FDIC Insurance: it’s time for a change
How Certain Companies Profit by Side-Stepping the FDIC Limits
The March 2023 regional banking turmoil renewed interest and heightened awareness of FDIC insurance limits. These limits are something that many individuals rarely think about when dealing with their bank, partly because your average (non-business) depositor probably doesn’t have more than $250,000* sitting idly in their checking account. However, insurance limits are an important consideration for certain banks catering to business or high-net-worth clients. Customers at these institutions tend to hold large account balances, resulting in uninsured exposure, which they may seek to mitigate in times of stress. One example — Silicon Valley Bank — catered primarily to Venture Capital clients. Nearly 94% of SVB’s total deposits were uninsured before the deposit run it faced on March 9. Another example is Signature Bank, which had 89% uninsured before their rapid unplanned disassembly. First Republic Bank, which catered to high net worth clients, had uninsured deposits at 68% before failure — lower than either SBNY or SVB, but still significant.
*The actual insurance rules are a bit more nuanced than a flat $250,000, but for most individuals this is a good proxy.
What if you are a customer at one of these banks with a deposit of $50 million — virtually all of which is uninsured — and you see the stock down 50% intraday, Jim Cramer frenetically screaming, “Sell, Sell, Sell!” on TV, and a tweet storm prophesizing the bank’s imminent demise? Maybe it’s blown out of proportion, and there is nothing to be concerned about, but what if it’s not? What’s the downside to taking action and protecting your money? Many depositors had this same internal monologue the week of March 9 and chose to “shoot first, ask questions later,” withdrawing their deposits en masse from SVB, SBNY and FRC.
Once you’ve withdrawn your money, what are your options to ensure its safety? You can move the money elsewhere, which is the option many took as the crisis unfolded, but where do you take the funds to avoid the same issue of having large uninsured exposure? One option is to move into a money market mutual fund, swapping your deposits for money market shares. These shares are backed by money market instruments such as t-bills and repurchase agreements which are extremely low risk. Another option would be to move to banks perceived as “too big to fail” e.g., the large money-center banks: BoA, JPM, Citibank or Wells Fargo. Depositors moving funds to these institutions would still be subject to the same insurance limits and have the same uninsured exposure as before; however the perception is that these institutions have an implicit government guarantee and would never be allowed to fail — as shown in 2008. Given their size and footprint, these institutions also have less funding concentration, making a run from any one economic sector (Venture Capital in this case) far less impactful.
For the truly risk-averse, moving funds to a money-center bank may not be enough to instill confidence. Yes, these banks are unlikely to fail, but you are still subject to the same insurance limits which caused you to leave your prior bank. For those who want to be absolutely certain their accounts are fully insured, there is always the nuclear option: break up your account into $250,000 increments and place them with “n” different banks — if you have $1,000,000 you need four banks. This will work, but who wants to manage four different bank accounts with four different passwords, four different relationship managers, and four different interest rates? Is there a better option?
Reciprocal Deposits
Intrafi — a provider of “balance sheet and liquidity management solutions”, is a company that bankers and corporate treasurers are undoubtedly familiar with — particularly given recent events. Intrafi pioneered a product called the “reciprocal deposit”, which facilitates exactly the arrangement discussed above — slicing deposits into fully insured chunks with one critical difference. Customers do not have to manage multiple disparate relationships with each bank; Intrafi handles that for you behind the scenes. From your perspective as a depositor, you do business with your bank as you always have. Intrafi leverages its network of participants to slice up your deposit into (n / 250,000) chunks, placing them with various banks in the network. These funds are then “reciprocated” to your financial institution using the same process.
For example, assume you are a customer of “Bank A” and have $2,000,000, which you would like to insure using reciprocal deposits. Intrafi will place the uninsured portion ($1,750,000) with seven network banks resulting in $250,000 exposure at each of the seven. Bank A, in return, will receive seven $250,000 deposits from different network participants. Each institution maintains the same deposit balance as it did before; only now those balances are fully insured. Bank A and the other network banks maintain the exclusive relationship with their customers, customers maximize their insured balances while only having to deal with their bank, and Intrafi makes a healthy profit for facilitating the arrangement. Everyone wins!
Not wanting to be left behind, other institutions have started rolling out their versions of reciprocal deposits. SoFi, for example, offers up to $2,000,000 of FDIC insurance via its Insured Deposit Program. A burgeoning cottage industry of products and services exists solely to side-step FDIC insurance caps in what is effectively a massive regulatory arbitrage. If depositors weren’t focused on maximizing their FDIC coverage before March, they are now.
Systemic Risk Exception
The events during March clearly show that FDIC insurance limits impact depositor behavior in times of stress. When SVB and SBNY collapsed, many other banks perceived to have similar flighty deposits came into the crosshairs: FRC, PACW, WAL, ZION, and various other regionals — particularly those with a west coast presence and VC exposure. If your bank had “West” or “Pacific” in its name, you had a bad March. If it had both, your regulators had you on speed dial. In an effort to stymy the run and bolster confidence, some banks even began disclosing their deposit levels and uninsured coverage ratio — a metric that shows how much available liquidity they have relative to uninsured deposits — on a near weekly basis. With no end in sight to the panic and to avoid a potential run on uninsured balances across the entire banking sector, the Treasury Secretary, the Federal Deposit Insurance Corporation (FDIC), and the Federal Reserve (Fed) announced on March 12, 2023, that the FDIC would guarantee uninsured deposits of SVB and SBNY under the Systemic Risk Exception.
