The events of the past week have proved that smaller bank oversight, regulation or both should be improved. Clearly, risk-management functions, on-site supervision and the qualifications and role of boards of directors should be evaluated. The $250,000 limit on deposit insurance should be raised, perhaps substantially, to at least $2 million or as much as $5 million or even $10 million. This step reflects the reality that depositors cannot be expected to monitor the financial condition of banks as if they were sophisticated investors.
But we must be realistic. Smaller banks cannot afford anything close to what the large banks must do, as the latter are able to spread the costs over their huge global operations, including large deposit bases. Calls for increased capital and liquidity, appealing in their simplicity, inevitably follow bank failures, but Silicon Valley Bank had plenty of both. If we impose large bank regulation on small banks, the small banks would be forced out of business, in many cases landing in the hands of larger banks.
It is clear that size-based regulation is necessary if we are to have a diversified banking system. We are concerned that this need will be ignored.
Excessive regulation isn’t the only threat facing smaller banks. With interest rates relatively high, banks face not just the market risk that helped bring down Silicon Valley Bank; they also have stiff competition for deposits, including from short-term U.S. Treasury bills. For anyone in a high-tax state, the after-tax yield of a Treasury security is likely to be superior to a bank deposit. The issuance of Treasury securities for January and February is already up 13.4 percent over those months in 2022, or $3.4 trillion. Because deposits are a key funding source for banking lending, if businesses and consumers move from bank deposits to Treasury securities in search of greater safety and higher returns, banks will not be able to lend as much. This will hurt important parts of our economy.
Whatever steps the government takes in the wake of the Silicon Valley Bank collapse, it must preserve the role of our diversified system, recognizing this truth: There are no ratios or tests that can replace the need for risk management and regulatory supervision. Moreover, regulators must always be ready to step in if panic selling or other destabilizing behavior emerges. It is why we have had banking supervisors and F.D.I.C. insurance for 90 years.
Enacting new tailored regulations that make smaller banks safer and help to protect all constituents makes sense, but they must be devised so they don’t result in more bank concentration or a reduction in available credit. Either outcome would harm economic growth and consumer welfare.
Jay Clayton was the chairman of the Securities and Exchange Commission from 2017 to 2020. Gary D. Cohn was the director of the National Economic Council from 2017 to 2018.
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Jay Clayton and Gary Cohn
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