Universal Deposit Insurance for Both Safer & Far More Productive Banking

Ever since Silicon Valley Bank collapsed last March, calls have been growing for the US Congress to raise, or even to remove, the US’s Federal Deposit Insurance limit of $250,000 per account type.

Congress should heed these calls quickly and remove caps completely on business transaction accounts, as proposed in draft legislation that I’ve shared with Members of both political parties in both Chambers of that national legislature.  At the very least, it must raise the caps far above where they are now.

This is crucial both to calm current tremors and to ensure the long-term future of the US’s venerable network of regional, industrial, and other non-Wall Street banks.

By removing coverage caps on transaction deposits — which thousands of small businesses, startups and nonprofits draw from to cover their payroll and other operating expenses each week — Congress will be both (a) ensuring that small firms and start-ups can bank safely without having to become financial wheeler-dealers on the side, and (b) reversing a mass exodus, now under way, of deposits from local Main Street banks to global Wall Street financial conglomerates.

A bit of history will help concretize the point.

Congress introduced Federal Deposit Insurance in the early 1930s when the US was undergoing a banking crisis strikingly reminiscent of the one it is facing today. The concern then, as now, was with short-term liquidity, not fundamental solvency. The danger, in other words, wasn’t that banks’ assets were troubled—as they were later, in 2008. It was that there was no deposit insurance, which meant that any bad news could trigger a self-fulfilling prophecy-style bank run—even on healthy banks.

This is precisely what happened at ‘boring’ Silicon Valley Bank. When its depositors — primarily tech firms with payrolls and large daily operating expenses to handle — withdrew funds to handle their own problems brought on by suddenly much higher interest rates wrongheadedly engineered by Fed Chairman Powell, SVB had to sell some of its Treasury securities at a slight loss to cover the withdrawals. That then reminded depositors of a worrisome truth: Their deposits in many cases now far exceeded the coverage caps that the Federal Deposit Insurance Corporation (FDIC) imposes.

This is precisely why things calmed somewhat the weekend of SVB’s failure just as the Fed, FDIC, and Treasury stepped up to make SVB’s depositors whole.

But how can $250,000 not be enough, some might now ask. This is simply the wrong question, a product of the typically self-absorbed tendencies of many, especially in now catastrophically deindustrialized and financialized America, to think this is all somehow ‘about [them].’

But it’s not about them, it is not about individuals, it’s about businesses—small businesses and startup businesses in by far the most dynamic and productive sectors of what remains of America’s manufacturing economy.

Again, most regional and sector-specific industrial banks’ depositors have large payrolls and formidable daily operating expenses. These make mere ‘peanuts’ of the $250,000 at which the FDIC currently caps coverage. Yes, that is more than enough for most of us individuals—certainly, it is for me—but it is not for the small businesses and startups that are the most dynamic drivers of the US’s productive industries.

If Congress doesn’t remove the insurance cap, business depositors will continue to migrate to the big Wall Street banks as they are rapidly doing right now. From a depositor’s vantage, these monolithic conglomerates are indeed safer because they are deemed to be ‘too big to fail’—too systemically important for federal authorities to allow them to go bankrupt. (When you hear people talking of ‘implicit guarantees’ of the Big Four US banks, this is of course what’s being alluded to.)

Should this continue, it will not only bring more banking concentration and less competition—it wasn’t that long ago that Americans referred to the ‘Big 8,’ then the ‘Big 6’ rather than the present ‘Big 4’ banks—but also will deprive our most productive small businesses and startups of banks that know their market niches, their localities, and their associated financing needs best.

One-size-fits-all Wall Street banks are far less sensitive to local conditions and the specialized needs of small businesses and startups in the US’s productive, not speculative—ie, manufacturing, not Wall Street gambling—industries than are America’s regional and sector-specific industrial banks. 

Some will of course argue that insuring large transaction deposits would amount to a subsidy for the rich. The same people will likewise argue that lifting the caps will encourage riskier behavior.

But Congress introduced risk-pricing for federal deposit insurance back in 2005, meaning that bigger and riskier banks pay more for the insurance — just as a smoker or mansion dweller pays more for health or for homeowners’ insurance. And depositors don’t act as monitors of bank practices in any case—that is what shareholders and subordinated creditors do.

Moreover, the schedule of FDI premiums can be structured progressively, such that banks can charge fees to bigger depositors but not smaller depositors to help defray costs. The Federal Deposit Insurance Completion Act—the bill mentioned above—that I shared with Congressmembers just after SVB’s collapse shows how to do this in just a few pages.

During all of the US’s previous ‘industrial revolutions,’  sector-specific industrial and regional banks played critical roles. They knew the needs of their sectors and regions, and focused on financing production in primary markets rather than speculation in secondary financial and tertiary derivatives markets—the markets where hedge funds and other speculators bet on stock, bond, currency and commodity price movements.

The end of interstate bank branching restrictions during the mid-1990s, which allowed banks to operate across multiple state boundaries, and 1999’s repeal of the Glass-Steagall Act, which had prohibited banks from merging with more speculative financial institutions like hedge funds, private equity companies and brokerage firms, upended this great tradition of US industrial banking. Americans are living the populist consequences of that now. 

But some of the old-style banks lived on, and the US can both save them and grow even more specialized Main Street banks now if it uncaps Deposit Insurance post haste. In effect, much of the worst of the mischief done to America’s economy by the benighted 1990s can be undone with the stroke of a pen. And nothing needs even be repealed.

This piece abbreviates the extended argument the author makes in their recently posted article Universal Deposit Insurance.

Robert Hockett is Edward Cornell Professor of Law at Cornell Law School, Adjunct Professor of Finance at Georgetown’s McDonough School of Business, Senior Counsel at Westwood Capital LLC, and a former Counsel at both the Federal Reserve Bank of New York and the International Monetary Fund.