Warnings about moral hazard ring hollow when everyone is already sitting on their hands. Big banks are mobilizing opposition to U.S. legislation that would strengthen state guarantees on some deposits and, quite possibly, lead to higher fees for paying them. The socialization of losses can actually dangerously confuse incentives for risk taking. However, readily available workarounds make the current insurance limit of $250,000 (€215,000, at the current exchange rate) meaningless.
Treasury Secretary Scott Bessent, in a speech last month to community bankers, joined Democratic Sen. Elizabeth Warren and others in supporting a bipartisan bill to increase deposit insurance to cover $10 million in business transaction accounts. A bill recently proposed in the Senate would authorize the Federal Deposit Insurance Corporation (FDIC) to do so.
This would mean that the law has adapted to reality. A loophole approved by regulators means many accounts already enjoy coverage well above the current limit. The method involves a bank distributing part of a customer’s balance among its counterparties, each of which adds an additional portion of insurance. By creating temporary overflow accounts, called mutual deposits, this can be effectively structured as an exchange between lenders that does not increase either party’s total balances. The more banks that join the exchange, the higher the effective insurance limit will be.
That’s how SoFi Technologies advertises $3 million in FDIC insurance per customer, or Texas-based Rosedale Bank says it offers up to $175 million, about 700 times the apparent limit. After the collapse of Silicon Valley Bank and the subsequent crisis of regional banks, the networks connecting custodians expanded. IntraFi, the largest, now has 3,000 members. In total, U.S. banks had $428 billion in mutual deposits at the end of June, triple the 2022 level, according to Bankregdata.com.
Worse, because the fees that fund deposit insurance are based primarily on a bank’s total liabilities, this realignment increases the government’s liability without having to pay additional premiums. All things being equal, we estimate that this is a loss of about $500 million per year for Uncle Sam.
Opponents of raising the limit are right about one thing: A larger backstop poses a moral hazard. A recent study found that banks that use mutual deposits tend to take higher risks. The problem is that this is already happening. The Senate proposal would likely place an additional burden on the already underfunded FDIC insurance fund, potentially requiring billions more in premiums. It is true that most of these costs would be borne by the six largest lenders in the United States, which would still leave smaller institutions’ incentives distorted. However, if the limit is already ignored, it is better to clearly label the risk and charge for it appropriately.
The authors are columnists for Reuters Breakingviews. Opinions are yours. The translation, by Carlos Gomez belowit is the responsibility of CinqueGiorni
