Small US banks have big problems. For now, they are focused on survival. That’s why the Mid-Size Bank Coalition of America has advocated for an extension of deposit insurance to stem outflows. But even after stability is restored, the lending capacity of regional banks will be severely limited. It will hurt the US economy.
The call to extend federal deposit insurance to deposits over $250,000 for the next two years shows that distrust of US banks has its own dynamic. The MBCA argues that this decision would immediately halt the exodus of deposits.
It didn’t have to come to this. Opponents of risk-free deposits are rightly concerned about moral hazard.
However, temporary guarantees may be necessary. Former FDIC Chair Sheila Bair said deposit flight could make the biggest banks even bigger, while otherwise sound lenders would be in trouble.
Regulators and politicians will do all they can to stave off this threat. In addition to potentially extending deposit insurance, they provide access to ample liquidity. Yet even if they succeed in calming the immediate crisis, America’s smaller banks will bear the scars.
The problem is not only that the advantages of regional banks over their larger rivals (more flexible regulations and lower capital requirements) risk being reconsidered. It’s also that some of the deposits that have moved in the current panic will not return.
If regional banks end up with a smaller “sticky” deposit base, they could, in principle, get liquidity from the Fed’s banking book funding program. However, its relatively high cost — the one-year overnight index swap plus 10 basis points — makes it an unattractive source of new lending, Jefferies analysts said.
This points to a credit crunch that will hit Main Street, not Wall Street. Regional banks have contributed to the growth of small businesses. Their willingness to lend was already fading even before the latest bank runs. The extension of the guarantee on deposits would reinforce them. It will not prevent the next loan crisis, but it will make it less severe.
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