Does the US Federal Deposit Insurance Corporation have enough resources to deal with a major banking crisis? And what about Europe?

14 June 2023 by Eric Toussaint


Bank deposits in the US have been legally guaranteed up to a limit of USD 250,000 since 2008. The decision to enact a federal law that guarantees savers’ deposits was made in the early years of Franklin Delano Roosevelt’s administration. In 1933, Roosevelt made his decision as one of the remedies to a serious financial crisis that had caused thousands of bank collapses in a matter of months. At first, there was a 2,500-dollar guarantee that only applied to deposits made to commercial banks. It should be recalled that Roosevelt also enacted the Glass-Steagall Act to separate commercial banking from investment banking. The government guaranteed deposits in commercial banks, while investments in investment banks remained at risk.



This separation was abandoned in the 1990s during William Clinton’s administration as part of the neo-liberal offensive that favoured the interests of big business, and in particular those of the large private shareholders of the big banks (and among these large private shareholders, investment funds Investment fund
Investment funds
Private equity investment funds (sometimes called ’mutual funds’ seek to invest in companies according to certain criteria; of which they most often are specialized: capital-risk, capital development funds, leveraged buy-out (LBO), which reflect the different levels of the company’s maturity.
such as BlackRock). This is a development that I described in the book Bankocracy, published in 2015. Investment banks that did not benefit from the State guarantee have been transformed into “universal banks” (particularly after the collapse of the Lehman Brothers investment bank in September 2008), as in the case of Goldman Sachs.

With the deregulation of the 1980s and 1990s, the major private banks became “universal banks” ­ a name which is misleading (see box). This allowed them to expand their investment-banking divisions while also starting a deposit-taking division to take advantage of the governmental guarantee. In addition to the United States, this trend also occurred in Europe and other places.

What is a universal bank Universal bank Sometimes described as financial supermarkets, universal banks represent a large financial set-up grouping together and covering the activities of commercial (deposit) banks and investment banks while also providing bank insurance. ?

A universal bank (also known as a “full-service financial firm” or “generalist bank”) is a large financial group that brings together and carries out the various business lines of retail banking, corporate and investment banking and asset Asset Something belonging to an individual or a business that has value or the power to earn money (FT). The opposite of assets are liabilities, that is the part of the balance sheet reflecting a company’s resources (the capital contributed by the partners, provisions for contingencies and charges, as well as the outstanding debts). management, while also playing the role of insurer. The main danger of this banking model is that the losses from risky corporate and investment banking activities are borne by the deposit banks, thereby jeopardising the assets of small savers.
Read more:
2007-2017: Causes of a Ten-Year Financial Crisis
Banking regulations: truth and lies
A Review of Bankocracy
Bankocracy – a review
The Liquidity Trap
The Mockery of Banking Discipline

Returning to the United States, the Federal Deposit Insurance Corporation (FDIC), set up in July 1933, is the federal agency that is still responsible for guaranteeing deposits in the thousands of banks that benefit from the state guarantee, as well as monitoring the seriousness of the banks’ activities.

In the event of a bank failure or bail-out, the FDIC draws on its resources to guarantee deposits. In March 2023, the failures of Silicon Valley Bank and Signature Bank cost the FDIC USD 20 billion. The bankruptcy of First Republic in April cost the FDIC a further USD 13 billion.

According to the Financial Times, in an article published on 2 June 2023 under the title “Bank failures drag FDIC insurance fund for deposits below the legal minimum,” [1] at the end of March 2023, the FDIC had USD 116 billion in assets, representing just 1.1% of total guaranteed deposits in the United States. Since then, the cost of rescuing First Republic has further reduced this ratio. Federal law requires the FDIC to have assets equivalent to at least 1.35% of deposits. The FDIC says it will achieve this by 2028. It is as if it did not foresee other bank failures, which are far from out of the question.

The FDIC’s resources are provided by the banks it guarantees Guarantees Acts that provide a creditor with security in complement to the debtor’s commitment. A distinction is made between real guarantees (lien, pledge, mortgage, prior charge) and personal guarantees (surety, aval, letter of intent, independent guarantee). . These resources are clearly greatly insufficient to cope with further bankruptcies, but the FDIC does not want to acknowledge that the situation is problematic.

The FDIC’s resources are clearly greatly insufficient to cope with further bankruptcies.

