In the failure of Silicon Valley Bank and Signature Bank, U.S. officials decided to cover all the uninsured deposits in both banks — that is, deposits that exceeded the $250,000 insurance coverage of the FDIC. The belief was that failing to cover those uninsured deposits ran the risk that bank runs could spread to more banks. Covering those uninsured deposits was intended to calm depositors in other banks, which would thereby make more bank runs less likely.
Since then, some people have called for officials to cover all deposits in the banking system, insured and uninsured, in order to keep people calm and prevent more bank runs. In other words, they are suggesting that the $250,000 deposit-insurance limit be lifted entirely.
Yesterday, however, Treasury Secretary Janet Yellen told the Senate Appropriations Committee that she is not considering “blanket insurance” to U.S. banking deposits. She said that officials would cover uninsured deposits only when a failing bank constituted a “systemic risk” to the entire banking system.
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Nonetheless, it is difficult to imagine that U.S. officials will leave uninsured depositors hanging in future bank failures, given that they just covered uninsured deposits at Silicon Valley Bank and Signature Bank. In future bank failures, uninsured depositors are going to be clamoring for coverage too, and they will be citing Silicon Valley Bank and Signature Bank as precedents.
The dark irony here is that by covering uninsured deposits at Silicon Valley Bank and Signature Bank, officials might actually be encouraging bank runs on an industry-wide basis in the future. That’s because everyone knows that the federal government does not have anywhere near the money to cover all the money on deposit in U.S. banks.
Such being the case, if several banks fail at once, people will have the incentive to get their money out of the banking system quickly before the government runs out of money as it begins to cover all the deposits in the banks that are failing.
In other words, raising the prospect of covering all the deposits in failing banks sends a signal that the feds could run out of money faster than if they limited their coverage to insured deposits. Knowing that could induce people not to transfer their money to another bank but instead to withdraw it entirely and put it under their mattress at home.
A March 21, 2023, Brookings article entitled “How Does Deposit Insurance Work?” states: “As of Dec. 31, 2022, the Deposit Insurance Fund had $128.2 billion, or about 1.27% of all insured deposits.”
That’s obviously not much of a reserve fund, not if there are many banks failing at once.
And keep in mind: The fund amounts to 1.27% of insured deposits. Covering uninsured deposits would obviously deplete the reserve fund much more rapidly.
By covering only the uninsured funds, people would have some degree of comfort knowing that the fund would cover more banks. But by signaling the possibility that uninsured deposits will be covered as well, people would know that the available funds would be more rapidly depleted, leaving no funds to cover deposits, insured or uninsured, in subsequent bank failures. That’s what could cause people to rush to withdraw their money, something they would be less likely to do if they were certain that uninsured deposits were definitely not going to be covered.
One thing is certain about the government’s hasty decision to cover uninsured deposits at Silicon Valley Bank and Signature Bank and possibly future banks that fail: This is a very precarious banking system, one that obviously depends on keeping depositors calm through the use of perilous deposit-insurance schemes.