Remarks by FDIC Chairman Martin J. Gruenberg to the Center for Financial Studies at Goethe University Frankfurt: "A Tale of Two Unions – Deposit Insurance in the United States and Europe"

Good evening.  It is a privilege for me to speak with you today. 

I especially would like to thank Goethe University’s Center for Financial Studies, and the Center’s President, Professor Doctor Axel Weber, for inviting me.  I have known Axel for many years and deeply value him as a colleague and friend.

Today, I would like to talk about the experience with deposit insurance and bank resolution in our two unions, the European Union and the United States.  In particular, I will discuss key developments in the European Union and will draw some comparisons to the history of the system in the United States. 

This seems to me an especially timely topic since many jurisdictions are continuing to work on enhancing their deposit insurance systems and resolution preparedness in view of lessons learned from the 2023 banking turmoil. 

Deposit Insurance in the European Banking Union

Let me start with my understanding of developments in the European Union with respect to deposit insurance.

In the remarkable history of the European Union’s single banking market, there was a foundational appreciation for the stabilizing role of deposit insurance in maintaining public confidence in the banking system and in the orderly handling of bank failures within a unified system.¹

Thirty years ago, the European Union, then known as the European Community, recognized that some degree of harmonization of Europe’s national deposit guarantee schemes would be essential for maintaining financial stability within the single market.  Europe’s original 1994 Deposit Guarantee Schemes Directive observed that “deposit protection is as essential as the prudential rules for the completion of the single banking market.”²  I must say I was struck by the strength of that statement.

This recognition by Europe set the stage for a deeper single banking market and, eventually, the Banking Union. 

The balance that Europe continued to work to achieve was to allow banks to operate freely across internal borders while making clear the expectations for the orderly handling of the failure of those cross-border banks.  A few years after adopting the 1994 Directive, Europe took a further step to strike that balance by adopting the 2001 ‘Directive on the reorganization and winding up of credit institutions.’  That 2001 Directive explicitly recognized that compulsory membership of banks in a deposit guarantee scheme in the home Member State created the need for rules for home-host cooperation within Europe.  That directive established the principle that the home authority should be responsible for protecting insured depositors of a failed banking organization.

With the experience of the 2008 Global Financial Crisis, the European Union (EU) took major steps toward establishing a framework for ensuring financial stability. The conceptual underpinning of the European Banking Union relied on three integrally related pillars - a single system for supervision, a single system for resolution, and a single system for deposit insurance. 

It is clear that Europe has made remarkable strides since it first announced the Banking Union project. 

It has established two of the three pillars - the Single Supervisory Mechanism and the Single Resolution Mechanism.³ The FDIC was privileged to work with our European counterparts in the early stages of those critical post-2008 reforms, in particular in regard to standing up the Single Resolution Board.⁴

With respect to the third pillar, the European Union has made progress to more closely align the systems of deposit insurance across Member States. The introduction of the Bank Recovery and Resolution Directive in May 2014, and accompanying changes to the Deposit Guarantee Schemes Directive to enhance depositor protections across the EU, were a significant step forward.⁵

The Deposit Guarantee Schemes Directive, as amended in 2014, requires each EU Member State to ensure that at least one deposit guarantee scheme is established in their jurisdiction. It also requires each EU Member State to require its banks to participate in its home state deposit guarantee scheme, with their branches in other member states (host Member States) also covered by the home state deposit guarantee scheme.

The 2014 Directive also sets minimum requirements for deposit guarantee schemes and the protections available to depositors. Those enhancements were several-fold.  It set the harmonized coverage level at EUR 100,000 (or equivalent for EU Member States outside the Eurozone). It harmonized the funding of deposit guarantee schemes to reach an established target level (of at least 0.8 % of the amount of the covered deposits of its members) through ex ante risk-adjusted contributions from its members. It also harmonized the rules governing the functioning of deposit guarantee schemes and reduced the permissible time for a deposit guarantee scheme to make a repayment when a deposit becomes unavailable, such as in the event of a member bank’s insolvency, from 20 working days in 2014 to 7 working days as of this year.

The 2014 Directive acknowledged that, through the changes being introduced, “depositors will benefit from significantly improved access to DGSs, thanks to a broadened and clarified scope of coverage, faster repayment periods, improved information and robust funding requirements. This will improve consumer confidence in financial stability throughout the internal market.”⁶

That pretty much is the state of things right now in the EU.

