In abrupt reversal, regulators to cowl Silicon Valley Financial institution, Signature uninsured deposits

The Treasury Department authorized a “systemic risk exception” Sunday night, allowing regulators to cover all uninsured deposits at Signature Bank of New York, which was closed on Sunday, and Silicon Valley Bank, which was closed on Friday.

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WASHINGTON — In a stunning decision, federal regulators issued a systemic risk exception to protect uninsured customer deposits at Silicon Valley Bank of La Jolla, California, in the wake of the bank’s sudden failure on Friday, and the Federal Reserve announced the creation of a lending facility large enough to cover all the insured deposits in the banking system. 

The regulators also said they would enact a similar systemic risk exception for Signature Bank of New York after its state chartering authority closed the bank on Sunday. 

Regulators are seeking to insulate the rest of the banking system from the contagion effects of the two failures, including the potential for runs at other financial institutions that cater to specific industries. 

Guaranteeing the banks’ uninsured deposits is meant to reassure jittery depositors at other banks who might have rushed to pull out their funds as soon as markets opened Monday morning. The new lending facility gives banks an option to access near-par value liquidity for discounted securities to quell liquidity concerns.

“This stuns me that they would do two systemic risk determinations of banks of this size, this early in the game,” said Arthur E. Wilmarth Jr., a professor emeritus at George Washington University Law School. “The fact they did this so early indicated to me that there is tremendous vulnerability at other banks.”

Treasury Secretary Janet Yellen approved the systemic risk exceptions, allowing the banks to be resolved in a way that “fully protects all depositors,” including those that contributed to the unusually high pile of uninsured deposits at Silicon Valley Bank. Treasury received the recommendation to do so from the boards of the Federal Deposit Insurance Corp. and the Fed. 

The Fed’s Bank Term Funding Program, or BTFP, will act as a supplement to the central bank’s discount window, its standard last-resort lending facility, albeit with several advantages. Qualified depositories will be able to take out loans from the facility at the overnight swap rate plus 10 basis points for up to one year — instead of the typical 90-day limit — by posting U.S. Treasuries, agency debt or agency-backed mortgage-backed securities as collateral.

Critically, the BTFP will lend against assets at their book values, rather than their market value minus a set discount — known as a haircut — as is the case for the discount window. This allowance enables banks to offset paper losses that have been a drag on many securities portfolios since the Fed began increasing interest rates last spring. When interest rates go up, bond values typically fall.

“It’s a robust facility,” a senior Fed official said. “The program’s capacity is huge and intentionally so. The facility is large enough in the aggregate to cover all the banking system’s uninsured deposits.”

The official declined to say exactly how much liquidity the facility could provide. The program is backstopped by a $25 billion pledge from the Treasury, but the official said he did not expect the Fed to have to tap into those funds.

The last time the Fed lent against assets at par value was in 2020, at the onset of the COVID-19 pandemic. Before that, the last time it took this action was in 2008, following the collapse of the subprime mortgage bubble that led to the global financial crisis.

The Fed Board of Governors voted unanimously to create the BTFP facility, the senior official said. Similarly, the entire board backed the declaration of a systemic risk exception.

A senior Treasury official said that first, the FDIC will use funds from the Deposit Insurance Fund to make sure that all of the depositors of the two banks that were put into receivership in the last three days are made whole. The Treasury, Fed and FDIC said in a joint statement that any losses to the DIF to support uninsured depositors will be recovered by a special assessment on banks, per the law.  

The FDIC had previously announced a hike in deposit insurance assessment fees as part of the agency’s long-term plan for the reserve ratio of the Deposit Insurance Fund to reach the statutory minimum of 1.35% by September 2028.

The events of Sunday evening call into question the precedent the federal government is setting as far as protecting uninsured deposits, and the financial stability risk of large regional banks like Silicon Valley Bank and Signature. 

“Just to be clear, this situation is not 2008,” the senior Treasury official said. “There are a lot of reforms that have been put in place. We are trying to help depositors of the institution. The bank’s equity and bondholders are being wiped out. They took a risk as owners of these securities; they will take the losses.” 

Policy watchers immediately asked whether this constitutes a “bailout” of tech firms, venture capitalists and startups who rely on the deposits in Silicon Valley Bank to operate, invest and make payroll, come Monday. 

“They went less than a day from no bailouts to a bailout and protecting all uninsured depositors — which represents a bailout,” said Wilmarth. “It happened in hours. So I have to believe regulators came in and said that if they don’t save these two banks, there are several more that are ready to go, and if that happens, they couldn’t say where the contagion would stop.”

The financial agencies said in their statement that no losses from the resolution of either Silicon Valley Bank and Signature will be borne by taxpayers. Still, that’s unlikely to quiet critics who will see the intervention of the federal government to protect depositors as a “bailout.” 

“It’s safe to call that kind of intervention a ‘bailout’ in the sense that governmental policy will spare individuals and corporations losses that they are legally required to take, in the name of systemic risk reduction,” said Peter Conti-Brown, co-director of the Wharton Initiative of Financial Policy and Regulation, and a fellow at the Brookings Institution.

Yellen said on Sunday hours before the systemic risk exception announcement that during the 2008 financial crisis, “investors and owners of systemic large banks” received bailouts, and that because of statutory and regulatory changes “we’re not going to do that again.” But she did say that regulators were “concerned about depositors and we’re focused on trying to meet their needs.”

The Fed and Treasury said in a release that the emergency moves were aimed at “strengthening public confidence in our banking system” to bolster the financial system against expected volatility in the wake of the bank failures. The Treasury, meanwhile, established a $25 billion fund to backstop the Fed’s facility.

The systemic risk exception is a procedure embedded in the Federal Deposit Insurance Corp. Improvement Act of 1991, a law that was passed in the wake of the Savings and Loan crisis of the 1980s and 1990s. The law stipulates that the FDIC may not use its authorities to insure uninsured depositors as a general rule as a means of conserving the resources of the Deposit Insurance Fund. However, the FDIC board may decide with a two-thirds majority to insure uninsured deposits if it believes that doing so would prevent greater damage to the financial system as a whole. That decision is then sent to the Treasury Secretary, who executes the systemic risk exception. 

As to whether the agencies’ decision could create moral hazard problems, a senior Treasury official said Sunday night that regulators are trying primarily to prevent the bank failures from leading to still more collapses in the future.

“Right now we are very focused on addressing the current issue and taking care of the current system and stabilizing the banking system,” the senior Treasury official said. “I do think we will be looking back with time and reassess and assess whether any changes should be made.” 

Karen Petrou, managing partner at Federal Financial Analytics, said there were likely to be lasting implications for the agencies’ moves, but the agencies are rightly concerned about the immediate risk of failing to do enough early enough to allow depositors all over the country regain confidence in the banking system. 

“This decision has major long term policy implications, but the simple fact that money is safe will stem the kinds of runs that seem to be brewing all over the country,” Petrou said. “Most people don’t understand if their banks have a complex business model or not. I’ve talked to lots of regular people who are frightened, and that’s exactly why the Fed, FDIC and Treasury think there was significant risk.” 

When asked whether the moves would be sufficient to meet that need, Petrou was cautiously optimistic.

“I would think so, but we won’t know until the banks open in the morning,” Petrou said. “That’s why regulators threw everything they could at this fire.”

Kate Berry and John Heltman contributed to this report.

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