Introduction
Good afternoon. I hope you are enjoying the 22nd annual Bank Research Conference. It is my pleasure to address you here today at the first fully-in-person Bank Research Conference since 2019. We are also celebrating the 90th anniversary of the establishment of the FDIC this year.
The Bank Research Conference is an example of the important role that research has played at the FDIC since it was established by the Banking Act of 1933. In fact, in the FDIC’s first full year of operation in 1934, the FDIC Board established the Division of Research and Statistics. During that first year and amid extraordinary banking stress, the Division developed data on the condition of 93 percent of licensed commercial banks in the United States, conducted a study of depositor losses from 1865 to 1934, and analyzed efforts to stabilize the banking system. Ninety years later, the FDIC remains reliant on and committed to high quality bank data, analysis, and research to inform our important work in maintaining the stability of the banking system and financial sector.
Bank Failures
As I am sure this audience is aware, on March 10, 2023, Silicon Valley Bank (SVB), Santa Clara, California, with $209 billion in assets at year-end 2022 and a 90 percent reliance on uninsured deposits, was closed by the California Department of Financial Protection and Innovation (CADFPI), which appointed the FDIC as receiver. The failure of SVB, combined with an announcement by Silvergate Bank two days earlier that it would wind down operations and voluntarily liquidate, signaled the possibility of a contagion effect on other banks. Consistent with contagion concerns, on Sunday, March 12, 2023, just two days after the failure of SVB, another institution, Signature Bank, New York, New York, with $110 billion in assets at year-end 2022 and also a nearly 90 percent reliance on uninsured deposits, was closed by the New York State Department of Financial Services (NYSDFS), which also appointed the FDIC as receiver. Amid signs of stress at other institutions, concerns grew about further contagion and economic spillovers.
After careful analysis and deliberation, the Boards of the FDIC and the Federal Reserve voted unanimously to recommend, and the Treasury Secretary, in consultation with the President, determined that the FDIC could use emergency systemic risk authorities under the Federal Deposit Insurance Act (FDI Act) to fully protect all depositors, including uninsured depositors, in the resolution of SVB and Signature Bank.
Less than two months later, on May 1, 2023, First Republic Bank, San Francisco, California, was closed by the California Department of Financial Protection and Innovation (CADFPI), which appointed the FDIC as receiver. At year-end 2022, First Republic Bank held $213 billion in assets and had a nearly 70 percent reliance on uninsured deposits. Unlike Silicon Valley Bank and Signature Bank, First Republic Bank was resolved via a purchase and assumption agreement by JPMorgan Chase Bank, National Association, Columbus, Ohio which assumed all of the failed bank’s deposits and substantially all of the assets. Since this was a least cost bid, there was no need to consider exercising a systemic risk exception.
The bank failures of 2023 have prompted a number of important policy discussions. These policy discussions have already benefitted from the existing body of research. We hope that your discussions at this Conference will prompt further research to inform consideration of these issues.
Among the policy issues is the role of uninsured deposits in the banking system. As I mentioned, SVB, Signature, and First Republic were primarily funded by uninsured deposits, which made them more susceptible to runs. It is important to reexamine the stability of uninsured deposits in the wake of these bank failures and the role that regulation and supervision may play in mitigating the liquidity risks.
The speed with which depositors withdrew funds at the failed banks also merits consideration as we consider our role in promoting financial stability with today’s technology. On March 9, the day preceding the failure of SVB, depositors at SVB withdrew $42 billion. $100 billion were scheduled to be withdrawn the next day if the bank had not been closed. Signature Bank lost 20 percent of its deposits on March 10, heading into the weekend of its failure. The ease with which deposits can run and the ability of social media to amplify panic pose significant challenges to regulators in their ability to respond to bank runs.
Another common vulnerability in the failed banks was the maturity mismatch of assets on the balance sheet and exposure to interest rate risk. As the federal funds rate increased from near zero at the beginning of 2022 to more than 400 basis points by the end of the year, long-term securities held on bank balance sheets declined in value. The decline in value was accounted for on bank balance sheets as unrealized losses, but for the three failed banks, and for most other banks, unrealized losses do not affect regulatory capital. Although interest rate risk is not new, the failures have highlighted important questions about how banks are currently managing their interest rate risk. It also raises questions about the appropriate treatment of unrealized losses for capital purposes. The newly proposed Basel III capital rule would begin to address this issue by requiring that unrealized losses on the balance sheets of banks with assets over $100 billion be recognized in the capital of the banks.1
SVB, Signature and First Republic also grew their assets rapidly in the years before failure. Rapid bank growth is often a signal of risk taking and their failures merit a re-examination of the connection between asset growth and risk.
