U.S. bank busts are prompting a closer look at deposit insurance — there and elsewhere

Bank failures are bad. Being unprepared for them is worse.

In Canada and dozens of other countries, deposit insurance protects people's money — up to a certain dollar value — when the worst happens and aims to provide financial stability.

Three times this year, the United States has seen deposit insurance in action, when mid-size banks have failed — most recently with First Republic Bank, an institution whose resolution is expected to cost the Deposit Insurance Fund, which is mainly supported through assessments on banks, some $13 billion US.

First Republic's collapse, the second-biggest bank bust in U.S. history, came weeks after the folding of Silicon Valley Bank (SVB) and Signature Bank in March. Those banks' prior resolutions cost the same fund more than $20 billion US.

Amid the tumult, the U.S. and other nations are eyeing adjustments to their deposit insurance offerings — though some experts say bank failures can occur no matter how much insurance is in place.

"It's not a silver bullet," said Claire Matthews, a banking expert at New Zealand's Massey University. "It's not going to prevent a bank failing, necessarily."

Fears remain about more banks failing

Ahead of First Republic's collapse, the U.S. Federal Deposit Insurance Corporation (FDIC) had been reviewing the failures of SVB and Signature and considering whether changes are needed. 

It has released a report outlining possible reforms in the wake of those failures, which were triggered by uninsured depositor runs.

The FDIC's standard deposit insurance amount is $250,000 US for each eligible deposit of each eligible type, per depositor. (In Canada, deposit insurance covers up to $100,000 for each of nine categories of eligible accounts, per CDIC-member institution.)

SVB and Signature each had high proportions of total deposits exceeding FDIC deposit-insurance levels — about 90 per cent. But regulators declared systemic risk exceptions for them, fully covering all the deposits. 

That decision was made to shore up confidence in the banking system, though a recent Gallup poll suggests nearly half of Americans remain worried about the money they have in the bank. 

Saqib Bhatti, co-executive director of the U.S.-based Action Center on Race and The Economy, said such fear could drive more people to move their money to large banks, which could further imbalance the scales in terms of the heft those larger institutions hold.

"Because we know that those banks are too big to fail, we know that the government won't let those banks go under, it makes it seem safer to put money in those banks," said Bhatti.

David Wessel, director of the Hutchins Center on Fiscal and Monetary Policy at the Brookings Institution, concurs such concern could put pressure on smaller institutions — to the detriment of those who rely on them.

"Smaller banks often are willing to take risks in lending to small businesses and in their communities that big banks aren't," said Wessel, echoing a point Bhatti also raised.

"We don't want a system where the small banks all get squeezed," Wessel added.

Yet the U.S. banking industry may have increasing exposure to the circumstances that surrounded SVB and Signature with "growing concentrations of uninsured deposits at large banks," as the FDIC said in its report.

That comes alongside operating in an environment in which social media can amplify panic and money can be withdrawn rapidly — such as when SVB depositors withdrew tens of billions in a span of hours.

"The faster it is for the depositor to move funds around ... the more likely it is that there is a run, given any rumours of problems or actual problems in a bank," said Francesc Rodriguez Tous, a lecturer in banking at the Bayes Business School in London.

Possibilities for reform

The FDIC's report lays out several possibilities for reform, including: sticking with the current approach of a limited level of coverage; going with an unlimited level of coverage; or having a targeted increase in coverage, where some types of accounts (like those used for business payments) would have higher protection levels than others.

Views on what's best vary among experts, but the FDIC says it favours the targeted option, given the protection to depositors and the stability it could provide, as compared to its costs.

Bhatti says the U.S. should implement an unlimited level of coverage for all depositors, which he believes is already the de facto reality. But he wants more stringent regulation, too.

"Let's actually just acknowledge that we're going to cover deposits and let's then clamp down on a lot of the risky behaviour that these banks are engaging in," he said.

Higher protection eyed in U.K.

The United Kingdom is also considering changes to its deposit insurance system.

The BBC reports this includes a possible increase to the protection offered for bank savings, which currently stand at £85,000 (roughly $145,000 Cdn).

Rodriguez Tous, of the Bayes Business School, says that would be justifiable on an inflationary basis alone, as the U.K. has not adjusted this threshold in years — and the longer that goes unadjusted, the more the proportion of uninsured deposits will grow.

"Typically, as time goes by, the threshold doesn't move. Then you have more and more uninsured deposits," he said.

However, Andrew Bailey, the governor of the Bank of England, has indicated that any move to increase coverage would carry an increase in costs for banks.

"Considering increasing deposit protection limits could have cost implications for the banking sector as a whole," he said during a speech in Washington last month.

"As with all things relating to bank resolution, there is no free lunch."

There have been calls for Canada to raise its own deposit insurance coverage. Ottawa has signalled its willingness do so, if needed.

Following the plan in New Zealand

New Zealand does not currently have deposit insurance, though that's slated to change.

Legislation was brought forward to create a compensation scheme protecting up to $100,000 New Zealand dollars (around $85,000 Cdn), per depositor, per institution. It's expected to receive royal assent this year, according to the Reserve Bank of New Zealand.

Matthews, the Massey University banking expert, said New Zealand has not seen a bank failure for years and the recent U.S. banking turmoil seems far removed from daily concerns.

The pending move toward a deposit insurance system has seemingly come from the realization that few other countries are set up the same way.

"We seem to be an outlier to not have deposit insurance," Matthews said.

"If something happened and there was significant loss, it would be hard to argue we were doing well if we were different to everybody else."