Government bureaucracies can’t supervise our banks. Here’s a private sector alternative

It’s hard to turn on financial news without seeing Sen. Elizabeth Warren (D-Mass.) crowing about how the recent failures of Silicon Valley Bank (SVB) and Signature Bank were caused by the 2018 legislation that exempted banks of their size from certain Dodd-Frank regulatory requirements — even though applying Dodd-Frank wouldn’t have prevented the SVB situation.

Warren also talks about banks taking too much risk in pursuit of profits, and she has a point there. But rather than cranking out even more regulations, which apparently didn’t stop the current turmoil, we should look to the private sector to provide solutions.

The failure of SVB and Signature Bank, and the turmoil surrounding similarly situated regional banks, is largely attributable to two specific causes, both of which are more supervisory than regulatory in nature. 

First, it’s widely reported that the vast majority of SVB’s deposits were above the $250,000 Federal Deposit Insurance Corporation (FDIC) limit, making them more susceptible to a “run on the bank,” as nervous depositors rapidly withdrew their funds. But as long as a bank maintains the appropriate levels of liquidity and reserves, having a disproportionately high number of large depositors isn’t in and of itself a problem.

Secondly, SVB’s management had invested significant depositors’ cash in longer-dated U.S. Treasury securities, which, while very safe from a default perspective and helpful in financing President Biden’s budget deficits, were very susceptible to a meaningful decrease in value should interest rates rise, which the Federal Reserve Bank has been doing aggressively. 

Once investors and depositors realized the growing risks and began withdrawing funds, SVB was forced to begin selling its U.S. Treasuries at a loss, decreasing its book equity and bringing its solvency into question.

Given the high percentage of uninsured deposits and the resulting need for substantial liquidity, buying shorter duration U.S. Treasury securities or interest rate hedges would have been prudent, but regulations didn’t require it. While those actions would have decreased reported profits, they would have protected SVB’s solvency and ability to continue as a going concern. 

Had the FDIC not stepped in to protect all SVB’s deposits above the $250,000 FDIC limit, depositors might have lost 10 percent to 15 percent of their holdings once all accounts were resolved. That would hurt, but it would also have been a “teachable moment.”

The turmoil has led to calls for tougher bank regulations, increases in government deposit insurance limits and other government-centric solutions. Given that commercial banking is one of the most heavily regulated and supervised industries known to man, perhaps more government bureaucracy isn’t the solution. So let us present a couple of private sector options.

Risk-spreading options: Depositors can already avail themselves of banking services that spread out their deposits among numerous financial institutions, keeping each institution’s share below the FDIC limit. There are minor record keeping fees, but it’s an inexpensive, readily available solution that’s not overly burdensome. But most corporate treasurers didn’t know about the option, and may have believed (apparently correctly) that the government would come to their rescue anyway.

Private insurance options: Currently, the federal government provides depositors with a type of stop-loss insurance through the FDIC up to a limit. But why should the government be the primary option for hedging risk? Individuals and businesses can buy private insurance, which is also regulated, to protect them from all types of business and personal risk. So why not bank deposit insurance?

Individuals and companies with deposits vastly exceeding the FDIC’s $250,000 cap should be able to buy private insurance that would immediately cover some or all their uninsured deposits. The risk of loss to the insurer would be small. U.S. banks don’t fail often. And once a failed bank’s assets are adjudicated, the insurer might lose only 10 percent to 15 percent, as mentioned earlier.

There are two important benefits to this approach. First, the depositor would know he would have access to all his funds with no time delay, which would discourage a run on a bank. Second, since private insurers would have a financial stake in the viability of any banks holding their insureds’ deposits, insurers would likely do much more due diligence overseeing banks’ practices — something the San Francisco Federal Reserve Bank and other regulators and supervisors apparently failed to do with SVB.

One more important point: If it is important to a bank to have large depositors, the bank could easily offer to pay the cost of the insurance coverage. The individual or company would pick the insurer, and the bank could credit the account for the cost.

The federal government does not run efficient large-scale insurance programs. The federal flood insurance program consistently underprices the risks it insures, leading to massive losses. 

Given the byzantine labyrinth of current banking regulations and the apparent inability of government bureaucracies to conduct adequate supervision, we need a private sector alternative. Private insurance companies, which are liable for paying claims, have the economic incentive to assess and efficiently price risk. Expanding their role, rather than the FDIC’s, is the better policy option.

Merrill Matthews is a resident scholar with the Dallas-based Institute for Policy Innovation. Wayne Stoltenberg is the former executive vice president and chief financial officer of Vine Energy, Inc., and chairman of the board IPI.