I understand that the European Union continues to be engaged in an ongoing discussion of the features of a deposit insurance and resolution system that can support the application of resolution tools to small and medium-sized banks, in addition to the largest ones. 

The European Commission’s 2023 proposals for reform, as set out in its Crisis Management and Deposit Insurance package (or, CMDI),⁷ are an important set of enhancements. The Commission’s CMDI package seeks to adjust and further strengthen the EU’s existing bank crisis management and deposit insurance framework, with a focus on small and medium-sized banks.  The objective of these proposals is to increase consistency and predictability in the application of resolution tools to EU banks, regardless of size.  The case for those reforms is clear - to reduce the likelihood within the EU for failing medium-sized or smaller banks to be handled outside the resolution framework and, in certain cases, using taxpayers’ money to do so. 

The CMDI package would introduce several changes to the EU framework for crisis management and deposit insurance. It would increase the powers of supervisors to intervene when banks are facing financial difficulties and to implement necessary corrective actions. It would revise the public interest assessment so that resolution could be applied to all banks, irrespective of size. It would implement a single tier depositor preference. It also would allow for the use of deposit guarantee funds in resolution with appropriate safeguards.  Many elements of this package, as proposed by the Commission, are consistent with the existing U.S. framework of the Federal Deposit Insurance Act. We see great benefits to each of those elements based on the FDIC’s experience. 

The package of reforms that the Commission has proposed is an important incremental step toward achieving the Banking Union.  I am hopeful that the Council and European Parliament will be able to reach agreement on that package, since they both recently adopted their respective negotiating positions, with a shared financial stability objective to enhance the consistency and predictability of the EU’s bank resolution process without recourse to public funds. 

By comparison, as I will cover next in more detail, the United States has had a long history of a single institution responsible for deposit insurance and resolution for our banking system.  The financial stability of the United States has clearly benefitted from the role played by the FDIC, as the deposit insurer and resolution authority for substantially⁸ the entire system of insured depository institutions, whether small, medium, or large and complex. 

That said, I would like to acknowledge that the logic of the U.S. system that I am describing today is not necessarily a prescription for others.  The European Banking Union’s system, and the challenges and constraints it would need to address, are unique to the European Banking Union’s institutional design, such as the pooling of funding commitments by multiple sovereign states and the absence of a single central finance ministry.  

I do hope, however, that some of the experience and institutional design of the U.S. system that I will describe today can serve as a point of reference as this important debate in Europe continues.  It may have taken the United States 90 years and counting in the United States to achieve the system that we have today. I do hope the European Union’s project to complete the Banking Union will require far less time.

The U.S. Experience with Deposit Insurance

Let me now turn to the U.S. experience with deposit insurance.

The FDIC was created in 1933 in the midst of the Great Depression.  After the stock market crash of 1929, an estimated 9,000 banks suspended operation in the United States. President Roosevelt declared a banking holiday immediately upon taking office in March of 1933.  Three months later, the United States Congress (Congress) passed the Banking Act of 1933, which created the FDIC.  This was not without controversy, as the president, senior legislators, and the American Bankers’ Association initially opposed the creation of federal deposit insurance.  The concerns expressed then were similar to concerns voiced in current discussions, such as those in Europe, that may sound familiar:  the system would be too expensive, subsidize poorly run banks, and lead to excessive risk-taking.  However, popular demand for safe bank deposits won out over these concerns.

Deposit insurance had a history in the U.S. prior to the creation of the FDIC.  At the state level, fourteen states had put in place deposit insurance arrangements over the previous one hundred years, but all of these had ceased operations by 1933.  In addition to the state efforts, there had been numerous legislative proposals for federal deposit insurance between 1886 and 1933.

The creation of the FDIC, with authority for both deposit insurance and bank resolution, helped to stabilize the banking system and prevent bank runs.  While bank failures continued during the rest of the Great Depression, they numbered annually in the dozens, rather than the thousands.⁹

Beginning in the early 1940s and for the next three decades, annual bank failures in the United States were in the single digits.  This was due not only to the post-war U.S. economic expansion, but also to government measures to limit competition among banks.  These included a prohibition on interest on demand deposits, ceilings on interest rates on other deposits, geographic restrictions on branching, and restrictions on the activities of banks.

