Bank Failures: The FDIC’s Systemic Risk Exception

When Silicon Valley Bank (SVB) and Signature Bank failed, 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 at those #banks under the statutory systemic risk exception to least-cost resolution (LCR; 12 U.S.C. §1823(c)(4)(G)). The FDIC insures deposits up to a statutory limit of $250,000. Currently, the FDIC projects that guaranteeing the uninsured deposits will cost the FDIC $16.3 billion. Under LCR, losses equal to that amount would have been borne by uninsured depositors. The two banks’ combined estimated uninsured deposits were $231.1 billion in 2022. H.R. 4116, as ordered to be reported in the nature of a substitute in April 2024, would require the failed banks’ regulator to report to Congress on supervision of the banks and would expand the scope of review by the Government Accountability Office (GAO) when the systemic risk exception is invoked.

FDIC Least-Cost Resolution,
When a bank fails, it does not enter the bankruptcy process like other businesses to resolve creditors’ claims. Instead, it is taken into receivership by the FDIC, which takes control of the bank and resolves it through an administrative process. Costs to the FDIC associated with a resolution are funded by drawing on the FDIC’s Deposit Insurance Fund, which is funded through assessments on banks and backed by the U.S. Treasury.
A banking crisis in the 1980s was more costly to the FDIC, and ultimately the taxpayer, because of the frequent use of regulatory forbearance—allowing troubled banks to stay open—which in many cases increased the losses that they suffered before they were ultimately shut down. In some cases, the FDIC used open bank assistance to provide funds or guarantees to troubled banks to keep them going rather than taking them into receivership.
Following the crisis, Congress reformed how the FDIC resolves banks in 1991 (P.L. 102-242). This act introduced prompt corrective action and LCR requirements as cornerstones of resolution. These two principles are intended to minimize resolution costs by ensuring that banks are resolved as quickly and inexpensively as possible. As such, uninsured depositors and other creditors can be repaid in a resolution only insofar as it is consistent with LCR, unless the systemic risk exception is invoked.

What Is the Systemic Risk Exception?
Systemic risk is financial market risk that poses a threat to financial stability. In the case of SVB and Signature, policymakers were concerned that a run by uninsured depositors would spread to other banks, causing a broader financial crisis detrimental to the real #economy.
Under the 1991 law, LCR can be waived under the systemic risk exception with five statutory requirements: (1) The Treasury Secretary, in consultation with the President and upon a written recommendation of at least two-thirds of the boards of the FDIC and Fed, determines LCR “would have serious adverse effects on economic conditions or financial stability” and the FDIC’s actions would avoid or mitigate those effects. (2) Any loss to the FDIC must be repaid through a special assessment on banks by the FDIC. In levying this assessment, the FDIC need not follow normal deposit insurance assessment #rates and may consider who benefited from the action and the effects on the banking industry (as amended by P.L. 111-22). (In this case, the FDIC levied the assessment on the 114 banks with over $5 billion in uninsured deposits.) (3) The Treasury Secretary must document the decision. (4) GAO must review the incident. (GAO released its review in April 2023.) (5) The Treasury Secretary must notify the congressional committees of jurisdiction within three days.
Before 1991, the FDIC considered several goals, including cost, in determining how to deal with a troubled bank. As such, LCR, even with the exception, represents a constraint on its pre-1991 authority. The FDIC can take a number of actions under the exception, but it can be used only in an FDIC receivership.

Previous Uses of the Exception,
Policy Issues,