More Deposit Insurance Won’t Make Banks Safe Dudley Mervyn King
The SVB debacle illustrated three key weaknesses of modern-day banking.
First, in an era of online transactions and social media, runs can happen with unprecedented speed.
Second, uninsured depositors aren’t a reliable source of market discipline: They have just two modes, complete inattention or total panic.
Third, authorities lack adequate tools to prevent panic.
What’s needed is a backstop that creates the proper incentives for banks to manage risk. With this in mind, I would propose an expansion of the Federal Reserve’s lender-of-last-resort function (along the lines of a mechanism proposed by Mervyn King, who headed the Bank of England during the 2008 financial crisis).
Instead of offering a blanket guarantee, the Fed would promise to lend banks the money needed to pay all their uninsured depositors — but, in exchange, banks would have to pledge sufficient collateral to cover those deposits.
With such a backstop in place, uninsured depositors would no longer have an incentive to run, because they would know that their bank would always be able to obtain sufficient cash to honor their withdrawal requests.
Well-capitalized banks with ample high-quality assets would have no problem meeting the Fed’s collateral requirements. By contrast, risker banks with a lot of uninsured depositors would have more difficulty, and would face powerful incentives to change how they operated.
The Fed’s track record here is reassuring. Its haircuts for both traditional discount window loans and emergency lending have always been conservative.
The Fed earned a profit on all its extraordinary interventions from the 2008 financial crisis, including loans made against the risky, illiquid collateral of investment bank Bear Stearns and insurer AIG.
Bill Dudley Bloomberg 5 juli 2023
The alchemy is “the belief that money kept in banks can be taken out whenever depositors ask for it”
Lord Mervyn King, former governor of the Bank of England. His book is called The End of Alchemy.
https://englundmacro.blogspot.com/2016/06/the-alchemy-is-belief-that-money-kept.html
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