Write Team: Raising important banking questions

Once upon a time, not so long ago, American bankers lived by the 3-6-3 rule.

That is, they paid 3% interest on deposits, charged 6% interest on commercial loans, and they could expect to be on the golf course by 3 p.m. Banks were standalone operations, barred from opening branches. Banking was, by and large, boring.

The last few weeks in American banking have not been boring.

Bank runs, once the scourge of the financial system, are very unusual nowadays. But Silicon Valley Bank, up until recently the 16th largest bank in the U.S., collapsed after some prominent depositors began pulling out their money. The Federal Deposit Insurance Corporation took it over after the bank saw $42 billion withdrawn in a single day. Another bank, First Republic, failed a few days later, as concern mounted in the financial sector. Regulators have since assured Americans the banking system is stable, but I think some important questions have been raised.

The first is how the failure of SVB fits into the economy. Although we still are recovering from the turmoil of the pandemic, the Federal Reserve has raised its benchmark interest rate 4.5% over the last year. The idea behind the Fed’s strategy is rising interest rates will diminish investment, which in turn will cause unemployment to rise, thereby dampening wage growth, while also reining in borrowing, and causing overall spending in the economy to fall, thus slowing down price inflation.

But it turns out the venture capitalists and technology startups that formed SVB’s depositor base were dependent on low interest rates. The recent past also has seen mass layoffs among the larger tech firms, but the broader job market has remained strong. It seems to me SVB’s failure has more to do with Silicon Valley than with banking generally.

The second question raised by the recent bank failures has to do with the FDIC’s deposit guarantee. Fewer than 15% of SVB’s deposits were less than the agency’s $250,000 limit on deposit insurance, but it was announced depositors would be protected from any losses. That implies all bank deposits are insured by the federal government – are they?

Banking is a private business providing public goods. It is the critical infrastructure of the market economy. It’s how we coordinate savings with investment, and how we decide who gets mortgages and car loans, which businesses can expand. By guaranteeing bank deposits, the federal government subsidizes the business of banking. And that’s a good thing.

The FDIC exists because when banks fail, they wipe out their depositors’ savings and destabilize the economy. It has been suggested, however, if the government is going to guarantee bank deposits in any amount, deposits might as well be made directly with the Federal Reserve. Banks could still lend, still be profitable. And it would be to the advantage of community bankers with knowledge of the local economy, because they can more readily identify good investments.

Last month, $67 billion in deposits went into the four largest banks while $120 billion was withdrawn from the deposits of regional and community banks. If the failure of SVB is an indication of how things are going, we can expect those big banks to keep getting bigger, although not necessarily better.

Samuel Barbour is a local economics professor musing on all things topical, within our community and abroad. Questions and comments are fielded at newsroom@shawmedia.com