Good morning. Thank you, Eugenia, for that kind introduction.
I am deeply grateful for the opportunity to speak with you today at the 21st Annual Conference of the International Association of Deposit Insurers (IADI). I really regret not being able to be with you in person in Buenos Aires. Nevertheless, I am delighted to be back with my IADI friends and colleagues, even if it is only virtually.
I’d like to thank IADI and my friend Alejandro Lopez, IADI Acting President and Chairman of the Executive Council, and Chief Executive Officer of SEDESA, for inviting me to share some thoughts on how we as deposit insurers must plan and prepare for the uncertainties we face in the current moment.
Earlier this month, the Royal Swedish Academy of Sciences awarded their 2022 Prize in Economic Sciences1 to former Federal Reserve Chairman, Ben Bernanke, and Professors Douglas Diamond and Philip Dybvig for their 1983 work on banks and financial crises.
Professor Diamond’s and Professor Dybvig’s paper underpins the theoretical foundations of deposit insurance by demonstrating the fundamental instabilities in the banking system due to the difference in liquidity between bank assets, which are longer term, and liabilities, which are shorter term. Their paper asserts that societal events can lead to fear, bank runs, and financial crises. In their model, the presence of government deposit insurance reduces bank runs and improves overall utility.
Former Chairman Bernanke’s work showed that this theoretical picture was consistent with the all too real events of the Great Depression in the United States.
These papers and the recognition they have received highlight the importance of the work we do in providing deposit insurance and maintaining financial stability. It is essential that depositors maintain unwavering confidence in the effectiveness of the deposit insurance system to endure any challenge, regardless of its source. In order to do so, deposit insurers must be equipped with the tools to prepare for the next crisis.
Introduction and historical context
When I joined the FDIC Board as Vice Chairman in 2005, the next crisis seemed a distant concern. At the time banks were benefitting from a decade of relatively benign economic conditions, interrupted only by a mild recession in the early 2000s. The FDIC was in the midst of a two and a half year period without a bank failure, the longest such period in its history. Banking conditions seemed so favorable that friends asked me at the time if I really wanted to become a member of the FDIC Board—after all, nothing was happening in the banking industry and I might find it boring.
As it turns out, much of my time since joining the FDIC Board has been spent responding to, recovering from, and preparing for, financial crises. From the Global Financial Crisis of 2008, the enactment of the Dodd–Frank Act in 2010, post–crisis recovery, and now a global pandemic, one key lesson I have learned is that we should guard against the temptation to become complacent about the risks facing the financial system. We should be modest about our ability to predict where and when the next crisis will emerge, and prepare accordingly.
Three years ago, conversations about the next crisis assumed it would be centered on developments in the real economy or the financial system. In the United States, this was true of the experience with the banking crisis of the 1930s, the thrift crisis of the 1980s, and, most recently, the Global Financial Crisis of 2008.
However, the pandemic demonstrated that exogenous shocks can also have a profound impact on the global economy and financial system. In the United States, the Financial Stability Oversight Council (FSOC), made up of the U.S. Treasury and the federal financial regulatory agencies, described COVID–19 as “the biggest external shock to hit the post–war U.S. economy.” Due to the increasing level of global economic interconnections, it is true today more than ever, that unexpected shocks can happen for a myriad of reasons, many of which we might not imagine until they occur.
Yet, while we may not know the origin of the next crisis, we know many of the steps we should take to prepare our organizations to respond. The steps that we take as deposit insurers in good times to build confidence, give us the credibility and the strength to respond during times of stress.
Today I would like to share with you the steps undertaken by the FDIC before and during the pandemic to manage our deposit insurance fund, support a coordinated government response, and continue ongoing operations, as well as the steps we are taking now to prepare for an uncertain future.
FDIC Experience, Managing the Fund, and the Pandemic
The Global Financial Crisis of 2008 exposed a number of vulnerabilities in the US regulatory framework, including, in retrospect, an inadequately resourced Deposit Insurance Fund (DIF).
Leading up to the crisis, a relatively low reserve ratio requirement of the Deposit Insurance Fund of 1.25 percent, coupled with restrictions on the FDIC’s ability to charge the healthiest banks for deposit insurance, resulted in effectively eliminating deposit insurance assessments for at least 90 percent of insured institutions for nearly ten years. As a consequence, the Deposit Insurance Fund balance was not as large as it should have been when the 2008 crisis occurred.
