Does deposit insurance matter if your bank can't fail?

Some observers say that while some bank customers will pursue more comprehensive insurance for their deposits, some may get the message that as long as their bank is large enough their deposits will be covered even if they are not insured.

Bloomberg News

WASHINGTON — Most companies don’t expect their main banking partner to fail — indeed, before this month, none had failed since 2020. So rather than depositing their money into the safest possible accounts, many firms have instead prioritized interest rate returns and convenience over reducing deposit risk. 

Greyson Tuck, president of consulting firm Gerrish Smith Tuck, says Silicon Valley Bank’s tech customers and their financial officers would rather hold large amounts of cash uninsured than manage hundreds of accounts in the name of absolute FDIC insurance coverage. 

“The CFOs of these companies are picking banks based on the services the bank will provide, the fees the bank will charge and the interest rate the bank will pay — not based on FDIC insurance,” he said. “The risk of maintaining uninsured deposits for many CFOs was not as great as the hassle that would be experienced by trying to structure the deposits in order to have full FDIC insurance.” 

Jaret Seiberg, managing partner at TD Cowen, says the risk of bank failure is so rare that most banks only have about half of their deposits covered by FDIC insurance. Seiberg says most companies can reasonably assume the risk of failure is negligible at institutions with relatively normal balance sheets. 

But Silicon Valley wasn’t normal — its name recognition and hegemony for banking huge names in information and biomed technology, he said, may have overshadowed the questionable details buried deep in the weeds of its balance sheet and call reports.

“If you’re trying to create the next Google, you’re not in the weeds on how your bank account works,” Seiberg said. “We can argue that [they] should have hired somebody to be more fixated on the back office, but Silicon Valley Bank was the well-known partner of venture capital firms that helped create scores of new companies and millions of new jobs. So what in hindsight seems obvious, I’m not sure would have been as clear 18 months ago.”

While bank failures of any kind have been rare in recent years, Seiberg said, the causes of SVB and Signature’s failures this month are even rarer — making them even less likely to raise alarms from the banks’ customers before it was too late. 

“We haven’t had a bank fail from interest rate risk or liquidity concerns since the end of the savings and loan crisis” in the early 1990s, Seiberg said.

Part of the reason companies often structure their relationship with a depository institution to be simple and convenient — rather than as insured as possible — is because making all deposits insured is a considerable hassle. For multi-million dollar companies with many business lines, inflows and outflows, fully insuring deposits could mean holding hundreds of banking relationships with many different entities. Experts say this effect was made worse by the particular facets of the tech industry that SVB banked. 

Karen Petrou, managing partner at Federal Financial Analytics, says another reason Silicon Valley had so many uninsured deposits was the way they allegedly enforced exclusive banking partnerships with companies seeking loans. If that was the case, she said, it means whole networks of tech companies and their affiliates had all their eggs in one basket.

“SVB appears to have mandated ‘exclusivity’ clauses requiring any venture capital firm that received funding from the bank not only to deposit proceeds with the bank, but also require by covenant that any entity in which the VC invested do the same,” said Petrou. “It is for this reason that so many small tech and biomed firms had such large deposits at SVB, including  payroll.”

Petrou said that if subsequent investigations confirm that SVB relied on exclusivity clauses for its startup clients, regulators should immediately prohibit such clauses as preconditions for banking relationships.

“If it turns out that these exclusivity clauses existed as firms tell me they did, then this practice needs to be sanctioned as soon as possible so no other depositor is ever put at this kind of risk ever again,” Petrou said.

While the recent volatility in the banking industry sparked by SVB and Signature’s collapse may renew hope that companies and banks have learned their lesson about insuring deposits, Tuck says the government’s decision to rescue depositors at the banks — which, in SVB’s case, lobbied to reduce federal oversight on itself — only encourages larger commercial banks and their customers to further sideline safety in the name of managerial ease.

“I think it incentivizes risky behavior, particularly with managers of large banks,” Tuck said. “It says, ‘If you take risks that jeopardize safety and soundness, and those risks don’t pay off, we as the government are going to come and backstop your risk, and we’re going to make all the other banks pay for that.'”

SVB and Signature’s failures are not without consequences, however. Tuck noted that, at least in the short term, banks will face additional scrutiny from clients and more demand for utilizing balance sheet management tools and tactics. 

Many in the industry were shocked to learn that SVB and Signature did not more effectively utilize deposit-swapping networks, where customers have a single relationship with a bank but can spread deposits among other FDIC-insured institutions, thus maximizing deposit insurance coverage. 

One such firm, IntraFi, had deposit-swapping relationships with both SVB and Signature, but at year-end the two banks’ reports indicate that they had only utilized the network to a modest degree. Silicon Valley Bank had just $469 million in reciprocal deposits, while Signature had $228.4 million, according to call report data from the Federal Financial Institutions Examination Council.

Tuck concedes that SVB’s demise could shape customer behavior in some subtle ways, such as by boosting demand for deposit sharing agreements across institutions. However, he said recent government actions communicate to banks and their customers that as long as their bank’s failure is deemed systemically risky, the government will cover their deposits, insured or otherwise. That has given customers a murky message about what their options are for protecting their working capital.

Going forward he sees three ways businesses will likely approach ensuring their money is not subject to a SVB or Signature scenario.

“Number one is an IntraFi type of arrangement, number two is to go to a banking partner that is in such a position of strength that it’s a non-issue,” Tuck said. “And number three is you go to one of these [banks that] the government has chosen as a winner,” he said.

Only an act of Congress can change deposit insurance limits, and Seiberg thinks that any reforms Congress can agree on in the wake of the crisis will be modest, given lawmakers have been more concerned with pointing fingers than pursuing sound bipartisan policy.

“If Congress is going to act, it’s probably going to be a narrower reform — looking at protecting payroll accounts, rather than all uninsured depositors,” Seiberg said. “But even that seems like a stretch in such a closely divided Congress, where both sides are already playing politics with the crisis.”