However, the FDIC itself states that the list of banks that could be affected by bankruptcy included 43 banks as of the end of the first quarter of 2023, compared with 39 at the end of the last quarter of 2022. Note that the FDIC does not make this list public; it only mentions the number of problem banks.

It should also be noted that depositors withdrew USD 500 billion from their accounts in the first quarter of 2023. This is the largest withdrawal in the last 40 years. These massive withdrawals increase tenfold the chances of bank failure in the United States, because they force banks to provide liquidity Liquidity The facility with which a financial instrument can be bought or sold without a significant change in price. - which they do not have in sufficient quantities to meet the risks they are taking - to customers when they withdraw their money. As they do not have enough liquidity available immediately, banks often have to sell securities in a hurry. This sale is often synonymous with losses, which, if they are too large, lead to bankruptcy because the banks’ equity Equity The capital put into an enterprise by the shareholders. Not to be confused with ’hard capital’ or ’unsecured debt’. capital is totally inadequate. But, as we have seen, bankruptcy means having to call on the FDIC, which is already almost empty, to bail out the bank in question.

The sums withdrawn from the accounts have largely gone into Money Market Funds MMF
Money Market Funds
Mutual investment funds that invest in securities, including money funds.
, which offer a better return but are not regulated (see box on Money Market Money market A short-term market where banks, insurance companies, corporations and States (via the central banks and Treasuries) lend and borrow funds according to their needs. Funds).

What are Money Market Funds?

Money Market Funds are financial companies in the United States and Europe that are subject to little or no supervision or regulation because they do not have a banking licence. They are part of shadow banking (see below). In theory, MMFs follow a prudent policy, but the reality is very different. In 2009, President Obama’s administration considered regulating them because, in the event of an MMF failure, the risk of having to use public funds to rescue them is very high. But very little has been done. MMFs give rise to a great deal of concern given the considerable funds they manage. In 2012, US MMFs handled USD 2.7 trillion in funds, compared with USD 3.8 trillion in 2008. By 31 May 2023, they were managing USD 5.4 trillion. As investment funds, MMFs collect capital from investors (banks, pension funds Pension Fund
Pension Funds
Pension funds: investment funds that manage capitalized retirement schemes, they are funded by the employees of one or several companies paying-into the scheme which, often, is also partially funded by the employers. The objective is to pay the pensions of the employees that take part in the scheme. They manage very big amounts of money that are usually invested on the stock markets or financial markets.
, etc.) These savings are then lent on a very short-term basis, often overnight, to banks, companies and governments. In the 2000s, MMF financing became an important component of short-term bank financing. Moody’s calculated that between 2007 and 2009, 62 MMFs had to be rescued from bankruptcy by the banks or pension funds that created them. These included 36 MMFs operating in the United States and 26 in Europe, at a total cost of USD 12.1 billion. Between 1980 and 2007, 146 MMFs were rescued by their sponsors. In 2010-2011, again according to Moody’s, 20 MMFs were bailed out. This shows the extent to which they can jeopardise the stability of the private financial system.

It should also be mentioned that banks that benefit from the FDIC guarantee are required to inform the FDIC of the potential losses to which they would be exposed if they had to sell the securities they hold in order to obtain the liquidity needed to repay depositors who withdraw their money from the bank. Remember that this is what happened with the three banks that failed, in particular Silicon Valley Bank. According to statements made by US banks at the end of March 2023, if they had had to sell the financial securities Financial securities Financial securities include equity securities issued by companies in the form of shares (shares, holdings, investment certificates, etc.), debt securities, excluding commercial instruments and savings certificates (bonds and similar securities), and holdings or shares in Undertakings for Collective Investment in Transferable Securities (UCITS). they held to cope with a massive withdrawal of deposits, they would have taken a loss of USD 516 billion. Total deposits amount to USD 17 trillion.

US banks, like banks on other continents, are constantly gambling with their customers’ deposits by taking high risks in order to maximise short-term profits. The biggest banks are eyeing the medium-sized banks to buy them out at a discount and increase their power. The biggest US bank, JPMorgan, has just bought First Republic.

 Are European banks more solid than those in the United States?

Nothing is less certain. The collapse of Crédit Suisse in March 2023 is proof of that. Deutsche Bank, one of the great colossi with feet of clay, is constantly on the brink of collapse. And it is not the only bank in that situation.