During this period, the FDIC was not the only deposit insurer in the U.S.  The Federal Savings and Loan Insurance Corporation (or, FSLIC), was created in 1934 and insured the deposits of thrift institutions (as opposed to commercial banks).  Other deposit insurance systems operated at the state level for both banks and thrifts. These co-existed until the next crisis of the 1980s and early 1990s.  An additional deposit insurer, the National Credit Union Administration (NCUA), also has a long history.  The NCUA continues to this day to insure deposits in federal credit unions, which represent around 10% of total domestic deposits in the U.S. banking system.¹⁰ The other approximately 90% are in FDIC-insured depository institutions.¹¹

The U.S. deposit insurance crisis of the 1980s and early 1990s comprised two crises: one in the savings and loan industry and one in the commercial banking industry.  The crises led to a number of changes in deposit insurance in the U.S. 

Savings and loans institutions (S&Ls) were regulated and supervised at the federal level by the Federal Home Loan Bank Board and their deposits were insured by its subsidiary, the Federal Savings and Loan Insurance Corporation.  Generally speaking, this was a mono-line industry offering savings accounts and issuing home mortgages.  As such, it was an industry greatly exposed to a particular macroeconomic risk: a severe spike in interest rates. 

This spike materialized in the early 1980s as the central bank sought to bring inflation under control.  High interest rates raised funding costs above the yield on long-term fixed-rate mortgages, creating negative earnings for much of the industry.  The losses rendered much of the industry insolvent, and the resulting failures threatened to drain the resources of the FSLIC.  The regulatory  responses to this situation only made the problem worse:  forbearance, lax accounting, artificial capital instruments, and an ill-advised expansion of powers.  It is widely accepted that these measures allowed the losses to balloon and ultimately outstrip the resources of the Federal Savings and Loan Insurance Corporation and the industry, thus requiring taxpayers to bear costs exceeding $100 billion to make good on the deposit insurance guarantee.   

Between 1986 and 1995, over one thousand savings and loans failed.  The FSLIC was abolished and the Resolution Trust Corporation, initially administered by the FDIC, was established by a law, the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, to resolve the insolvent institutions.  The FDIC assumed the responsibility for insuring the deposits of the surviving industry. 

The crisis in the commercial banking sector was of a different nature from that of the S&Ls.  Commercial banks held fewer long-term fixed-rate assets and were thus not as vulnerable to a spike in interest rates.  Instead, the problems were driven by a series of regional recessions accompanied by boom-and-bust markets in farmland, energy, and commercial real estate. During this crisis, more than 1,600 banks failed, and the FDIC’s deposit insurance fund was depleted.

The demise of the Federal Savings and Loan Insurance Corporation and the severe problems faced by the FDIC led to calls for reform of our deposit insurance system. The concerns centered on the way deposit insurance was funded and the exercise of discretion in handling bank failures.

The amount banks paid for deposit insurance had been set by statute at a flat rate.¹²  This “flat-rate” system had two implications.  First, the FDIC had no authority to manage the fund balance.  For example, the FDIC could not build up the fund during good times nor replenish it to protect taxpayers.  Second, the rate that banks paid did not vary by risk and risky banks were charged no more than safe ones.  This was viewed as both unfair and creating incentives for excessive risk-taking.

There were also concerns during that period about the way the FDIC exercised its discretion when resolving failed banks.  At that time, the FDIC had considerable leeway when a bank failed to protect not only insured depositors, but also uninsured depositors and other creditors. When Continental Illinois, the seventh largest bank in the U.S. was on the brink of failure in 1984, the FDIC used this discretion to protect all depositors and creditors.  By contrast, in the period immediately before that event, the FDIC did not protect uninsured depositors when small banks failed.  This disparate treatment was widely viewed as unfair, and, after Continental Illinois, the FDIC started to use its discretion also to protect all depositors in most small bank failures.  While this addressed the fairness question, it heightened concerns about moral hazard and lack of depositor discipline.

In 1991, Congress enacted the Federal Deposit Insurance Corporation Improvement Act (FDICIA) to address concerns about funding and FDIC discretion in handling failed banks.  It abolished the flat-rate funding system and required the FDIC to levy assessments on banks as necessary to maintain the Deposit Insurance Fund at or above a target level and to put in place risk-based pricing of deposit insurance premiums.  The law also added the Least-Cost Test, which requires the FDIC to resolve a bank at the least cost to the Deposit Insurance Fund. This constrains the FDIC’s ability to provide protection beyond insured depositors. FDICIA also provides a systemic risk exception in order to mitigate serious adverse effects on economic conditions or financial stability.  