Large numbers of bank failures caused the Deposit Insurance Fund to be depleted. It fell to a low of negative $20.9 billion in 2009. In order to shore up the fund’s net worth and liquidity, the FDIC levied a $5.5 billion special assessment, significantly increased assessment rates, and required institutions to prepay more than three years’ worth of assessments. These actions, while necessary, had a pro–cyclical effect on an already struggling financial system and economy.
In response, the Congress enacted and the FDIC implemented a number of reforms that broadened the tools available to manage the DIF and ensure that deposit insurance remains a source of public confidence, during and after a crisis.
Specifically, the Dodd–Frank Wall Street Reform and Consumer Protection Act of 20102 increased the minimum reserve ratio for the FDIC’s DIF to 1.35 percent of estimated insured deposits and gave the FDIC Board the authority to establish a Designated Reserve Ratio (DRR) for the Deposit Insurance Fund at a level sufficient to withstand a future crisis.
The reforms provided the FDIC significant and authorities to manage the DIF and better prepare for the next banking crisis, whenever that might occur.
With these flexibilities, the FDIC published its comprehensive, long–range Deposit Insurance Fund management plan in 2011. The plan set a higher fund target, or Designated Reserve Ratio, to 2 percent based on data and experience spanning multiple decades.
The FDIC determined, using a historical simulation, that allowing the reserve ratio to grow past 2 percent would have prevented the Fund from falling below zero during the past two US banking crises.
With the onset of the pandemic, these preparations were put to the test. Monetary policy actions, direct government assistance to consumers and businesses, and an overall reduction in consumer spending due to the COVID–19 pandemic resulted in an unprecedented inflow of more than $1 trillion in estimated insured deposits in the first half of 2020. As a result, the reserve ratio of the Fund declined below the statutory minimum, and as of June 30, 2020, was at 1.30 percent. As required by the Federal Deposit Insurance Act3 the FDIC Board adopted a new Restoration Plan in September 20204 to restore the DIF to at least 1.35 percent by September 30, 2028, maintaining the assessment schedule in place at the time.
A key assumption surrounding the 2020 Restoration Plan was that insured deposit growth would normalize, and the surge of insured deposits associated with the pandemic would recede over time. The banking industry has instead continued to report strong insured deposit growth. In fact, excluding quarters affected by the increase in insured deposit limits in 2009 and the early pandemic, insured deposits increased in the first quarter of 2022 by the largest amount in at least 30 years. While the second quarter showed possible signs of insured deposit growth normalizing, updated analysis and projections for the DIF balance and reserve ratio indicated that, absent an increase in assessment rates, the reserve ratio is at risk of not reaching the statutory minimum of 1.35 percent by the statutory deadline of September 30, 2028.
Recognizing the need to rebuild the DIF and prepare for an uncertain future, a two basis point increase in assessment rates was recently approved by the FDIC Board. This action is intended to achieve two objectives. First, increasing the likelihood that the reserve ratio will reach the statutory minimum by the statutory deadline. And, second, to support growth in the Fund toward its long–term target, the 2 percent Designated Reserve Ratio.
We believe that it is better to take prudent but modest action now, rather than to delay and potentially have to consider a larger increase in assessments at a later time when banking and economic conditions may be less favorable. Despite the extraordinary challenges of the pandemic and other economic and geopolitical stresses, the U.S. banking industry remains resilient. The increased assessments are expected to have a very small effect on banking industry income and not impact lending or credit availability.
Supporting an Effective and Coordinated Government Response
The pandemic also tested the FDIC’s ability to effectively support the government’s broader efforts to coordinate and respond to a crisis.
Like many other jurisdictions, the U.S. government responded quickly to the pandemic with unprecedented public support. Congress approved more than $4.5 trillion dollars, much of which directly helped households and small businesses through a broad array of direct aid, emergency lending programs, and credit facilities. The Federal Reserve also stepped in during the early days of the pandemic, providing support to calm the financial markets, exceeding the support provided during the Global Financial Crisis.
In coordination with the other financial regulators and the U.S. government, the FDIC put in place a set of regulatory and banking supervision measures intended to mitigate the impact of the coronavirus pandemic on the U.S. financial system and to support American households, communities, and small businesses.
The FDIC’s longstanding relationships domestically and abroad allowed us to maximize coordination during the onset of economic and financial market volatility caused by the pandemic. As the pandemic progressed, the FDIC actively monitored economic and financial market conditions and was prepared to take actions as necessary to maintain stability.