Contrary to claims that the capital of European banks is sufficient to cope with the risks of losses, it is not nearly enough to cope with large losses. The risk-weighting of assets allows banks to lie about the real proportion of their capital in relation to their balance Balance End of year statement of a company’s assets (what the company possesses) and liabilities (what it owes). In other words, the assets provide information about how the funds collected by the company have been used; and the liabilities, about the origins of those funds. sheet. Risk-weighting is a calculation method authorised with the complicity of the authorities responsible for banking regulation and security. It allows banks to claim that their capital-to-balance sheet ratio is over 12%, when in reality it is between 3% and 6%. This means that if a bank suffers a loss of between 3% and 6% of its entire balance sheet, it is on the brink of bankruptcy.

Read more: Banks bluff in a completely legal way

Just before it collapsed in March 2023, Crédit Suisse claimed that its ratio of equity capital to balance-sheet total was 18%. But its capital base vanished like snow in a matter of weeks, if not days. With the agreement of the banking authorities and the Basel Committee, Crédit Suisse’s equity capital included the famous AT1s, which amounted to 17 billion Swiss francs. This was reduced to zero over the weekend of 18 and 19 March 2023. An AT1 is a convertible bond Bond A bond is a stake in a debt issued by a company or governmental body. The holder of the bond, the creditor, is entitled to interest and reimbursement of the principal. If the company is listed, the holder can also sell the bond on a stock-exchange. . AT1s are sold as bonds by the companies that issue them to finance themselves. An AT1 is a debt security for its purchaser, giving entitlement to guaranteed interest Interest An amount paid in remuneration of an investment or received by a lender. Interest is calculated on the amount of the capital invested or borrowed, the duration of the operation and the rate that has been set. . The interest is higher than for a normal bond, generally fluctuating between 5 and 8%. In the case of Crédit Suisse, the interest rate was 8%, which is high and indicates that the buyer was taking a risk. In fact, these bonds can be converted into equities, i.e. shares, and therefore into risk capital. AT1s are a product of the 2008 crisis. Although they were debt securities, they were accepted by the banking supervisory authorities as part of a company’s capital and therefore of its equity capital. The authorities did this so that the banks could artificially increase their equity capital.

 Are deposits in European banks properly guaranteed?

From a financial point of view, far from it. It should also be borne in mind that there is no such thing as a European guarantee fund. Each fund is a national fund.

 And what about shadow banking?

This is an essential question. The financial activities of shadow banking are mainly carried out on behalf of the big banks by financial companies set up by them. These financial companies (SPVs, money market funds, etc.) do not receive deposits, which means they are not subject to banking regulation. They are therefore used by the big banks to avoid national and international regulations, in particular those of the Basel Committee on capital adequacy and prudential ratios. Shadow banking is the complement or corollary of universal banking.

The financial amounts managed by shadow banking are much larger than the amounts shown on the banks’ balance sheets. If there is a crash in shadow banking, there is bound to be a knock-on effect on the health of the banks. A recent report by the European Central Bank Central Bank The establishment which in a given State is in charge of issuing bank notes and controlling the volume of currency and credit. In France, it is the Banque de France which assumes this role under the auspices of the European Central Bank (see ECB) while in the UK it is the Bank of England.

ECB : http://www.bankofengland.co.uk/Pages/home.aspx
makes this abundantly clear. According to this ECB ECB
European Central Bank
The European Central Bank is a European institution based in Frankfurt, founded in 1998, to which the countries of the Eurozone have transferred their monetary powers. Its official role is to ensure price stability by combating inflation within that Zone. Its three decision-making organs (the Executive Board, the Governing Council and the General Council) are composed of governors of the central banks of the member states and/or recognized specialists. According to its statutes, it is politically ‘independent’ but it is directly influenced by the world of finance.

https://www.ecb.europa.eu/ecb/html/index.en.html
study, the shadow activities of the major banks in the eurozone account for 15% of their funding, i.e. far more than their equity capital (See: Financial Times: “Eurozone: Shadow bank funding raises risks for big lenders, warns ECB”, 31 May 2023. Online version: “Shadow bank funding creates risks for big eurozone lenders, warns ECB Links between eurozone’s largest lenders and less regulated sector provokes increasing alarm among policymakers”). In that article,The Financial Times wrote: “Researchers at the central bank found the 13 largest banks in the eurozone account for about 80 per cent of all borrowing from shadow banks, or non-bank financial intermediaries (NBFI). ‘Any turmoil in the NBFI sector is likely to disproportionately affect large, complex, systemically important banks, as asset exposures, funding linkages and derivative exposures are concentrated in this group,’ the officials said.” The ECB study is online: “Key linkages between banks and the non-bank financial sector,” May 2023. This includes the largest banks in the eurozone: BNP Paribas, Crédit Agricole, Société Générale and BPCE in France, Deutsche Bank in Germany, ING in the Netherlands, Santander in Spain and UniCredit in Italy.

