GAO Evaluates Use of "Systemic Risk Exception" During 2023 Bank Failures

The Government Accountability Office analyzed the actions taken by the FDIC, the Federal Reserve and the Treasury to invoke the systemic risk exception during the March 2023 failures of Silicon Valley Bank and Signature Bank. 

In its report to the Senate Banking Committee and the House Financial Services Committee, the federal agencies explained that the "systemic risk exception" allows the FDIC to protect all deposits with a failed bank (i.e. over the ordinary insurance amount of $250,000) when guaranteeing the deposits are less than allowing the bank to fail. The GAO found that the decision to invoke the systemic risk exception for Silicon Valley Bank and Signature Bank was informed by (i) consideration of the regulators' recommendations; (ii) consultations with the President; and (iii) a review by Treasury staff of public financial filings data and views of external parties, such as asset management firms. The GAO said the bank regulators believed that letting the banks fail without paying off deposits (i) would lead to bank runs, (ii) could intensify liquidity pressures, (iii) would reduce credit availability, (iv) would cause widespread corporate disruption, (v) would reduce market confidence, and, generally, (vi) would lead to broader negative economic effects.

The GAO concluded that the FDIC's actions "likely helped prevent further financial instability." The GAO found that deposit outflows from commercial banks outside the 25 largest banks slowed in the week following the bank failures and stabilized the following week. However, the GAO said it remained unclear how these indicators would have performed without the invocation of the systemic risk exception.

The GAO cautioned that protecting all deposits, including uninsured deposits, can create moral hazard by reducing incentives for banks and depositors to manage risk, as they may come to expect future bailouts. To address these concerns, the GAO highlighted proposed financial regulatory reforms introduced by regulators and Congress, which include changes to deposit insurance and capital requirements.