Turns out you don’t have to be that big to be too big to fail.
Turmoil in the financial system set off by the failure of Silicon Valley Bank has many people feeling a bit uneasy over where they’ve got their money parked. They’re wondering whether their banks could go the way of SVB or New York-based Signature Bank, which regulators also just shuttered. That has caused some consumers to take their deposits over to the big banks — the JPMorgans of the world that are considered too big to fail and more tightly regulated.
It’s an understandable move for people who are feeling a little on edge after the events of the past week. It may also be a little unnecessary. If you have less than $250,000 in the bank, that’s covered by FDIC insurance and really is fine. The government is currently covering uninsured deposits above $250,000 from SVB and Signature as well, making deposit insurance limits, at least in the current moment, perhaps a bit of a moot point. What’s more, there’s good reason to want smaller banks to exist and for people to use them. They’re often closer to their communities and can develop relationships with customers and small businesses that their bigger counterparts do not.
More broadly, it’s good to have competition in the economy, including in the banking system. Before you ask yourself why the United States needs more than a handful of banks, think about the last time you flew and consider how it’s going with having four major airlines. An awful experience? Expensive? There you have it.
“Concentration matters in banking, not just because of community involvement and those kinds of things, because they’re important, but also for our political spectrum and our democracy,” said Morgan Ricks, a professor of banking and finance at Vanderbilt University. “Concentration of banking is something that many parts of the political spectrum over the course of all of American history have been very skeptical and leery of.”
This isn’t to say smaller banks, whether regional or community, are perfect. There are real concerns that others could face similar issues to SVB and Signature — San Francisco-based lender First Republic Bank is reportedly exploring a sale. Amid recent events, it’s hard not to think they should be subject to more regulatory scrutiny and tighter supervision, that regulators should be looking more closely under the hood and making sure they can handle varying economic scenarios.
“This scene we’re seeing unraveling and unfolding does raise the question of regulation toward smaller banks, and perhaps that’s the missing link,” said Fiona Cincotta, financial market analyst at StoneX, a financial services company. “Obviously, more regulation is costly, and these smaller banks aren’t going to have access to the same resources as the bigger banks. I’m not saying they need the same level of regulation, but there are certainly some questions that need to be raised.”
If you are a little leery of the banking system right now, nobody can blame you
It has been an unnerving couple of weeks in the financial sector. Beyond Signature’s shuttering and SVB going under in a spectacular fashion, crypto-friendly Silvergate bank said it was shutting down as well.
The US federal government stepped in to say they were going to make SVB’s and Signature’s depositors whole in what amounts to a bailout, though not a taxpayer-funded one. The Federal Reserve, whose interest rate hikes partly precipitated this mess, is trying to shore up confidence in the financial system with a new lending facility to help other banks avoid SVB’s fate. Now, European bank Credit Suisse, which has long been problematic, appears to be in trouble too and has gotten a bailout from Switzerland’s central bank.
Despite government efforts to put investors and depositors at ease, the fear of contagion, meaning that these types of issues will continue to spread to other banks and across the financial system, is real.
On Tuesday, the Financial Times reported that big banks in the US such as JPMorgan Chase and Citigroup are being “inundated” with customers trying to move their funds from smaller lenders. The publication noted that executives at the big banks don’t want to look like they’re exploiting the situation to their benefit and that JPMorgan has instructed bankers not to actively poach depositors from smaller institutions. “Goliath is winning,” Wells Fargo analyst Mike Mayo said of JPMorgan in a note to investors earlier in the week.
“I don’t blame any institution or business with a cash balance that is in excess of insurance caps from saying, ‘You know what, I don’t want to take this risk, I’ll go to the safest place I can,’ and the safest place is JPMorgan,” Ricks said. With JPMorgan, “there’s just no conceivable way” that you’d ever find yourself needing deposit insurance. “It’s not in the realm of possibility that the federal government would let JPMorgan default its uninsured deposits or any other claims on JPMorgan. It’s too big to fail. And if you’re running a business or you’re a fiduciary for someone else, why not maintain your balance there?”
CNN reported that deposit outflows from small and mid-sized banks have slowed, citing a Treasury Department official, a sign the government’s efforts to put people at ease are working.
Cam Fine, the former head of the Community Bankers of America and president of Calvert Advisors LLC, told me he’s heard from dozens of community bankers in recent days and most say that, by and large, it’s business as usual. “They’re saying things like our customers are talking about it, and they’re asking us some questions about it, but there’s no angst, there’s no anxiousness, nobody’s pulling big deposits out of our bank,” he said, positing that the deposits to the big banks are largely coming from regional banks.
I promise you we want more banks than JPMorgan and Wells Fargo
Even if people aren’t acting on their concerns, plenty are thinking about it. If you’re wondering whether your money is safe in your regional or community bank and are thinking about pulling it out and handing it over to a big bank in New York, the answer to whether you should do it is “absolutely no,” said Dick Bove, an analyst at Odeon Capital Group. “Who took all their money out of Silicon Valley bank? It was money managers who had no relationships to the community, they had no relationships to employees.”
