CRS Reviews the FDIC "Systemic Risk" Exception

The Congressional Research Service ("CRS") reviewed the policy issues raised by the FDIC’s guarantee of uninsured deposits in response to the Silicon Valley Bank ("SVB") and Signature Bank failures. 

In an In Focus report, the CRS explained that when a bank fails, the FDIC generally must resolve the bank using the "least-cost resolution." When a bank failure poses a systemic risk that threatens financial stability, banking regulators may choose to invoke a "systemic risk exception." In the case of SVB and Signature Bank, Treasury, the FDIC and the Federal Reserve Board invoked the systemic risk exception to contain a potential run by uninsured depositors that could have spread to other banks and the broader economy. According to the report, the FDIC projects that guaranteeing the uninsured deposits will cost the FDIC $16.3 billion. The CRS highlighted that, before 2023, GAO reported five planned uses of the systemic risk exception since 1991, all occurring between September 2008 (in the depths of the financial crisis) and March 2009.

The CRS considered the following policy concerns on the use of the systemic risk exception:

• The systemic risk exception is "a recognition by Congress that financial stability concerns sometimes trump the desire to minimize potential costs to the taxpayer." The CRS said that the exception is an "emergency tool ...[which gives] policymaker[s] broad ...power to respond quickly." However, CRS noted: "[p]olicymakers may have 'itchy trigger fingers' and intervene before the need has been proven." The CRS stated that in isolation, the failures of SVB and Signature posed "little risk to the economy or financial system," and "it may be that other banks could have fended off the pressure of withdrawals on their own and conditions could have stabilized."
• "The downside to intervening," the CRS stated, "is the cost to the government and moral hazard—the concept that when individuals or businesses are protected from losses they will act more recklessly." By using the systemic risk exception, policymakers have signaled that banks and their uninsured depositors need be less concerned about risk taking going forward.
• The use of the systemic risk exception for SVB and Signature Bank, two banks that were not previously considered "too big to fail," underscores ongoing concerns about moral hazard, where banks might take excessive risks believing they will be bailed out due to their importance to financial stability. (See related coverage.) This could disadvantage smaller banks, as uninsured depositors might perceive deposits at larger banks as safer, assuming these institutions are more likely to receive government support during crises.
• Narrowing the discretion of policymakers in using the systemic risk exception could potentially limit their ability to respond swiftly and flexibly to crises.
• "Guaranteeing uninsured depositors also shifts the costs of the resolution to banks that did not fail."