Saturday, March 18, 2023

Ex-FDIC chair worries bank 'bailouts' could drive deposits out of community banks; they'd have less money to lend

Federal officials' determination that two bank collapses posed “systemic risk” to the banking system, justifying their guarantee of uninsured deposits at the banks, poses a threat to smaller banks, a former chair of the Federal Deposit Insurance Corp. told James Jacoby of PBS's "Frontline."

Ex-FDIC chair Sheila Bair (PBS image)
“I do worry about community banks, in particular,” said Sheila Bair, FDIC chair in 2006-2011. “For these larger institutions, $100 billion, $200 billion, that’s not huge. But if you’re a $1 billion community bank, it’s a big difference. And what happens to them if the market starts assuming anybody, say, over $100 billion is going to have their uninsured deposits protected? Then that money is going to start going out of the community banks into those institutions that are viewed as having favored status. So these one-off bailouts that are particularly just for a couple of institutions create a lot of distortions and competitive disadvantages for others.”

Referring to what she called "bailouts" of Silicon Valley Bank and Signature Bank, Bair said "It’s extraordinary that they’re singling out just a couple of midsized institutions to basically bail out all their uninsured depositors. That is extraordinary. I have never seen that before. And the systemic-risk exception itself, which is the legal mechanism they’re using, is very extraordinary to trigger. It is meant to be used very rarely when things are really dire. . . . If they think just a couple of these small institutions have to be bailed out, how resilient is the system, really?" Later, Bair said, "At this point, I still think these risks can be managed. I think that Silicon Valley Bank in particular was unusual, in that it had a lot of uninsured deposits. And it was a very concentrated group of depositors … Silicon Valley folks. And word spread very fast precipitating a bank run and that had a cascading effect on some other banks that had somewhat similar vulnerabilities though not as severe." That said, "The FDIC and the Fed have quietly bailed out most uninsured depositors since 2008," notes Los Angeles Times Washington columnist Doyle McManus.

What about us? "I would say, if you have your money in a traditional community bank or regional bank, one where you banked for a long time, that has lots of households and businesses that do business with them, have done business with them for a long time, most of their deposits were insured or with institutions that have loyalty and multiple relationships with them — that’s the vast majority of the regional banks and community banks in this country. Stay where you are, right? Don’t get scared. If you’re a household, make sure you’re under the insured deposit limits," $250,000 per depositor, per bank, in each account ownership category. "If you are, the FDIC has a perfect record. … Again, I think most banks are okay. What we need to guard against is just contagion: otherwise healthy banks starting to lose deposits just because everybody gets scared."

The threat to smaller banks is a threat to small busienss, report Justin Lahart and Telis Demos of The Wall Street Journal: "Even if any outflows are halted or reversed, small banks may now grow cautious, such as by simply sitting on more of their cash as a defensive measure. Doing so would effectively reduce their capacity to extend credit. For small and midsize businesses that rely on smaller banks, this would be worrisome, says Raghuram Rajan, an economist at the University of Chicago’s Booth School of Business and former governor of India’s central bank. Loans to them are often based on so-called soft information that local lenders have built up over years." Rajan told the Journal, “These are loans built on strength of character and a handshake.”

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