Treasury Secretary Janet Yellin has given differing guidance to the millions of depositors at federally insured banks. The current insurance limit is $250,000 per depositor, per institution. This limit was easily exceeded by many depositors at the now failed Silicon Valley Bank (“SVB”). To avoid inducing a crisis in the broader banking market, Yellin and the Federal Deposit Insurance Corporation (“FDIC”) worked out a special deal that covered all depositors at SVB, no matter the size of their accounts.  In Senate testimony, Yellin stated she had no plans to do that again; in House testimony the next day, she said she was not ruling out doing that again. The Administration’s position appears to be, for now, that “each case will be considered on its own merits.”

This is an imperfect solution to a crisis in confidence. The present system, enshrined in the Dodd-Frank bill of 2010, increased the FDIC insurance limit and left open the possibility of additional measures to help banks whose size made them “too big to fail.” The actual phrase in the law was “systemic risk,” but it came down to the same thing: depositors of big banks could expect to be bailed out far above the regulatory limit. In return, the federal banking regulators would subject those banks to special requirements to which smaller banks, whose failure would not cause systemic risk, were not subject.  SVB was not in the “systemic risk” category—yet, by the Administration’s action of two weeks ago, its depositors received the insurance coverage as though they had been, while SVB had escaped the tighter review requirements during the years it ran up its investment portfolio that failed so spectacularly.  

How about the stockholders in SVB? Their status was just enhanced with the US Treasury-engineered acquisition of SVB’s remaining assets and accounts by First Citizens Bank. The deal might eventually make them whole; however, protecting a bank’s shareholders is not essential to prevent a run on other banks. Protecting depositors is.  

 In 1991, the last great banking crisis in America, the FDIC also exceeded its then limit of $100,000 to help depositors at larger banks. Freedom National Bank, a regional bank in Harlem, New York City, was allowed to fail, without compensation for its depositors above that limit. As long as Treasury’s approach is “case by case,’ depositors at smaller banks must worry that they will be seen as less worthy of the federal government’s attention and assistance. The cold-hearted rationale is precisely because they are small – hence posing no “systemic risk.” The obvious result will be a flight of depositors out of these smaller banks and into those big enough to qualify as a systemic risk should they fail. That flight has already begun. During the week after SVB closed, deposits at smaller banks suffered their largest percentage decline in more than 15 years, while deposits at larger banks soared.

This trend has an economic as well as a social implication. Smaller banks are lenders to local businesses and serve communities which the larger banks have not addressed. To treat them as expendable threatens an important source of finance and raises important questions of fairness.  

FDIC insurance should be extended to all deposits at all member banks, regardless of the size of the bank or the size of the deposit. Bank shareholders and executives, however, should remain at risk of losing their investments and their jobs. That possibility would remain as the most reliable disincentive to banks taking inappropriate risks. Depositors are innocent. They have no upside from a bank taking undue risks. Stockholders, and bank CEO’s and risk officers, however, receive higher monetary rewards from taking risks; hence, they should lose when those risks did not turn into rewards. That discipline will address the problem economists call “moral hazard,” the willingness by those with no downside risk to take undue chances with other people’s money.