVB's deposits were uninsured.
When SVB failed on Friday, March 10, the FDIC initially established a Deposit Insurance National Bank (DINB), which is a self-liquidating vehicle under FDIC control.
We announced that insured depositors would have full access to their funds on the Monday after failure and that uninsured depositors would have access to a substantial portion of their funds shortly thereafter 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.2
The prospect that uninsured depositors at SVB would experience losses alarmed uninsured depositors at several other regional banks, and depositors began to withdraw funds. Signature Bank of New York in particular experienced heavy withdrawals. A contagion effect became apparent and there was clear evidence that the failure of a regional bank in which uninsured depositors faced losses could cause systemic disruption.
On Sunday March 12, just two days after the failure of SVB, the New York State bank regulator closed Signature Bank and appointed the FDIC as receiver. Like SVB, Signature had experienced a run on deposits and was ultimately unable to meet its obligations, and also like SVB, over 90 percent of its deposits were uninsured.
Faced with growing contagion in the system, the boards of the FDIC and Federal Reserve voted to recommend that the Secretary of the Treasury, in consultation with the President, make a systemic risk determination under the Federal Deposit Insurance Act with regard to the resolutions of SVB and Signature Bank.
The systemic risk determination enabled the FDIC to extend deposit insurance protection to all of the depositors of SVB and Signature Bank, including uninsured depositors. The FDIC as receiver chartered two bridge banks to carry this out and we then started the process of finding potential buyers for the bridge banks. This process allowed for the possible sale of the entire bank to an acquirer or major pieces of it to separate buyers.
A regional bank with a similar business model, New York Community Bank’s subsidiary, Flagstar Bank, purchased Signature a week after it was placed in receivership. Another regional bank, First Citizens Bank of North Carolina, purchased SVB after two weeks.
As this audience is well aware, the events of March were not solely contained within the U.S. SVB’s resolution was complicated by its international activity as part of a larger corporate group providing financial services to clients in a number of other jurisdictions. SVB, the U.S. insured depository institution, had a UK bank subsidiary, and loan production branches in Canada and Germany. The Bank of England used its resolution powers to transfer the ownership of that entity over the same weekend to HSBC UK. Canada’s Office of the Superintendent of Financial Institutions sought the appointment of a branch liquidator with whom we worked closely. In Germany’s case, we coordinated closely with BaFin, the Federal Financial Supervisory Authority, in a way that I think represents an excellent example of cross-border coordination.
Allowing the branch to continue operations while under the FDIC’s control and granting recognition of actions taken by the FDIC as receiver to be effective under German law enabled a smoother resolution process.
Although the FDIC was authorized to proceed under the systemic risk exception in these cases, it is important to recognize that both institutions were allowed to fail. Shareholders lost their investment. Unsecured creditors took losses. The boards and the most senior executives were removed. The FDIC is conducting investigations, as it is legally required to do, to hold directors, officers, and executives accountable for losses and misconduct.
Less than two months later, on May 1, 2023, First Republic Bank of California, was closed by the state regulator, and again the FDIC was appointed receiver. At year-end 2022, First Republic Bank held $213 billion dollars in assets. First Republic had a nearly 70 percent reliance on uninsured deposits and was clearly impacted by the contagion effect of the previous two failures.
First Republic was resolved via a purchase and assumption agreement with JPMorgan Chase Bank, which assumed all of the failed bank’s deposits and substantially all of the assets. This was done under the least-cost test and without a systemic risk exception.
Implications for Deposit Insurance and Financial Stability
The three regional bank failures earlier this year illustrated a point I have made in previous speeches3: while regional banks may not be as large, complex, and internationally active as the Global Systemically Important Banks — or G-SIBS as they are called — they pose distinct and significant challenges in resolution that could raise serious financial stability risks. In particular, the heavy reliance of regional banks on uninsured deposits for funding has the potential to create a destabilizing contagion effect on other banks if one regional bank were to fail and uninsured depositors took losses. Contagion can, and did, spread very quickly and well beyond its original source.
The events of the spring raised questions about the role of deposit insurance in the U.S. banking system. As a step toward addressing these questions, on May 1, the FDIC released a report on “Options for Deposit Insurance Reform.” The report is a comprehensive overview of the deposit insurance system, its history and objectives, an assessment of the risks facing the system, and reform options for consideration to address those risks. The report deals with many of the issues IADI seeks to address in its Core Principles for Effective Deposit Insurance Systems (Core Principles) and the trade-offs all deposit insurers must face.
First, the report analyzes relevant trends in deposits in the U.S. In particular, uninsured deposits have trended up over time and have increased the risk of bank runs. At their peak in 2021, the proportion of uninsured deposits in the banking system was almost 47 percent, higher than at any time since 1949. Large concentrations of uninsured deposits increase the potential for bank runs and can threaten financial stability.
The report presents a fairly straightforward discussion of deposit insurance issues that will be familiar to all of you here today. Deposit insurance has two main objectives. One is to promote financial stability by making damaging bank runs less likely. Another objective is to protect small depositors. As of year-end 2022, more than 99 percent of deposit accounts in the U.S. were under the $250,000 deposit insurance limit.
While providing these benefits, deposit insurance can also lead to moral hazard and excessive risk-taking by making depositors less likely to care about the risks their banks are taking. Concerns about moral hazard can be addressed to some extent by certain design features of the system, such as limited coverage and risk-based premiums.
However, the report highlights that the effectiveness of deposit insurance depends on how it interacts with other aspects of the banking regulatory system. Regulation and supervision play an important role in supporting the financial stability objective of deposit insurance and limiting risk-taking that may result from moral hazard.
