This is no time for lectures on moral hazard, former U.S. Treasury Secretary Lawrence Summers said ahead of the raft of U.S. policy initiatives announced on Sunday to stabilize the financial system in the wake of the collapse of Silicon Valley Bank. Maybe, but might we at least be allowed a brief lament?
Depositors in SVB are to be made whole even if their cash holdings with the failed lender are above the $250,000 cap that’s meant to apply to U.S. bank deposit insurance. As in the financial crisis of 2008-2009, the authorities have stepped in to ensure that depositors don’t lose money.
There were many voices arguing for such a move. The alternative was to risk the stability of the deposit system and inflict huge damage on the technology sector. If SVB customers weren’t protected, that might have spooked depositors in other smaller U.S. banks, triggering runs.
It looks like a cost-free move that ticks a lot of boxes. There’s no bailout for shareholders or bondholders — so those who consciously put capital at risk have paid the price. And it’s far from clear that there’s a colossal gap between SVB’s assets and the total deposit liability. The U.S. Federal Reserve said no taxpayer funds would be needed to cover losses from SVB’s failure. It appears the banking sector will ultimately pick up the tab if there is one. The net effect is that depositors are safe, the risk of bank runs is sharply reduced and there’s been some visible punishment.
But there will be longer-term costs. After the financial crisis, the limits on deposit insurance were drilled into bank customers. The caps are there to give small retail depositors confidence in their lenders. Depositors with big cash holdings are — reasonably — expected to be aware of the risks and spread their cash around several institutions. Businesses backed by venture capital, such as the customers of SVB, ought to have been advised how to manage their liquid holdings.
As it is, the sight of depositors being made whole will surely give larger bank customers comfort that they can put their cash in whatever lender is willing to give them the most favorable terms. It provides a disincentive for both depositors and banks to be prudent. There’s no reward here for SVB customers who banked more carefully. The policymakers and economists will say the whole of society would have been way worse off if there was a banking crisis. But what happens next time, especially if the next failure is bigger than SVB? Who will pick up the tab for a blanket emergency guarantee on uninsured deposits then?
The good news is that the British government has avoided having to backstop depositors in SVB’s U.K. bank thanks to a hastily orchestrated rescue by HSBC. The rhetoric from London over the weekend implied several potential scenarios that could have put U.K. taxpayers’ money at risk to support the clients of the U.K. subsidiary. That has at least been avoided with a clean sale: This private deal is exactly what was needed.
There are no easy answers to how to properly insure bank deposits. As ever in a crisis, decisions have to be taken at speed and end up being made by comparing the consequences of the choices available. But once again, a cap on deposit insurance has been found to hold only until something bad happens.
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Chris Hughes is a Bloomberg columnist covering deals.
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