I don’t want to idealize smaller banks here, but their proponents say there are real benefits to them for customers and communities.
The US is a nation of small businesses, which often have better luck getting loans and developing relationships with smaller and community banks, Fine said. “If you were so concentrated in five, 10, or 12 banks … what chance would those businesses have?” he said. According to one Harvard Kennedy School study from 2015, community banks provide 77 percent of agricultural loans and over half of small business loans. Smaller banks also proved crucial in the Paycheck Protection Program implemented at the outset of the pandemic to try to help keep small businesses afloat.
“If the money goes to JPMorgan Chase, which is where it’s going, that money is in a huge bank, which makes loans to huge companies, and it doesn’t get loaned to the local community, to small business,” Bove said.
Fine added that in moments of crisis, some people at the local level do like to be close to their money. “They see the local community banker and the local community bank as being there, that their money is right there, it’s not being sent off from wherever they are to a headquarters in New York or San Francisco or LA,” he said. (To be clear here, Fine is talking about community banks with $50 billion in assets or less, not Silicon Valley Bank, which had $200 billion.)
Culturally, in the US, there’s been a preference for small banks and a more diversified landscape.
“Traditionally, as a nation, we want more local control. We don’t want to live in California and be controlled, financially, out of New York, for example,” Fine said. Ricks concurred. “Banking law, traditionally, has sought dispersion and diffusion of the banking system,” he said.
“Republicans and Democrats in this country only want to kill each other, but the bottom line is they do agree on one issue, and that’s that they don’t want bigger banks and they don’t want community banks to go away,” Bove said. He noted that the number of banks in the US has been in steady decline for quite some time — many smaller banks have already been scooped up or driven out by larger competitors. It’s probably also worth pointing out the big banks haven’t historically always been awesome.
Broadly, it’s good for companies, including banks, to have to compete for customers’ business. “Competition is always in the benefit of the consumer and the customer. If you reduce competition, suddenly the customer’s not in the driver’s seat, it’s not beneficial,” Cincotta said.
Congress and regulators might want to take a closer look at the smaller players
None of this means that smaller institutions should be off the hook here. There are real questions about how bank regulators and supervisors dropped the ball and weren’t alert to the very real risks, for example, at SVB. That it had a concentrated clientele, that its investments were sensitive to interest rate hikes, that it had a lot of uninsured deposits were not surprises. In 2018, a bipartisan group in Congress passed a banking deregulation law that, among other things, eased certain oversight requirements of banks under $250 billion. Whether SVB would have been fine without that change is impossible to know. Regardless, it’s hard not to think someone should have sounded the alarm on SVB earlier — and it’s possible stricter scrutiny is about to land on small banks now, as it should.
“It’s not just the big banks we have to worry about. If the failure of smaller banks can cause such turmoil, then we have to regulate them and monitor them more,” said Itay Goldstein, a finance and economics professor at Wharton.
As Matt Zeitlin at Grid News points out, smaller and mid-sized banks have been trying to say that they’re not like SVB or Signature and have pushed for a long time for a lighter regulatory touch. They’ve also been a bit of a DC darling — politically, it’s generally more palatable to be friendlier to smaller players in finance than the big guys. Given this latest meltdown, as Zeitlin notes, that could be about to change.
So where does this all leave us? It’s a little hard to say. Plenty of people are rightly nervous about what’s going on in the financial system and worry that another bank failure might be around the corner. Because of the nature of the current moment, a lot of concern is focused on smaller and regional banks. I am not here to give you financial advice or to say where you should or shouldn’t keep your money, but amid the turbulence, there are some things to keep in mind.
For one thing, the FDIC insures deposits of up to $250,000, so if you’ve got less than that in the bank — and the vast majority of people do — really, you are fine. Whatever happens to your bank, which will probably also be fine, your money is safe. Right now, the government has also said it’s going to get the money back to depositors with over $250,000 who had money in SVB and Signature, which sort of means that insurance deposit limits don’t currently exist. Whether that’s a good thing, or whether it’s worth having deposit insurance limits at all if the government is going to bail people out anyway, is a conversation for another day.
“People saying we should have tough love, we should punish the non-insured, and people are not happy about insuring. In the end you’re like, okay, look, do we want to have a banking process now? Is now a good time for that? Is now a time for tough love? To teach a lesson?” said Itamar Drechsler, a professor of finance at Wharton.
But before everybody decides the way to go is to just toss money into a handful of giant, too-big-to-fail institutions and write off smaller entities, it’s important to remember that competition in all industries is generally positive, and you get competition by having multiple players in the mix. Do we really want JPMorgan and Wells Fargo and Morgan Stanley to be even more powerful than they already are? Intuitively, most people know the answer to that: We don’t.