Tag: deposit insurance

Resolution of First Republic Bank

JPMorgan Chase’s purchase of First Republic Bank appears to be a standard purchase and assumption resolution of a failing bank. The Federal Deposit Insurance Corporation (FDIC) has organized hundreds of such bank resolutions there by painlessly purging bad banks for the banking system. The only mistake in my view was selling it to the country’s largest bank.

Purchase and assumption resolutions involve the simultaneous purchase of a failing bank’s good assets and the assumption of its deposit liabilities by a good bank and putting what’s left into bankruptcy (wiping out its shareholders and some or all of its corporate debt). Its the risk of loss to shareholders that provides the market scrutiny of bank risk taking. “Institutional and Legal Impediments to Efficient Insolvent Bank Resolution And Ways to Overcome Them”

Money (currency and demand deposits) should not be at risk of a bank failure. Depositors should not need to evaluate the safety and soundness of the bank they chose to hold their money in. So the FDIC insures deposits up to $250,000. But all deposits in the last three banks to fail were made whole whether insured or not and there is talk that all deposits should be explicitly (rather than just implicitly) insured. Central Bank Digital Currency (CBDCs) would provide such total protection to those holding it (retail CBDCs would be issued/administered by commercial banks and fully backed by an equivalent amount at the central bank).

Public “runs” on banks in order to move vulnerable deposits to cash or a safer bank, result from the fact that banks can fund long term loans with callable deposits. They can lend your deposit to someone buying a house with a 30-year mortgage. This works as long as banks keep enough cash or quickly liquidated assets on hand to cover any deposit withdrawals their depositors might want to make. An alternative to deposit insurance for all deposits is to isolate demand deposits from bank lendable resources by requiring that they be 100% back at the central bank (as with CBDCs) and not available to cover any losses on other bank activities.

It is time to take so called narrow banking (or The Chicago Plan) seriously. CBDCs are the natural vehicle for this restructuring of our money and credit systems.  “Protecting bank deposits”

Protecting bank deposits

Following the collapse of Silicon Valley Bank last week there has been considerable discussion about whether and how the regulatory regime might be strengthened (or actually more effectively implemented) to prevent such collapses (yet again) in the future. Raising deposit insurance coverage to 100% of all deposits is being suggested (and was provided ad hoc to SVB and Signature Bank this week). Econ 101: SVB and bank runs – Warren’s space (wcoats.blog)

Insuring all deposits and adopting the Chicago Plan represent two very different approaches to removing all risk of loss to depositors and thus any incentive to run from a bank. In the search for regulatory or market checks on excessive bank risk taking or poor management, the expectation that depositors would carefully monitor the behavior and condition of their banks was never realistic. Thus, removing any financial incentive for such due diligence by raising deposit insurance to cover all deposits would have little to no impact on bank behavior. Such scrutiny by bank shareholders and managers is much more realist and thus important. US bank bankruptcy procedures do not spare shareholders, who in the case of SVB have lost everything. However, more might be done to impose losses on managers of insolvent banks.

Following the bankruptcy of SVB considerable attention has rightly focused on the speed with which facts or rumors of a bank’s weakening financial condition can spread over the Internet. What might have taken weeks as depositors began to line up outside their banks to withdraw their deposits while the funds lasted, now takes minutes, dramatically accelerating the speed with which a bank must try to liquidate enough of its assets to fund the withdrawals.

Full deposit insurance and the Chicago Plan of 100% reserve banking (deposits at the central bank, which are always safe and instantly available) eliminate any incentive for bank runs. But the difference between them deserves more attention. The full deposit insurance approach puts the cost of bailing out the depositors of a failed bank on the rest of the banking system (on the “good” banks) who finance the insurance fund.  The cost of the Chicago Plan, if indeed it is a cost at all rather than a benefit, is the need for banks to fund their credit operations with equity or long-term debt, rather than with potentially volatile deposits. We should move to the Chicago Plan and fully separate money from credit.

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