Explained: All about the Fed’s rescue act that saved depositors’ money, assuaged panic

The sudden failure of a few regional US banks – key among them being Silicon Valley Bank (SVB) and Signature Bank – kept the US and indeed global financial system on tenterhooks for the past few days. Given that these two banks were the second and third largest in size that failed since the shuttering of Washington Mutual during the global financial crisis of 2008, a run on smaller banks and a contagion would have worsened the situation for depositors.

But the US government and the Federal Reserve (along with the Federal Deposit Insurance Corporation (FDIC)) stepped in quickly and took steps to calm depositors and stakeholders, and ensured that they got a fair deal.

Here’s more about how the rescue program would work, how depositors would be repaid and other key implications for the financial system.

Depositors get their entire money back

During the global financial crisis of 2008, the regulators in the US took quite a while before deciding on how to rescue banks and decided on the quantitative easing by printing easy money at low interest rates and making them available to banks. The delay in decision-making took a toll on many large institutions that eventually failed. The rescue package then was taxpayer funded.

SVB had as much as $175 billion in deposits as of December 2022 and Signature Bank had over $89 billion in deposits as of last week. The amounts are indeed humungous.

This time around, when the two regional banks were shuttered, the Federal Reserve, FDIC and the Treasury Department decided that piecemeal repayment of deposits of the failed banks is not the right path.

The FDIC insures deposits of up to $250,000 only. But the regulatory bodies decided that all depositors would get their entire money back, even beyond the $250,000 limit.

That move was critical because over 93% of the deposits in SVB’s case were uninsured. But the decision to fully return the deposits reduces the panic levels that may set in the financial system when banks fail and repayments are only partial.

The FDIC reportedly has $128.2 billion in its deposit insurance fund, which is funded by insurance premiums and interest earned from investments made in US government securities, according to the Washington Post.

It is also important to note that SVB has $209 billion in assets and Signature Bank had over $110 billion in assets as of December 2022.

Since the banks have been shuttered, the FDIC would auction the assets of SVB and Signature Bank to repay depositors. Specifically, in SVB’s case, the assets are said to be of high quality and many investment firms and groups such as Apollo, Carlyle, Blackstone and KKR are reportedly interested in buying those assets, though nothing is confirmed as of now.

New easy financing program

To stem any financial panic from setting in into the banking system, the Federal Reserve has also started a new Bank Term Funding Program (BTFP), so that troubled banks have easy access to funds.

The BTFP will give easy access of credit lines to banks. Banks can pledge treasuries, bonds, T-Bills and mortgage backed securities and other such high-quality securities to the Fed and get funds for their requirements.

The key positive in this operation is that the securities that are pledged will not be mark to market and would actually be recognized at face value.

For example, if a bank held a government bond purchased a couple of years ago at a value of $100  but the market value is just $90 now, the Fed will recognize the pledged security at $100. And there would be no discounting in the value of credit offered – the amount equal to the pledged value would be given.

The key aspect here is also the interest rate that would apply. The 1-year overnight index swap (OIS) rate plus 10 basis points would apply on these credit lines offered to banks. That would make such loans very moderately priced and comfortably serviceable.

These credit lines would be available for at least one year, till March 2024, according to the regulatory bodies.

What is even more welcome is that this BTFP would be backstopped by a $25 billion fund made available from the Exchange Stabilization Fund (ESF), just in case some of the borrowers fail to repay. The ESF is an emergency facility of the US department of Treasury.

However, the expectation is that the ESF may not be required.

Winners, losers, and the flight to safety

The obvious beneficiaries from the rescue package put together by the regulators are the depositors. With a few procedural aspects in place, they would get all their money back. This also includes many companies from the tech and start-up spaces that had parked their deposits with the likes of SVB and had experienced disruptions in operations.

That the taxpayer is not going to fund the rescue effort is a major relief, as they wouldn’t need to foot the bill for private banks’ follies, as they had to during the global financial crisis.

But who loses? The shareholders would see the value of their holding dip to zero and would end up at the losing end. Unsecured creditors to these banks would also not get any of their money back.

One aspect to note here is that FDIC may introduce an assessment fee that will be levied on all banks to restore the amount it pays out during the repayment to depositors.

The fee amount will vary depending on the size of the bank. Many expect banks to either pass this cost on to customers as higher borrowing rate, or lower interest on deposits or by levying new charges on depositors and customers.

Given the fear around smaller and regional banks in the current environment, depositors may take their money to the larger financial institutions in search of safety.

In fact, Bank of America has seen $15 billion in deposit inflows since SVB’s failure on March 10. Other larger banks such as JP Morgan, Wells Fargo and Citigroup also reportedly received billions in new deposits.

Inflation and interest rates

After the Federal Reserve raised interest rates by 450 basis points in less than a year, inflation is coming down in the US, though it is still way higher than the 2% target it has. Despite the trouble around start-ups and tech companies, the employment market is still tight with wage expectations still being high.

The Fed has been quite relentless in its fight against inflation. Before the bank failures, the Fed was still hawkish, though some believed that US rates would reach their peak by the end of this year.

But the sudden failure of banks and with it the general fears around the financial system, it may do a rethink.

Also crude prices have dipped sharply below $75 a barrel, which is likely to reduce inflation levels.

Whether the Fed would pause in its interest rate meeting next week or not, remains to be seen. But the prospects of heavy interest hikes seem quite low now.

It is worthwhile remembering that SVB’s failure was due to its badly managed investment book that suffered losses due to the spike in interest rates.

For now, a contagion has been contained, though sentiments would be weak in the near term.