 Can we trust the big audit firms that review the banks’ accounts?

There are four major audit firms worldwide: Deloitte, EY (Ernst & Young), KPMG and PwC (PricewaterhouseCoopers). Each is the result of numerous mergers, the oldest of which date back to the mid-nineteenth century.

The history of these audit firms is littered with scandals and conflicts of interest. Their mistakes are monumental. To take just one recent example. KPMG was responsible for auditing the accounts of the three US banks that went bankrupt in March 2023: Silicon Valley Bank, Signature Bank and First Republic. However, in its February 2023 report, KPMG declared that the situation of these banks and their accounts was unproblematic and issued a clean bill of health. (See: Financial Times: “KPMG under scrutiny as banking sector’s largest auditor after trio of lender failures,“a paywalled article published online on 3 May 2023 under the headline”Three failed US banks had one thing in common: KPMG".

According to the FT, there was a conflict of interest between senior managers at KPMG and managers at at least two of the three failed banks. The chief executives of Signature Bank and First Republic were both former senior KPMG employees. There is also the situation of Keisha Hutchinson, who was the senior manager of KPMG’s audit team at Signature Bank in 2020 and a few months later was recruited by the bank to the position of director of the risk assessment department in 2021. She was hired by Signature Bank for this position just two months after signing the 2020 audit report as KPMG’s proxy. The rules of the Securities and Exchange Commission (SEC), which is the main supervisory body for banks in the United States, impose a 12-month cooling-off period before an employee of an auditing firm is hired by a company in a role overseeing financial reporting. This period was not respected.

With regard to Silicon Valley Bank, depositors have launched legal proceedings against KPMG, accusing it of having allowed the Bank not to declare the depreciation of its assets to customers, even though this is what partly caused the bankruptcy.

Clearly, we would be wrong to trust the health and morality reports published by the major audit firms, in particular KPMG, Deloitte, EY (Ernst & Young) and PwC (PricewaterhouseCoopers).

As for the health of the private banking sector, it is clear that the banking authorities have not really put their house in order and that private banks are very fragile because their only concern is to make maximum profits as quickly as possible. New episodes of banking crises can be expected in the future. There is an urgent need to socialise the entire banking sector.

Read more:
How to Socialize the Banking Sector
Socialising the banks: some historical examples

Translated by CADTM

What is to be Done with the Banks? Radical Proposals for Radical Changes

Footnotes

[1The title of the online pay version is different : “US bank failures stretch deposit insurance fund. Ratio of assets to insured deposits lowest since 2015 after collapses of SVB and Signature Bank” https://www.ft.com/content/e795cc50-61e9-4ac4-8e04-0417c4ea2ca4 published on 31st May 2023.

Eric Toussaint

is a historian and political scientist who completed his Ph.D. at the universities of Paris VIII and Liège, is the spokesperson of the CADTM International, and sits on the Scientific Council of ATTAC France.
He is the author of Greece 2015: there was an alternative. London: Resistance Books / IIRE / CADTM, 2020 , Debt System (Haymarket books, Chicago, 2019), Bankocracy (2015); The Life and Crimes of an Exemplary Man (2014); Glance in the Rear View Mirror. Neoliberal Ideology From its Origins to the Present, Haymarket books, Chicago, 2012, etc.
See his bibliography: https://en.wikipedia.org/wiki/%C3%89ric_Toussaint
He co-authored World debt figures 2015 with Pierre Gottiniaux, Daniel Munevar and Antonio Sanabria (2015); and with Damien Millet Debt, the IMF, and the World Bank: Sixty Questions, Sixty Answers, Monthly Review Books, New York, 2010. He was the scientific coordinator of the Greek Truth Commission on Public Debt from April 2015 to November 2015.

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