While facing a crisis with investors running to pull their money out of Silicon Valley Bank[1], the Federal Reserve (Fed) rolled out a federal backstop called the Bank Term Funding Program (BTFP) on March 12th.[2] The program offers one-year loans to banks struggling to provide liquidity to investors.[3] The Fed Board, pursuant to section 13(3) of the Federal Reserve Act,[4] ordered all twelve reserve banks to free up the funding necessary for the program.[5] This post examines whether the BTFP encourages banks to make more risky decisions, as well as the “moral hazards”[6] that federal lawmakers and regulators must consider before providing a parachute to free falling depositories struggling to come up with liquidity during a bank run.
Historically, federal backstops for banks date back to the Great Depression era and were used primarily as an attempt to bolster investor confidence and curb bank runs that could jumpstart economic declines.[7] After the 2008 recession and the subsequent passing of the Dodd-Frank Financial Reform Act, the Federal Deposit Insurance Corporation (FDIC) instituted a backstop, which insures bank accounts up to $250,000, unless the bank’s failure “presents a systemic risk to the financial system.”[8] This systemic risk exception led to the controversial concept that depositories can be “too big to fail.”[9] The main criticism of this concept is that the government “ends up sending the message that it’s willing to protect banks that engage in reckless behavior,” or alternatively, provides a “moral hazard” by giving incentives for banks to take risks because they believe the government will bail them out.[10] Generally, it is believed excessive risk-taking by banks can cause a financial meltdown.[11]
The Fed’s decision to start the BTFP in March reignited conversations about whether the government is becoming too bank-friendly to the detriment of investors.[12] Some financial analysts railed against the move, arguing “If the Fed is now backstopping anyone facing asset/rates pain, then they are de facto allowing a massive easing of financial conditions as well as soaring moral hazard.”[13] Others herald the Fed’s action as necessary, saying “It’s certainly a stress relief in the short-term, and we can worry about moral hazard and lax regulation later.”[14] The immediate effects the BTFP will have on bank risk-taking is currently unclear but some believe there is a direct correlation between these type of government actions and bank behavior, “[t]here’s a lot of research that shows in countries that have very high deposit insurance caps or no cap at all — unlimited deposit insurance — banks gamble with depositors’ money to a much higher degree,” said Patricia McCoy, financial analyst and professor at Boston College Law School.[15]
The debate has seized the attention of Congress, which held multiple hearings in late March to examine “regulatory lapses” that allowed Silicon Valley Bank to take allegedly reckless risks.[16] 94 percent of Silicon Valley Bank’s deposits were above the FDIC’s $250,000 insurance limit when the bank failed.[17] Certainly many bank executives will be watching as lawmakers consider raising the FDIC insurance limit, as they did following the 2008 crisis, or choosing to implement guardrails against the risky investing that led to Silicon Valley Bank’s decline. Immediately after launching the BTFP, the Fed started reviewing tougher liquidity requirements for depositories and a stricter annual “stress test” that checks whether a bank can withstand recession conditions.[18] Perhaps the government will allow the next depository that gambles with risky investments to fail and cool off moral hazard concerns. Until that happens, all indications from the federal government are that it is willing to hand out more parachutes.
[1] See Matt Levine, Silicon Valley Bank Ran Out of Money, Bloomberg (Mar. 22, 2023),https://www.bloomberg.com/opinion/articles/2023-03-22/silicon-valley-bank-ran-out-of-money#xj4y7vzkg.
[2] See Bank Term Funding FAQ, Fed. Rsrv., https://www.federalreserve.gov/monetarypolicy/files/bank-term-funding-program-faqs.pdf (last visited Apr. 6, 2023).
[3] Id.
[4] See 12 U.S.C. § 343(3).
[5] See Fed. Rsrv., supra note 2.
[6] See Yahoo! Finance, What is Moral Hazard?, Yahoo! (Mar. 22, 2023) (defining “‘Moral hazard’ [a]s essentially when one entity engages in an activity of elevated or heightened risk, knowing that another party or entity is their safety net.”), https://news.yahoo.com/moral-hazard-000034380.html?guccounter=1&guce_referrer=aHR0cHM6Ly93d3cuZ29vZ2xlLmNvbS8&guce_referrer_sig=AQAAAKOcPdpKuXt7e4UwkjF_biiP03mhSVKnEQUYpCNmePQL73hS5PvKgeEwVFeEl1ZWZB0_wek6iFJaxF2InaSDUQMpQazngEuPnoL2scU5mUVod1F7qu0jNbkFM3e49AisblEjho51yhv5qV_ks_787Y39q7OH-A4TmJbBwREey8kK.
[7] See Cassandra Jones Harvard, Ever since the invention of insurance over 300 years ago, it’s encouraged people to take more risk. Welcome to ‘moral hazard.’, Fortune (Mar. 21, 2023), https://fortune.com/2023/03/21/what-is-moral-hazard-insurance-banking-risk-financial-recklessness/.
[8] Id.
[9] Id.
[10] Id.
[11] See R. Christopher Small, Risk-Taking by Banks, Harv. L. Sch. Forum on Corp. Governance and Fin. Reg. (Apr. 11, 2012), https://corpgov.law.harvard.edu/2012/04/11/risk-taking-by-banks/.
[12] See Scott Murdoch & Carolina Mandl, Experts Flag Moral Hazard Risk as U.S. Intervenes in SVB Crisis, Reuters (Mar. 13, 2023), https://www.reuters.com/business/finance/experts-flag-moral-hazard-risk-us-intervenes-svb-crisis-2023-03-13/.
[13] Id. (quoting Rabobank bank strategists Michael Every and Ben Picton in a note to their clients).
[14] Id. (quoting Steve Sosnick, Chief Strategist at Interactive Brokers in Connecticut).
[15] See David Brancaccio & Alex Schroeder, “Moral Hazard” at Banks Isn’t Just a Theoretical Concern, Marketplace (Mar. 22, 2023),
https://www.marketplace.org/2023/03/22/moral-hazard-at-banks-isnt-just-a-theoretical-concern/.
[16] See Chelsey Cox, Key Lawmakers Say Upcoming Hearings on Bank Failures Aim to Boost U.S. Confidence in Banking Sector, CNBC (Mar. 24, 2023), https://www.cnbc.com/2023/03/24/svb-failure-congress-hearings-aim-to-increase-confidence-in-banks.html.
[17] Id.
[18] See Andrew Ackerman, Fed to Consider Tougher Rules for Midsize Banks After SVB, Signature Failures, Wall St. J. (Mar. 14, 2023), https://www.wsj.com/articles/fed-to-consider-tougher-rules-for-midsize-banks-after-svb-signature-failures-4453fe5d?mod=article_inline.