Given that the FDIC ended up guaranteeing all of these deposits anyways, why not just increase the limits before a bank fails? In 2008, the FDIC did just that via the Transaction Account Guarantee (TAG), which temporarily suspended insurance caps on certain non-interest-bearing transaction accounts. Enacting a similar guarantee in early March could have squelched the crisis before it fully materialized. This did not occur because it turns out the FDIC no longer has the authority to modify the insurance limits outside of the resolution process. Enacting the Systemic Risk Exception to cover uninsured deposits once a bank has been placed in receivership can be initiated by the Treasury Secretary in consultation with the President (and a written recommendation by 2/3 majority of the FDIC Board and Federal Reserve). However, changing the insurance limits before failure would require congressional approval. The FDIC was stuck — they needed to stop the run on uninsured deposits but couldn’t increase the insurance caps before failure. Instead, they did what they could with the tools in their tool-belt by guaranteeing them after failure.
Why has Congress not pushed for a change in these limits? Had it been possible to temporarily guarantee accounts similar to TAG in 2008, several recently failed banks would likely have survived. Instead, now the FDIC must use its Deposit Insurance Fund (DIF) to cover uninsured depositors of the failed institutions — a task it was not created for.
Deposit Insurance Fund
The FDIC’s Deposit Insurance Fund (DIF) protects insured depositors at covered banks. It is funded by quarterly payments from covered banks which are based on various depositor characteristics — for simplicities sake, we can view these assessments as primarily dependent on the amount of insured deposits a bank has. The assessment is effectively an insurance premium — the more coverage you need (more insured deposits), the higher your premium.
On the surface, offering temporary unlimited coverage to depositors places a larger financial burden on the FDIC and greater exposure to the DIF, since every deposit effectively becomes fully insured. However, to the extent depositors regain confidence in their banks and cease withdrawals, it can save the FDIC money. In a normal bank failure, the FDIC immediately pays out insured depositors from funds in the DIF, whereas other creditors (including uninsured depositors) must seek recovery from the sale of any remaining assets*. If the bank doesn’t fail, the DIF doesn’t have to pay for anything. So perhaps paradoxically, increasing the DIF’s exposure via unlimited guarantees on a temporary basis can result in less funds having to be paid out.
*Technically, uninsured depositors are paid an “advanced dividend” based on the FDIC’s assessment of the ultimate value remaining in the receivership.
FDIC Insurance Limits in 2023
In response to the March regional banking crisis, the FDIC committed to reviewing the appropriateness of the current insurance thresholds. On May 1, 2023, they published Options for Deposit Insurance Reform, outlining several possibilities for updating the thresholds. This was a step in the right direction, but for now, the exercise appears to be primarily academic, suggesting various approaches but with no timeline in place for implementation.
Given that the majority of deposit outflows were from clients with large uninsured balances and the FDIC ended up guaranteeing all of them anyhow, perhaps the insurance limits need an update? The $250,000 limit has been in place since 2008 when it was last increased from $100,000 in what was originally meant to be a temporary increase under the Emergency Economic Stabilization Act of 2008:
All it takes is a look at housing prices or one’s grocery bill to figure out that things today are considerably more expensive than they were 15 years ago. Why, then, is the limit still $250,000? Even ignoring the growth in the money supply and corresponding inflation since 2008, it makes little sense for a business to have the same insurance limits as an individual.
Some argue that businesses should be responsible for performing their own risk analysis on the banks they hold large deposits with. Providing a blanket guarantee on all deposits may result in weaker banks attracting depositors they otherwise could not — and this puts the DIF at risk. While there is some credibility to that argument, there is a big difference between a small “mom & pop” community business and a large publicly traded company that likely has a corporate treasury department. The latter has the resources to perform a proper credit analysis on its bank. The former does not. Your local dry cleaner shouldn’t have to pour through SEC filings before opening up a bank account. As Dale Gibbons, CFO of Western Alliance Bank, recently quipped in an interview with the New York Times (paywalled):
“I feel bad for depositors, they didn’t sign up to be bank equity analysts.”
Regulatory Capture
It’s pretty clear that deposit insurance limits need change, yet here we are — with the same limits in place that were set 15 years ago. Who stands to benefit from the status quo? Perhaps a private sector company who, through sleight of hand and technological prowess, can transform uninsured deposits into insured deposits for a healthy profit? A more skeptical take as to why the limits have been slow to change is that maybe it’s just good business for certain well-connected players.
Intrafi — the company previously mentioned which pioneered reciprocal deposits — has a Board of Directors littered with former senior regulators from the FDIC, OCC, and Federal Reserve. CEO Mark Jacobson was previously Chief of Staff at both the FDIC and OCC. It is perhaps no surprise that Intrafi has recently stepped up its lobbying efforts, given its vested interest in keeping insurance limits right where they are. If the FDIC were to increase the limits or, at the extreme, eliminate them entirely, Intrafi’s business model would evaporate overnight. Perhaps Congress has not acted to increase these limits because there is a conflict of interest at play.
Intrafi isn’t the only player in the reciprocal space. Reich & Tang offers a similar product, and as mentioned earlier, several institutions have recently begun to create in-house versions — SoFi being one example. These products exist for a reason — there is demand for more insurance than the FDIC currently provides depositors. Banks are not in the wrong for leveraging these products — it’s good for them as well as their customers. However, a better solution would be to have the FDIC cut out the middleman and pass that savings onto depositors.
Conclusion
It is not the private sector’s job to protect depositors, it is the FDIC’s job. Modifying the insurance limits to a level more appropriate for 2023 — and ideally in a framework that distinguishes business from consumer depositors, is long overdue. If there is demand for significantly more insurance than the FDIC currently provides, and that demand is being met by the private sector through reciprocal deposits — why doesn’t the FDIC step in? They are already on the hook for the additional deposits insured via reciprocal arrangements, so there is no real reason why this can’t be done. Finally (and critically), reciprocal arrangements cannot technically guarantee that a depositor is always fully insured. That depends on the size and availability of the reciprocal network — a topic for another time.