FDIC: pricey deposits make bond ballast acceptable cargo for banks

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A bank’s business model centres on the arbitrage between its funding costs and lending income. Borrow from customers at, say, 2 or 3 per cent and lend out at 5 or 6 per cent. Capture the spread as profit.

US regulators believe that bank executives are too easily seduced by that simple calculus.

The Federal Deposit Insurance Corporation has therefore proposed new rules. One requires regional banks with more than $100bn of assets to issue a minimum amount of long-term debt, equivalent to 6 per cent of their risk-weighted assets.

The agency believes boosting these balance sheet liabilities — swapping flighty deposits for stickier debt securities — will reduce the risk of bank failures. It should also limit the watchdog’s costs for bailing out depositors. That was necessary earlier this year at Silicon Valley Bank, Signature Bank and First Republic. 

It is a reasonable proposal. The risk is one that market forces already police. With deposit capital electronically mobile, banks must pay up to attract it. Banks might as well pay a bit more to get the benefits of long-term bonds. These are safe from redemption by smartphone or customers visiting branches.

According to analysts at Jefferies, the 17 regional banks they cover collectively have $216bn in long-term borrowings. Those institutions would need to raise another $6bn of debt to meet the new requirements (several already have sufficient). The impact upon earnings per share would be just 1 per cent, netting out coupon payments against reinvestment of cash raised. 

An additional layer of debt capital would theoretically impose losses upon sophisticated private sector investors should the banks run into trouble. Yet in a deposit run as bad as the one that felled Silicon Valley Bank, a layer of junior bonds would offer small protection. In that case, customers withdrew $42bn in a single day,

Deposit insurance is already funded by levies on banks. The relatively high cost of deposits should make the FDIC’s new rules more palatable for lenders.