During the Global Financial Crisis, the FDIC’s Temporary Liquidity Guarantee Program proved to be invaluable in stabilizing the system by guaranteeing certain newly issued debt and fully guaranteeing certain non–interest–bearing transaction deposit accounts. Following the crisis, the Dodd–Frank Act put some limits on the FDIC’s discretion to implement a similar program for a future crisis. The law allows the FDIC, with agreement from the Federal Reserve Board and Secretary of the Treasury, and with congressional approval, to create a widely available debt guarantee program.5 In 2020, recognizing the potential importance of such a program and the effect of the pandemic on financial markets, Congress provided the FDIC with the temporary authority to create such a program to guarantee obligations of solvent insured depository institutions or solvent depository institution holding companies.6
This authority, as well as ongoing communication with government and industry stakeholders, put the FDIC in a position to stand ready to support a coordinated response should a liquidity event take place that warranted a guarantee program. Fortunately, it was not necessary, but having the preparations and authority available provides reassurance even if they do not ultimately end up being used.
Continuing Normal Operations in Abnormal Times
Preparations to protect the DIF and support a coordinated government response would have been less effective if not for earlier efforts to ensure continued operations through a crisis.
To maintain public confidence in the financial system throughout the pandemic, we, like many, had to be fully operational, but suddenly we had to do it virtually. The FDIC successfully moved to a full telework environment overnight due to steps taken in the years prior, including transitioning all employees to laptops, implementing collaborative work tools like Microsoft Teams, and modernizing our remote capabilities.
During the pandemic, supervisory activities were moved offsite. The FDIC established a new approach to bank closing activities including appointing a health and safety officer, establishing a smaller on–site closing team supplemented by a remote team, employing greater use of technology, and modifying travel plans for attending the closing. The FDIC has successfully executed three resolutions using these techniques since March 2020 and lessons learned from these resolutions are being incorporated into plans for future supervisory and resolution activities. The same preparations and tools utilized during the pandemic are now being deployed to manage the transition to a hybrid work environment.
Globally, the FDIC has continued working with our IADI and other international partners. Our collective ability to adapt during such uncertain and challenging times would not have been possible without the efforts made over the last 12 years to strengthen cross–border relationships and improve coordination, update and develop international standards, and harmonize laws.
At the FDIC, formal engagements such as our principal–level exercises with the European Union and the United Kingdom on cross–border resolution of global systemically important banks (GSIBs), as well as Crisis Management Groups, continued virtually. This allowed us to keep developing plans, testing scenarios, and improving capabilities in order to enhance our collective resolution readiness.
We were also able to provide technical assistance and training, like FDIC 101 and the Bank Resolution Experience, virtually, enabling us to maintain commitments to our international counterparts. Although the technology facilitated our interactions, it was our existing relationships, built up over years of preparing and working together that made them effective.
Continued operations were also made easier and more effective through international standards. The standards adopted through G20 reforms and that comprise the Financial Stability Board’s (FSB) Key Standards for Sound Financial Systems7 like the Basel Core Principles for Bank Supervision,8 IADI Core Principles for Effective Deposit Insurance Systems,9 and the FSB Key Attributes of Effective Resolution Regimes for Financial Institutions,10 provided a strong foundation for jurisdictions to take the actions needed to support their systems. Through a series of surveys by the FSB and other Standard Setting Bodies, it was found that most measures taken to manage the shock from the pandemic used the flexibility available in international standards by design. By taking consistent actions we are able to support the resilience needed from the financial system while preserving a level playing field internationally.
IADI also published a report on the impact of the pandemic on deposit insurance.
I was pleased to learn that most deposit insurers quickly implemented business continuity plans and utilized their crisis management frameworks to ensure continuity of their primary responsibilities and that many have reviewed or plan to review their plans as a result of the pandemic.
Preparing for future risks
As deposit insurers, we plan for the future knowing that it is not whether but when the next crisis will occur. Our shared experiences from the Global Financial Crisis and the pandemic remind us that the future we prepare for will include new and different sources of risk with the potential for profound impacts on the economy and financial system.
