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VERIBANC BLOGS Next blog: Bring Back Glass-Steagall Senate Banking Committee - Deposit Insurance Reform - Be Careful!On September 10, 2025 the chair-elect, Mr. Kenneth Kelly, of the American Bankers Association (ABA), testified on behalf of the ABA at a hearing before the Senate Banking Committee. After reading the testimony, I am writing to you to offer a different perspective and to propose several questions for your consideration. Mr. Kelly presented the ABA’s view on how the deposit insurance system could be “modernized”. His rationale was to “reflect the needs of today’s depositors, banks and communities while promoting financial stability and a level playing field for banks of all sizes.” A paramount concern with raising or expanding deposit insurance has always been an increase in the moral hazard risk. This increase in risk is due to underwriting higher risk loans because of their higher interest rate return. Higher risk loans, like commercial real estate loans, would have more, if not all, of the risk now transferred to the FDIC. I am sure anyone that has studied history recognizes that human nature needs constraints to help discipline any endeavor. With a higher or broader level of FDIC insurance protection, those constraints are mitigated and the associated discipline. Higher risk taking does not lend itself to a more stable financial system. Also, the depositor with more than $250,000 and/or the markets should bear the responsibility and/or risk of monitoring a bank and not be incentivized to become lax because of a broader safety net. Furthermore, consumers, private and public entities that have exposure above the $250,000 FDIC insurance limit are not unsophisticated and have at their disposal one or more mechanisms to protect their deposits above the FDIC’s limit. These include: pledged securities, a Federal Home Loan Bank letter of credit, deposit parsing networks, rating companies and private deposit insurance. Some of these mechanisms have inherent and frequent monitoring for safety and soundness built in. The ABA also made a recommendation to grant the FDIC preemptive approval to temporarily back deposits and other liabilities under a specific set of crisis conditions as it did during the pandemic. The goal would be to limit the risk of contagion. This strategy is tantamount to closing the barn door after the horses have left the barn. A few fundamental questions should be asked for any bank failure. Why did the bank fail? Why did the regulators not act sooner? Do regulators need stronger leadership? A regional bank failure like Silicon Valley Bank presents an ideal case for understanding why state and federal regulators let this bank’s condition deteriorate to the point it had a deposit run. The Federal Reserve Office of Inspector General’s report of September 25, 2023 identified more than one regulatory short coming that should have preempted management from continuing down the road of a flawed business strategy. Especially their “doubling down” purchases of long-term U.S. government securities over many quarters. The main point is this – the bank run, resulting chaos, market turmoil and unparalleled intervention by Treasury, the Federal Reserve and the FDIC could have been avoided had the state and federal regulators, to quote a famous coach – had “done their job” in a timely manner. The federal banking regulators already have the tools necessary to prevent a bank from failing. Their tool kit was enhanced with the passage of FIRREA of 1989, FDICIA of 1991 and the Federal Reserves “Source of Strength” doctrine. Rather, it’s the consistent implementation and frequency of applying these tools, (during the exam process) that should be addressed as in the noted failure of Silicon Valley Bank. So any contagion would have and should have been avoided without the need for any special additional actions. Yes, regulation and its application through examinations have a natural and inherent contention with the banking industry, as it should. Unbiased monitoring is a must, due to the impact a bank failure has on the economy and financial system it serves. However, even the federal banking regulators should have a play book that details special conditions that defines a crisis and the actions to be taken in such cases. Certainly, they can define and craft a crisis playbook by studying the various historical financial crises in the U.S. As respects it being transparent, this is a flawed argument. Knowing what’s in the play book may lead to trying to - game the system. An important issue needs further discussion. That is the inherent conflicts of interest between a bank and its federal regulator. This situation should be eliminated. Although it has been a policy since the inception of the Federal Reserve, no banker should be on the Board of Directors of its federal regulator. Specifically, Mr. Gregory W. Becker, the president and CEO of Silicon Valley Bank, at the time of its failure, was also on the Board of Directors of the San Francisco Federal Reserve. Did this relationship, in any way, impact the delay of action by the regulators? If the Federal Reserve System wants/needs input from the local banking community then limit any banker’s participation to a single - two year term. It is further suggested, to limit any potential for a conflict of interest, that a diverse committee be set up that consists of bankers, representatives from various associations in that particular Federal Reserve district, i.e., technology, manufacturing, construction, transportation, agricultural, energy, utilities, retail, health care, insurance, finance, real estate and academia that reports to the Federal Reserve’s Board of Directors. With the size and variety of these sectors the committee will be better able to transmit a broader and more in-depth economic perspective within their Federal Reserve district. Also, you mitigate the potential influence or bias any one member has over the group. The ABA also made a number of recommendations as to what should be factored into the way the FDIC resolves a bank failure. Historically, the number of bank failures (defined as - when the executive management team is replaced by their regulator) has decreased from a high of 157 in 2010 to between 2 and 5 failures per year, over the past five years. Also, let’s keep in mind that the number of banks has decreased from a little over 8,300 banks in 2008 to under 4,500 in 2025. In addition, the FDIC has found another bank to purchase all of the assets and all of the deposits of a failed institution in over eighty-five (85) percent of the cases since 1995. So, the impact on the communities is historically very low. This historical resolution strategy by the FDIC has also benefited the ABA members through lower FDIC insurance assessments as opposed to any other resolution method that requires dipping into the Deposit Insurance Fund, which must be replenished. We would propose that more regulation is not needed and the current system is already “modernized”. The current regulatory system is in need of tweaking. Monitoring should be more thoroughly implemented, consistent and examinations should be more frequent, not less. |
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