FDICIA introduced several additional important reforms to enhance the consistent application of the resolution regime to insured depository institutions.  One such reform was to give the FDIC the ability to appoint itself as receiver for an insured depository institution in order to prevent loss to the deposit insurance fund that may arise from a delay in appointment by the appropriate Federal banking agency or the appropriate State supervisor.  FDICIA also expanded the FDIC’s authority to borrow from the U.S. Treasury, subject to safeguards for repayment of borrowed funds. 

During the crisis of the 1980s and early 1990s, the state-chartered privately operated deposit insurance systems faced severe problems as well.  By the end of the crisis, all but one had failed or gone out of existence. The one that exists to this day functions only as a supplement to FDIC deposit insurance.  Our federal system of deposit insurance in the United States, and the powers of the FDIC to administer that system and to intervene to resolve failing banks in that system, remains in effect today.

The crisis subsided in the early 1990s.¹³  The deposit insurance fund recovered from a negative balance to a positive balance.¹⁴  The replenishment of the deposit insurance fund was due in large part to the near tripling of deposit insurance premiums during this period.¹⁵

Once the deposit insurance fund reached its target level, the banking industry argued that, after several years of paying historically high premiums, banks should not be required to build the fund significantly beyond the target level. In 1996, Congress prohibited the FDIC from requiring banks that were well-managed and well-capitalized to pay into the deposit insurance fund.  For the next ten years, while banks experienced year after year of record profitability, virtually no premiums were assessed to build the Deposit Insurance Fund.  We of course came to appreciate that building the fund in the good times is the best way to position for effective crisis management when the bad times eventually come.

Just prior to the Global Financial Crisis of 2008, Congress removed the restriction on assessments in response to arguments made by both the FDIC and the industry that the system was flawed for two reasons.  First, it did not make sense to charge virtually no premiums during long periods of strong profits and then charge steep premiums during crisis periods. Second, new banks were able to enter the system and existing banks were able to grow rapidly, without proportional contributions to the fund.

As it turned out, after Congress relaxed the law there was little time to build the deposit insurance fund before the onset of the 2008 crisis.  The deposit insurance fund was once again depleted – a negative balance of $20 billion in 2010 – and banks were once again required to pay high premiums when they were least able to afford them.

Looking back, the FDIC’s experience across the crises of the 1980s and 1990s, and also 2008, was that losses from bank failures across those crises shifted among geographic regions.  Regions of the country that experienced the most significant concentrations of bank failures contributing to losses to the deposit insurance fund in the late 1980s and early 1990s were significantly different from the regions with that experience during the 2008 financial crisis.  Not only did the regions hit hardest differ across crises, but the underlying causes of those crises and the magnitude of the losses to the deposit insurance fund across crises also differed.

With the benefit of hindsight, it is clear that the breadth and depth of the federal system of deposit insurance in the United States offered the benefit of the diversification of risks across a rolling series of regional recessions.  Without that diversification, large economic centers in the United States would have suffered sustained damage as their banks failed, from Texas, to Oklahoma, to New England, to California, and, eventually, to the Southeast of the United States.  The experience could have been better, but it also could have been far worse.

The failures of three large U.S. regional banks in early 2023 brought to bear a risk about which the FDIC had been concerned for many years.  While regional banks may not be as large, complex, and internationally active as the Global Systemically Important Banks – or G-SIBs – they pose distinct and significant challenges in resolution that in fact raised serious financial stability risks.

We have clear evidence now, based on the 2023 experience and the failures of Silicon Valley Bank (Silicon Valley), Signature Bank (Signature), and First Republic Bank (First Republic), that the heavy reliance of those banks on uninsured deposits for funding created a destabilizing contagion effect on other banks.  The runs materialized after we announced that the failure of Silicon Valley Bank would result in losses to uninsured depositors. 

While the FDIC resolved all three failed institutions last year in a manner that mitigated systemic risk, that outcome was by no means certain.  In particular, the resolution of Silicon Valley and Signature required the use of extraordinary authority by the FDIC, the Federal Reserve, and the Treasury -- the systemic risk exception under the Federal Deposit Insurance Act -- to protect uninsured depositors at those institutions, setting aside the least cost requirement to the Deposit Insurance Fund.  The value of our federal system in responding to those regional bank failures was once again underscored.  We had available for our use significant resolution powers and tools, including financial resources, to intervene in a rapidly changing environment to calm the contagion.