There is broad consensus, both domestically and abroad, that the effects of climate change and the transition to reduced reliance on carbon–emitting sources of energy represent one such risk. While many of our jurisdictions have remained resilient through severe weather events, changing climate conditions pose greater challenges ahead. These include rising sea levels, increases in the frequency and severity of events, and new types of natural disasters. Deposit insurers, including the FDIC, must prepare accordingly to ensure that the financial system and deposit insurance remain strong.
As members of a global organization as diverse as IADI, we must also consider the impacts of climate change on different economies and populations. Studies in the United States have found that the adverse effects of climate change may have a disproportionate impact on the financially vulnerable. As such, the manner in which deposit insurers prepare should consider and seek to reduce potential shocks on jurisdictions and communities least able to respond.
At the FDIC, addressing the financial risks posed by climate change is one of our top priorities. The FDIC joined and recently hosted an outreach meeting of the Network of Central Banks and Supervisors for Greening the Financial System (NGFS) to foster collaboration and share best practices in addressing climate–related financial risks on a global basis. This complements our existing work with the Basel Committee’s Task Force on Climate–related Financial Risks.
I know that IADI has also begun work in this important area, including a recent policy brief highlighting the operational risks that deposit insurers may face from climate change. The FDIC strongly supports these efforts and their consideration as we update the Core Principles.11
In my remarks today, I shared with you some of the measures the FDIC undertook before and during the pandemic to manage our deposit insurance fund, support a coordinated government response, and continue ongoing operations, as well as the steps we are taking now to prepare for an uncertain future.
It is clear we are heading into a very challenging economic environment. Inflation, geopolitical tensions, rising interest rates, and a slowing global economy pose serious risks that may have consequences for us as deposit insurers.
It is our responsibility as deposit insurers to draw on our previous experiences and prepare for the uncertainties we face. Preparedness takes a number of forms including contingency plans to ensure continuity of operations, strengthening deposit insurance funds when the system is healthy, and ensuring our frameworks are designed in a way to allow us to act swiftly. All of these actions share the common goal of demonstrating our credibility to do our part to support financial stability.
IADI has an important role to play in bringing together the deposit insurers of the world to share experiences and provide support to each other in meeting these challenges. I very much look forward to working with all of our IADI partners as we prepare for the challenges ahead.
Thank you again for the opportunity to speak with you today. I wish you a successful conference.
1 The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2022.
2 See United States Congress, Dodd-Frank Wall Street Reform and Consumer Protection Act (July 21 27, 2010), at https://www.congress.gov/bill/111th-congress/house-bill/4173/text.
3 See Federal Deposit Insurance Corporation, FDIC Law, Regulations, Related Acts (June 16, 1933), at https://www.fdic.gov/regulations/laws/rules/1000-2000.html#:~:text=1000%20%2D%20Federal%20Deposit%20Insurance%20Act&text=(A)%20IN%20GENERAL.,be%20prescribed%20by%20the%20Corporation.
4 See Federal Deposit Insurance Corporation, Amended Restoration Plan and Notice of Proposed Rulemaking on Assessments, Revised Deposit Insurance Assessment Rates (June 21, 2022), at https://www.fdic.gov/news/financial-institution-letters/2022/fil22026.html.
5 See 12 U.S.C. 5611-12.
6 See United States Congress, CARES Act (March 27, 2020), at https://www.congress.gov/116/bills/hr748/BILLS-116hr748enr.pdf.
7 See Financial Stability Board, The Compendium of Standards, Key Standards for Sound Financial Systems (November 1, 2014), at https://www.fsb.org/work-of-the-fsb/about-the-compendium-of-standards/key_standards/.
8 See Bank for International Settlements, Financial Stability Board, Basel Core Principles for Bank Supervision (September 14, 2012), at https://www.bis.org/publ/bcbs230.pdf.
9 See International Association of Deposit Insurers, Core Principles for Effective Deposit Insurance Systems A proposed methodology for compliance assessment (November 2010), at https://www.bis.org/publ/bcbs182.pdf.
10 See Financial Stability Board, Key Attributes of Effective Resolution Regimes for Financial Institutions (October 15 2014), at https://www.fsb.org/2014/10/key-attributes-of-effective-resolution-regimes-for-financial-institutions-2/.
11 See International Association of Deposit Insurers, Climate Change Fever: Can Deposit Insurers Stay Cool? (October 5, 2021), at https://www.iadi.org/en/assets/File/Papers/Policy%20Briefs/IADI_-_Policy_Brief_5_Climate_Change_Fever.pdf.