Capital and liquidity requirements, as well as supervision of interest rate risk management, rapid growth of assets and liabilities, and uninsured deposit concentrations are important examples. The report also discusses new tools that might be considered to complement deposit insurance system reforms such as a requirement that banks maintain an amount of long term debt to absorb losses ahead of uninsured deposits. These are all matters under review in the U.S., and in some cases action has already been taken.
The report also looked at possible reforms to our deposit insurance arrangements, particularly with respect to coverage. The report considered three main options. The first is to raise the level of deposit insurance coverage. This could provide more protection for savers, but it would likely do little to address the financial stability and contagion risks that we experienced. That is because uninsured deposits are held by relatively few depositors: they account for 40% of all domestic deposits but are held by only one percent of depositors. Raising the limit by even a significant amount would do little to change this.
A second option would be to provide unlimited coverage. This would effectively remove run risks as insurance backed by the federal government provides a strong deterrent to bank runs. However, it also would exacerbate moral hazard by removing depositor discipline and may have unintended broader financial market effects. It would also dramatically increase the cost of deposit insurance to the banking industry.
The third option would be targeted coverage which would allow for different levels of deposit insurance coverage across different types of accounts. In particular, it would focus on higher coverage levels for business payment accounts. Business payment accounts may pose a lower risk of moral hazard because those account holders are less likely to view their deposits using a risk-return tradeoff than a depositor using the account for savings and investment purposes.
At the same time, business payment accounts may pose greater financial stability concerns than other accounts given that the inability to access these accounts can result in broader economic effects from the failure to make payrolls that might be mitigated by higher deposit insurance coverage.
However, there are challenges in targeted coverage around establishing a practical definition for accounts that merit higher coverage while limiting the ability of depositors and banks to circumvent those distinctions.
Any change in deposit insurance coverage in the United States would require legislation by the Congress. While there was considerable interest in the immediate aftermath of the bank failures earlier this year, that has dissipated with time. At this point there does not seem to be any imminent likelihood of changes to deposit insurance coverage in the U.S.
IADI’s Role in Global Financial Leadership
The bank failures of 2023, including Credit Suisse in Switzerland, have prompted many important policy discussions. As these discussions evolve, IADI will be called upon to provide leadership in its role as the international standard setter and global voice for deposit insurers.
In that regard, IADI has a critical role to play in bringing together the deposit insurers of the world to share experiences, discuss forward-looking policies, and provide support in meeting the challenges posed by this year’s events.
Revising IADI’s Core Principles will be an integral part of this process. This is an opportune time to incorporate the lessons of this year. The Core Principles have served deposit insurers around the world well and have been adopted as the international benchmark on which an effective deposit insurance system should be based. The stress in the banking sector earlier this year was a reminder of the importance of sound deposit insurance policies that must keep pace with the evolving banking environment and bank failures.
Guidance on the liquidity risks of uninsured deposits would seem to be a particularly urgent topic to address.
The IADI Core Principles are complements to the Financial Stability Board’s (FSB) Key Attributes for Effective Resolution Regimes (Key Attributes).
Of significant note, these organizations have already begun developing a stronger relationship. The IADI Executive Council (EXCO) met with the FSB Resolution Steering Group (ReSG), which I chair, in June to discuss recent events and areas where IADI and the FSB can collaborate on deposit insurance topics as they relate to resolution. Following the joint discussion, IADI committed to conduct further work on coverage and the potential impact of different options that provide more confidence to depositors, as well as on the interaction between deposit insurance and the other safety-net participants - supervision and resolution. I was encouraged by the commitment shown by both organizations to work together to promote effective standards and relevant policies that further support financial stability.
The work plan of the Resolution Steering Group for 2024 specifically calls for further cooperation and engagement with IADI.
Two additional points.
Strong governance allows IADI to have an effective voice as the deposit insurance standard setting body and to participate in the ongoing global conversation on behalf of deposit insurers. I look forward to seeing the progress the Executive Council and the General Meeting make on important reforms to the IADI governance structure.
Finally, IADI can also improve its policy formulation and monitoring processes. These processes are key to achieving the organization’s strategic goals of promoting deposit insurance system compliance with the Core Principles, advancing deposit insurance research and policy development, and providing members with technical support to modernize and update their systems. IADI is uniquely positioned to serve as a global resource for deposit insurers and resolution authorities by collecting, storing, and sharing data and information on deposit insurance and bank resolution.
Conclusion
In conclusion, let me once again thank my friend Alejandro Lopez for the chance to speak with you all today.
I believe this is a moment of opportunity for IADI. I can’t remember a time in which deposit insurance has been more central to global discussions of financial stability and financial risk. The global financial community needs IADI’s participation in those discussions and IADI is well positioned to play an influential role. I look forward to the work to come.
Thank you.
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FDIC: PR-16-2023 3/10/2023. See 12 U.S.C. 1821(m). Under a Deposit Insurance National Bank structure, all insured depositors will typically have full access to their insured deposits no later than the next business day. The FDIC will pay uninsured depositors an advance dividend based on a valuation of the assets of the failed institution, and they will receive a receivership certificate for the remaining amount of their uninsured funds. As the FDIC sells the assets of the failed bank, future dividend payments may be made to uninsured depositors
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Remarks by Martin J. Gruenberg, Chairman, FDIC, on The Resolution of Large Regional Banks — Lessons Learned to The Brookings Institution Center on Regulation and Markets, Washington, D.C., August 14, 2023, available at https://www.fdic.gov/news/speeches/2023/spaug1423.html; Remarks by Martin J. Gruenberg, Member, FDIC Board of Directors on An Underappreciated Risk: The Resolution of Large Regional Banks in the United States to The Brookings Institution Center on Regulation and Markets; Washington, D.C., October 16, 2019, available at https://www.fdic.gov/news/speeches/2019/spoct1619.html