That experience affirmed not only the benefits of our federal system, but also the need in the United States for meaningful action to improve the likelihood of an orderly resolution of large regional banks under the Federal Deposit Insurance Act, without the expectation of invoking the systemic risk exception. The FDIC and other financial regulatory agencies are in the process of taking a number of steps toward that goal, including a long-term debt requirement for large regional banks.

The spring of 2023 highlighted the risks of heavy reliance on uninsured deposits and raised questions about the purpose and design of the deposit insurance system. In response to last year’s bank failures and the issues they raised, the FDIC published a report that covered the role and history of deposit insurance and offered three main options for reform of the system.¹⁶

The first is to raise the level of deposit insurance coverage. This could provide more protection for savers, but would likely do little to address the financial stability and contagion risks experienced last year. That is because uninsured deposits are held by relatively few depositors in large amounts.

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 broader, unintended effects on financial markets.

The third option would be targeted increased coverage for 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. Holders of accounts for operational business purposes 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 those accounts can result in broader economic effects resulting from failure to make payrolls.

However, there are challenges to establishing a practical definition for transaction accounts that merit higher coverage while limiting the ability of depositors and banks to circumvent those distinctions.  It is also worth noting that any change in deposit insurance coverage in the United States would require legislation by Congress.            

To better understand the dynamics of deposit funding, the FDIC recently issued a request for information on the characteristics of different types of deposits, particularly uninsured deposits, and whether more detailed or frequent reporting on these characteristics or types of deposits could enhance offsite risk and liquidity monitoring; inform analysis of the benefits and costs associated with higher deposit insurance coverage for certain types of deposits; improve risk sensitivity of deposit insurance pricing; and provide analysts and the general public with accurate and transparent data.¹⁷ That request for information is pending.       

Lessons from the U.S. Experience with Deposit Insurance

Considering this history, I would like to share some takeaway observations about the FDIC’s role as an insurer of deposits held in the U.S. banking system.

Let me start by observing that there are a number of benefits to a federal system of deposit insurance.  There is one set of arrangements for how deposit insurance will protect bank customers and for the vast majority of depositors, that message is simple: your money will be protected and available immediately if your bank fails.  The federal system results in diversification of risk across geographies, size, and banking business models.  The federal system also results in an agency with significant resources – it has the people, operational capabilities, and financial wherewithal to carry out its mission effectively.  In terms of financial resources, the FDIC benefits from having the mandate to have the banking industry pay for the costs of bank failures.  While the obligations of the FDIC do carry the full faith and credit of the U.S. government, which is critically important, that is a backstop that would only be called upon under extreme circumstances.

While the FDIC has responsibility for deposit insurance, resolution and bank supervision, it is clear that is not the only arrangement that could work.  What is important is that the deposit insurer has meaningful engagement and close coordination with resolution and supervisory authorities.

The FDIC also benefits from having several tools to manage the risks it faces.  These include, among others, the early intervention in problem banks, the ability to withdraw deposit insurance if problems are not addressed, and the mandate to price deposit insurance according to risk.

I recognize that the EU is not a federal system, but the open borders within the EU for banking lend themselves to realizing the similar benefits within a single market that we have observed in the United States.  The logic of the original vision of a banking union within Europe founded on three pillars, including deposit insurance, remains compelling to me, while acknowledging the internal challenges that establishing such a system may pose.

A European Deposit Insurance Scheme presents an opportunity to deepen the Banking Union and to enhance the financial stability of the system. Important steps have been taken, with the establishment of the Single Supervisory Mechanism, the Single Resolution Mechanism, and standards to provide consistency across national deposit guarantee schemes. That said, without a unified deposit insurance system at the European level, the cost of depositor protection remains at the national level. Differences in national backstop capabilities in turn may undermine the completion of a Banking Union. The critical missing component, in my view, to address this continuing issue is a European Deposit Insurance Scheme.

Conclusion

In conclusion, I hope that sharing this experience is helpful as jurisdictions continue to pursue opportunities to enhance their own systems of deposit insurance and resolution.  I also hope that the European Banking Union’s aspirational third pillar may become a reality in the years ahead.

I would like to thank once again Goethe University’s Center for Financial Studies for the opportunity to participate in this program. I place enormous value on our working relationships with our colleagues in the European community.  I look forward to our work together to integrate deposit insurance and resolution to ensure a stable, resilient financial system.