Deposit Insurance Reform Offers A Path To Public Purpose Banking

Op-ed: A finance specialist makes the case for unlimited deposit insurance – for banks serving the public interest.

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In the wake of Silicon Valley Bank’s collapse, regulators and lawmakers are discussing a number of ways to prevent future bank failures. Topic one is altering the $250,000 limit on FDIC deposit insurance. Several lawmakers are pushing to eliminate the FDIC insurance cap on all transaction accounts, at least temporarily; Janet Yellen has also indicated support for increasing deposit insurance coverage.

The discussion about changing the insurance limit has so far focused on (a) whether and how it would stabilize the banking system, and (b) ensuring that U.S. taxpayers won’t be on the hook for increased insurance costs. But how might increased deposit insurance coverage be used to make the banking system better at serving the public interest?

Back in 2008, irresponsible mortgage lending brought the financial system to its knees. A couple of big investment banks went under, some investors took heavy losses, a few senior managers lost their jobs. But, thanks to the government’s action, the banking system survived and, except for the few unfortunate casualties, emerged largely unscathed — and basically unchanged. The heaviest costs of the meltdown were borne by ordinary people who lost their homes, jobs and life savings.

When a bank makes a loan, it makes sure that the borrower will use the money for a legitimate purpose and has the willingness and ability to repay the debt. When you or I make a bank deposit, we in fact become the bank’s creditors. The bank owes us the amount we’ve entrusted to it. We, however, don’t get any say in how the bank will use the deposited money. And, largely because of federal deposit insurance, most of us don’t have to worry that we will get repaid. As long as our accounts are under $250,000, we know we’ll get back the amount we deposited no matter what happens to the bank.

We have this confidence not because we believe that fees paid by banks will maintain the FDIC insurance fund’s solvency, but because we understand that, ultimately, we the taxpayers are standing behind the safety of bank deposits.

To me, this doesn’t seem equitable. If things go well, bank shareholders and managers keep the profits; if they don’t, we have to make up the losses.

There’s a more just alternative to simply providing unlimited deposit coverage to banks that may need it to stay afloat. Any bank can receive unlimited deposit coverage provided that most — let’s say at least 80% — of its assets meet a defined “public purpose” test. We can call these new banks “public purpose banks.”

Defining what assets qualify as having public purpose may be a tricky task. One solution: specifying that any loan or investment that is guaranteed or insured by a federal or state agency qualifies.

According to the Congressional Budget Office (CBO), federal loan guarantees now total almost $12 trillion. Characterizing these loans as eligible “public purpose” assets has a couple of advantages. First, it will ensure the safety of banks receiving unlimited deposit coverage. When borrowers default, the guarantee ensures that a governmental entity will pay most of the losses.Plus, government-guaranteed loans can easily be sold to investors, ensuring that a bank can easily raise cash should it need to meet increased depositor demand.

The second advantage is that federal or state guarantee programs are almost always targeted to finance projects — such as infrastructure upgrades, economic development in distressed neighborhoods, small business support and affordable housing — that need help securing funds and are essential to the nation’s economic health and the public’s interest.

CBO also estimates that in 2023 the federal government will guarantee about $2 trillion in new loans to assist farmers, homeowners, small business owners, veterans and others. In the aggregate, these programs are remarkably inexpensive. By one estimate, they actually have a negative cost; that is, they make money. One reason is that most borrowers repay their loans and the government only incurs a cost when they don’t. The second reason is that for several programs, fees paid by borrowers and lenders are sufficient to cover losses. This is why, for example, the Small Business Administration’s $30 billion loan guarantee program costs taxpayers absolutely nothing.

Guaranteeing innovative mortgage products would reduce housing costs and expand housing construction, especially among people of color. A government-guaranteed second mortgage with deferred interest payments could reduce a homeowner’s monthly payment or assist in purchasing a home, for example.

Here’s the upshot. The federal government’s loan guarantee portfolio has experienced remarkably low costs over the years. Creative partnerships with state governments could keep these costs low. A large number of banks could become protected lenders, providing credit where it matters most — without increasing the burden on taxpayers.

There’s no reason America can’t afford loan guarantee programs to encourage clean energy production, promote affordable housing construction and address other pressing priorities.

It’s important to note that public purpose banks could actually provide higher returns to shareholders than many conventional commercial banks. Because the assets of public purpose banks would be guaranteed, at least in part, by the government, regulators could require them to hold less capital than other banks. This would allow them to make more loans safely.

As recent events in California, Mississippi, Texas and elsewhere have shown, climate change will make weather-related catastrophes both more frequent and more destructive. Because of their financial strength, public banks would be in a position to serve as “financial first responders” when people are displaced by floods, hurricanes, fires and tornadoes. Without endangering their safety or profitability, a $10 or $15 billion public purpose bank could easily make thousands of small advances — perhaps as little as $1,000 to $2,000 — to people who need food, clothing or a place to stay until government help arrives.

Let’s say that just 1% of all U.S. banks, about 40, were to choose to become public purpose banks. Given that the typical bank has a $14 billion balance sheet, institutions with about $560 billion (that is, 40 banks multiplied by $14 billion) in assets would be transformed into lenders dedicated to making the American economy both more sustainable and more equitable.

It’s clear this change in regulatory policy can provide significant improvements to the financial system. By tying unlimited deposit insurance to institutions offering public purpose investments that improve our economy and communities, we can build our financial stability and public investments, at no additional cost to taxpayers.

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Paul Pryde was the U.S. Treasury Department's chief policy consultant during the Obama administration, overseeing a $1.5 billion effort to provide financial guarantees for job-creating small businesses. He has also served as a consultant and board member for various national policy development organizations, such as Wall Street Without Walls, the Minority Business Development Agency, the Northeast-Midwest Institute, and Prosperity Now (formerly Corporation for Enterprise Development), where he chaired for four years. Paul is the author of “Black Entrepreneurship in America,” which explores enterprise formation and economic progress within the African American community.

Tags: banking

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