In addition to these topics, the bank failures in Spring 2023 have generated significant interest in the appropriateness of the current design of the deposit insurance system in today’s environment. In response, on May 1, the FDIC released a report “Options for Deposit Insurance Reform.” I encourage you to go to our website and read it, if you have not already done so. I believe that our economists, many of whom are in this room, did an excellent job of laying out many of the key issues for the discussion. They did so in what I will admit was a very tight time frame of just six weeks. That was at my request given the urgency of informing the public debate on the issue after the failures in March.
I will spend my remaining time discussing this issue and the findings of the report.
Deposit Insurance Reform and the Role of Research
Options for Deposit Insurance Reform is an effort to place the events of Spring 2023 in the context of the history, evolution, and purpose of deposit insurance since the FDIC was created in 1933. The report discusses three options to reform the deposit insurance system, as well as the tools that may complement possible reforms.
The primary objectives of deposit insurance are to promote financial stability and protect depositors from loss. The business of banking, which accepts deposits that are available on demand while making long-term loans, remains susceptible to runs. Deposit insurance provides assurance to depositors that they will have access to their insured funds if a bank fails, thereby reducing the risk of bank runs. As of December 2022, more than 99 percent of deposit accounts were under the $250,000 deposit insurance limit.
The report highlights that while the overwhelming majority of deposit accounts remain below the deposit insurance limit, growth in uninsured deposits has increased the exposure of the banking system to bank runs. At its peak in 2021, uninsured deposits accounted for nearly 47 percent of domestic deposits, higher than at any time since 1949, although less than 1 percent of deposit accounts. Uninsured deposits are thus held in a small share of accounts but can be a large proportion of banks’ funding, particularly among the largest banks by asset size. Large concentrations of uninsured deposits increase the potential for bank runs and can threaten financial stability.
While deposit insurance can promote financial stability by reducing depositors’ incentives to run, it can also increase moral hazard by providing an incentive for banks to take on greater risk. Banks practicing sound risk management incorporate the risks associated with deposit withdrawals into their decision making.
Before discussing changes to the deposit insurance system, 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.
The report evaluates three options to reform the deposit insurance system: maintaining the current structure of Limited Coverage, including the possibility of an increased but clearly delineated deposit insurance limit; Unlimited Coverage of all deposits; and Targeted Coverage, which would allow for higher or unlimited coverage for business payment accounts.
Of these options, the report identifies Targeted Coverage as having the greatest potential for meeting the fundamental objectives of deposit insurance relative to its costs. 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. The report points out that providing a practical definition and ensuring that banks and depositors cannot circumvent those definitions to obtain higher coverage are important for the effective implementation of Targeted Coverage.
To produce a report like Options for Deposit Insurance Reform, the authors relied heavily on a large body of academic and policy research, including work produced by people in this room. The final version of the report cites more than 70 sources and that number is only a fraction of the literature that created the knowledge base for the reports’ authors. Although some of the challenges in 2023 are new, the literature provides an invaluable framework that lays the groundwork for our understanding on important policy issues. We hope that those of you participating in this conference continue to pursue research that can inform this important debate.
Thank Yous
An event like this takes a tremendous amount of effort from many people. I want to thank FDIC Special Advisor Haluk Ünal for his leadership in organizing the Conference not just this year but since its origins years ago. I also want to thank Senior Economic Researcher Jonathan Pogach, Financial Economist Troy Kravitz and our FDIC economists for organizing this year’s event. Much of the work that makes a conference successful involves people doing work behind the scenes. Conference Coordinator Eboni Oliver and all of our administrative and technical team, including Keyonna Brooks, Karla Duff, Lisa Peterson, Diana Soard, and Donna Vogel, do a tremendous job each year in putting together the Bank Research Conference. We would especially like to thank David Spanburg. After 26 years of outstanding service, including many years supporting this conference, David will be retiring with the conclusion of the Conference tomorrow afternoon. On behalf of the FDIC, I would like to express our gratitude to David and wish him well.
Finally, I would like to thank the presenters and discussants whose research and insights are the reason we hold the Conference each year. We thank you for your contributions.
Conclusion
The events of Spring 2023 raised a number of important policy issues. The existing body of research has already been influential in shaping the analysis and thinking. Yet, there remain many open questions to address. I thank you for participating in this year’s conference. I encourage you to continue working to inform our understanding of these issues which are having such a large impact on the banking system and bank regulation.
- 1
Specifically, the proposed rule would require covered institutions to reflect unrealized gains and losses on available-for-sale securities in regulatory capital.