How do we fend off another banking crisis?
How can the U.S. avoid a replay of the regional banking crisis we saw earlier this year? One top regulator thinks he has the answer to that question.
Why it matters: The Federal Deposit Insurance Corporation, or FDIC, bore the brunt of the losses from the failures of Silicon Valley Bank and First Republic — some $20 billion and $13 billion, respectively.
- This week, the FDIC's chairman, Martin Gruenberg, laid out in a major speech the changes he wants to make to prevent such failures from happening again.
What he's saying: "These are perhaps lessons we should have learned from the 2008 financial crisis," said Gruenberg. "The events of earlier this year provide us with another opportunity. This time I don't think we'll miss."
- Yes, but: So far all we have is a speech, not a detailed plan — something that would need to be approved by the Comptroller of the Currency and the boards of the FDIC and the Federal Reserve before being released for public comment.
- After that, the comments would be digested, the plan would be revised, and even if a final rule does end up being promulgated, it would surely have a substantial implementation period. None of this is going to happen overnight.
The big picture: At the core of Gruenberg's plan is something very simple — requiring big banks to issue bonds.
- In principle, this should be uncontroversial. The banks in question are sophisticated financial institutions with hundreds of billions of dollars in liabilities already.
Between the lines: When a bank fails, it often ends up defaulting on its bondholders. By requiring banks to issue bonds, Gruenberg would effectively impose a crude market discipline on them.
- The riskier banks would have to pay more in bond coupons, hurting their competitiveness — and the high yields on their bonds would act as a risky-bank warning to the market as a whole.
- And by absorbing losses in the event of default, bondholders would act as a buffer, making it less likely that the FDIC insurance fund would end up on the hook.
- The FDIC would also have more resolution options when it took over a bank with bonds, given that it could restructure those bonds in various different ways.
Zoom in: Gruenberg has other ideas, too.
- When a bank's assets fall in value — perhaps because of rising interest rates — that drop in value would be subtracted from the bank's capital position, possibly forcing it to raise more capital.
- Big regional banks would also need to draw up more detailed "living wills" — plans for what they intend to do if they find themselves in or near failure and that don't place the onus on the FDIC to find a buyer over the course of a weekend.
The other side: Making these plans a reality won't be easy, given opposition from the banking lobby. It does seem clear that increases in safety would cause lower profits for the banking industry.
The bottom line: Gruenberg's proposals are simple and easy to understand, in contrast to the menagerie of AT1s and CoCos found in Europe. They look like they're likely to work — if they manage to become reality.