resolution

Although HFSC’s hearing this week is cancelled due to the shut-down, there is no doubt that Congress will give careful consideration to proposals from mid-sized banks seeking a lot more deposit insurance for selected accounts.  But this doesn’t mean Congress will also advance this proposal unchanged or unaccompanied.  Last week’s letter from Chair Scott to Acting FDIC Chair Hill makes it clear that the Senate Banking Committee head is carefully and correctly thinking through not just which banks win or lose with FDIC-coverage changes, but also what these policies mean to the public good.  In short, it’s a lot.

Sen. Scott focuses on three important questions about the second-order effects of coverage change:  what might happen to depositor behavior, what rules might need to change to offset unintended consequences, and whether statutory change is needed to limit moral hazard.  How FDIC coverage changes for whom drives answers to each of these questions, but several over-arching effects are clear.

First, limiting added FDIC coverage to banks based on certain asset-size thresholds ensures that banks without added protection will not roll over and cough up more insurance premiums.  They’ll do what they can to avoid costs unaccompanied by benefit.  The largest banks are thus likely to reduce higher-cost domestic deposits and replace them with FHLB advances, wholesale deposits, and global funding.  If they substitute these for higher-cost retail and small-business deposits, as seems more than likely, then big banks are also likely to increase their reliance on short-term assets that accord with …