“Be careful what you ask for” is a rule that should guide banks with the same discipline it does dieters. In both cases, getting what you think you want can do a lot of damage. But, there’s a difference: for community banks, the damage may be done just by the asking. With their push to continue TAG, banks have reinforced the belief that banks – big or small – can’t make a go of it without a bail-out backstop. For an industry that prides itself on exemplifying American capitalism, that’s a costly image problem.
FDIC coverage is a hallmark of the U.S. financial system and it’s largely unavailable anywhere else in the world. But, that’s because the U.S. banking system has historically been the only one that cared about average customers. While most non-U.S. banking systems focus on too-big-to-save protection for the largest customers, the premise of the Depression-era program is that it should protect only the innocent – that is, average bank customers who can’t reasonably be expected to assess the risk they take when they cross a bank’s threshold. Even so, President Roosevelt opposed the program out of fears that it would lead to moral hazard, and deposit-insurance ceilings were kept very low for decades to ensure that only the lifetime savings of average customers enjoyed a federal safety net.
Is it a surprise that a quiet amendment to boost the FDIC coverage levels to $100,000 in 1980 sparked the S&L crisis? Of course not. Nor is it surprising that another way around deposit-insurance limits – brokered deposits – allow customers to game the system for unlimited coverage at the FDIC’s – and taxpayer’s – expense. With higher direct and de facto limits, customers can quickly find an insured depository bidding a bit higher because it’s a lot riskier and then send their money along, secure in the knowledge that the funds are safe even if the bank goes bust.
There was a lot of talk about “moral hazard” during the financial crisis. It’s the risk that customers bet with the government’s – not their own – money when picking a bank. Much of the moral-hazard opprobrium fell on the biggest banks which then did of course enjoy a too-big-to-fail implicit guarantee. But, moral hazard is just as seductive when it comes to small banks and equally damaging to the fabric of a financial system built on the capitalist values community banks are proud to espouse. They aren’t any more moral than big banks when seeking taxpayer protection from market discipline in the TAG program just because they’re smaller.
At the heart of the community-bank quandary isn’t TAG. It’s that many small banks have lost franchise value because services are limited, customers are mobile and the old-style home-town bank model is a thing of the past. Here, the community-bank problem is little different than the main-street hardware store’s dilemma – customers have changed their shopping patterns. But, there’s one difference: community banks can turn to what the Wall Street Journal aptly calls “Uncle Sugar.” Does this do them or us any lasting good?
Keeping TAG as is does nothing to address this fundamental strategic problem for community banks. All it in fact would accomplish is to delay the day of reckoning for banks unwilling or unable to restructure themselves in the current, far more demanding marketplace. Are there mortgages community banks can offer that big banks can’t? Small-business loans no one else can make? Retirement advice they are best able and most trusted to provide? I think so, but community banks won’t find out until they give up looking for the next safety net and, instead, stand on the path cut through the financial-services marketplace by changing customer, technology and regulatory demands. These won’t change, so community banks must.