Wednesday, March 15, 2023

Small bank thoughts

 Three small thoughts. 

1) There is much commentary that bank troubles will interfere with the Fed's plan to lower inflation by raising rates. Actually, this is a feature not a bug. The main mechanism by which, in the Fed's view, raising interest rates slows the economy and lowers inflation is by "constricting credit," "tightening financial conditions," lowering borrowing that finances investment and consumer durables purchases.  The Fed didn't want runs, no, but it wants the result. If you don't like that, well, we need to think of other ways to contain inflation, like taking the fiscal gasoline off the fire. 

2) On uninsured deposits. A correspondent suggests that the Fed simply mandate that all large depositors participate in the sorts of services, there for the asking, that split large accounts into multiple $249k accounts spread over multiple banks, or sweeps into money market funds. 

I don't think that mandating this system is a good idea. If you're going to do that, of course, you might as well just insure all deposits and keep it simple. 

But the suggestion prompts doubt over the oft repeated notion that we want large sophisticated depositors to monitor banks. Anyone who was large and sophisticated enough to monitor banks had already gamed the system to make sure their accounts were insured, at some nontrivial cost in fees and trouble. The only people left with millions in checking accounts were, sort of by definition, financially unsophisticated or too busy running actual companies to bother with this sort of thing. Sort of like taxes. 

We might as well give in, that all deposits are here forth insured. If so, of course, then banks are totally gambling with the house's money. But we also have to give in that if they can't spot this elephant in the room, asset risk regulation is hopeless. The only workable answer (of course) is narrow deposit taking -- all runnable deposits invested in reserves and short term treasuries; fund portfolios of long term debt with long-term borrowing (CDs for example) and lots of equity.

3) Liquidity and fixed value are no longer necessarily tied together. I still don't quite get why better payment services are not attached to floating value funds. Then we wouldn't need run-prone bank accounts at all. 



  1. At JPM, or Schwab(they have a bank) automatic sweeps to a MMA do not take place; at each putting funds in to a MMA can only be done via their respective investment vehicles and buy and sells must be initiated by the investor. As to having these for cash purposes, settlement is T+1, so ,no, one cannot go to an ATM and access this source for funds.
    Your construct of deposits backed by short term instruments makes sense and is probably easier, more doable than suggestion I made back in 2008 time period to some influential Pols to have a deposit co sub of a bank with all risk activities outside this sub with the sub appropriately capitalized.

  2. Not sure why everyone thinks the two poles are the only possible answers--either stick to the 250K or insure everything. There are lots of ways to do something in between. Say the first 250k is insured 100%, the next 250k is insured 90%, and keep going down in increments until you get to everything else being insured at 50% or so. That would still reassure the bank customers without covering everything. And then, of course FDIC would have to base their premium charge on what they insure.

    1. Less than 100% guarantees on all deposits and you'll still risk runs.

  3. In the aggregate deposits are liabilities of the banks, they appear on the liability side of the banks balance sheets and so they cannot be invested in reserves or short term treasuries because for the banks they are not an asset that can be invested they are a liability that is owed. An accounting entry of who the beneficiaries of the banks assets are. When a customer make a transfer to a different bank, either transfers for an accounting period between the two banks net off, or an asset, usually a central bank reserve, changes hands between the two banks.

  4. what about being audited by KPMG and been given a clean slate 2 weeks before collapse mean for KPMG and SVB?

  5. Hi John Cochrane.
    How would it be possible, as you recommend, for banks to finance all long term lending using long term liabilities in for example Mortgages. Where would the long term liabilities come from. Each year there are millions of house buyers wanting thousands of dollars each in new 30 year mortgages in the USA, but there are not millions of house sellers who would or could accept 30 year bank bonds as payment.

  6. insurance fees scaled to the amount covered
    actuaries are pretty good at pricing such
    risk management guys seemed to be lacking in the SVB saga
    30 yr mbs funded by demand deposits used to be called an asset liability mismatch and was an obvious no no.
    In physics history has no role. everything relevant is in the immediately prior state. human stuff depends on history. how could they be sooooo clueless?

  7. Why not allow depositors to purchase insurance for accounts in excess of $250,000. FDIC could charge the depositor rates based on their assessment system. The rates are pretty small especially for highly rated banks. Less than 10 bps per $100 per year.

    Being able to buy the insurance quickly and easily and for short terms, a week, a month, or a quarter, would provide an alternative to moving money to another bank. Further, the purchases would provide FDIC with information as to which banks are starting to teeter.

    1. I like the idea. I'm just wondering if we would see another AIG type collapse. Insurance of this type would require asymmetric information to be largely vanquished.

  8. Did Congress write the legislation that allowed the FDIC/Treasury to arbitrarily decide to cover deposits over $250k. I recall that it took Congress to pass legislation increasing it to $250. Is this another example of Congress delegating its responsibilities to the Executive branch?


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