Yellen: Government Could Step in Again to Protect Other Banks From Deposit Runs to Stop Contagion

Yellen: Government Could Step in Again to Protect Other Banks From Deposit Runs to Stop Contagion
Treasury Secretary Janet Yellen delivers remarks on "Next Steps in the Evolution of Development Finance" at a Center for Strategic and International Studies (CSIS) in Washington, on Feb. 9, 2023. (Leah Millis/Reuters)
Bryan Jung

U.S. Treasury Secretary Janet Yellen on Tuesday defended government intervention in the banking sector and suggested that it may be necessary to take similar measures in case smaller financial institutions experience deposit runs that could lead to contagion.

She also called the American banking system “sound,' and said that overall “the situation is stabilizing” due to strong actions by federal regulators in her attempts to calm the markets after two regional bank failures this month.

Yellen spoke at the American Bankers Association on March 21, where she made her prepared remarks.

The Treasury secretary said that additional rescue arrangements “could be warranted” if further regional bank runs pose “the risk of contagion” and endanger the nation’s financial stability.

She said further steps would be made to protect bank depositors if smaller institutions suffer additional bank runs that threaten the sector.

“The steps we took were not focused on aiding specific banks or classes of banks. Our intervention was necessary to protect the broader U.S. banking system,” Yellen said in her remarks.

The massive failure of Silicon Valley Bank in California, on March 10, and the collapse of New York-based Signature Bank, on March 12, have roiled the banking industry, in the second- and third-largest bank collapses, respectively, in U.S. history.

Depositors rushed to withdraw money in a bank run after major concerns over the health of those lending institutions.

A third bank, First Republic Bank, in San Francisco, later received $30 billion in funds last week, which was raised by 11 of the top U.S. banks in an attempt to prevent its total collapse.

Yellen Calls Moves by Government Positive for the Banking Sector

Yellen spoke over a week after the Federal Deposit Insurance Corp (FDIC) shut down the failed Silicon Valley Bank and Signature Bank.

She stated that the “decisive and forceful” actions by the FDIC, the Federal Reserve, and the Treasury have reduced the risk of further bank failures that would have imposed losses on the bank-funded Deposit Insurance Fund.

The Treasury secretary praised their actions for strengthening public confidence in the U.S. banking system and protecting the American economy.

So far, “the U.S. banking system remains sound,” Yellen said.

“The Fed facility and discount window lending are working as intended to provide liquidity to the banking system,” she explained, and that “aggregate deposit outflows from regional banks have stabilized.”

Federal regulators earlier announced that depositors at the two failed banks, including those holding uninsured funds exceeding $250,000, would be protected by FDIC insurance.

The government has been taking steps to create a new Federal Reserve liquidity facility, which will provide a “resolute commitment to take the necessary steps to ensure that depositors’ savings and the banking system remain safe.”

The latest banking crisis has forced the Biden administration to try to restore public confidence in the banking system and to prevent any further turmoil in the sector.

The Justice Department and the Securities and Exchange Commission (SEC) have also launched investigations into the collapse Silicon Valley Bank.

Treasury Secretary Calls Community Banks Essential

Yellen’s remarks also underscored the importance of community banks in the eyes of regulators.

“Community banks play a vital role in providing credit and financial services to small businesses,” she said, recognizing that the survival of smaller regional banks was essential for local businesses and the economy.

“Large banks play an important role in our economy, but so do small- and mid-sized banks.”

“These banks are heavily engaged in traditional banking services that provide vital credit and financial support to families and small businesses. They also increase competition in the banking sector, and often have specialized knowledge and expertise in the communities they invest in.”

“Treasury is committed to ensuring the ongoing health and competitiveness of our vibrant community and regional banking institutions,” she continued.

This sentiment has been echoed by many in the banking industry who see community banks as the lifeblood of local economies. These institutions are often more flexible and responsive to the needs of their customers, particularly small businesses.

The recent crisis, however, has put a strain on community banks, which have been hit hard by the economic downturn. The fear of contagion has led many depositors to withdraw their funds, creating a ripple effect throughout the banking system.

Yellen’s statement suggests that the government is prepared to take swift action to prevent these kinds of runs from spreading.

While it remains to be seen exactly what form these interventions will take, Yellen’s words offer some hope for those who rely on community banks.

Biden Administration Calls for Major Changes to Bank Regulations

President Joe Biden has asked Congress to strengthen rules on regional banks and to impose tougher penalties on the executives of failed banks.

Several Democrat lawmakers and some economists have blamed a 2018 rollback of portions of a 2010 law intended to prevent a future financial crisis as a primary cause of the institutional failures.

Meanwhile, the Republican House Freedom Caucus said it opposes expanding deposit guarantees beyond the FDIC’s current $250,000 limit per depositor, which could put a halt to any action by the government aimed at stemming a worsening crisis.

The new actions to provide guarantees for uninsured deposits in specific troubled banks would require Yellen, the president, and “supermajorities” of the Fed and FDIC board to determine that the bank qualifies for a “systemic risk exception,” similar to the cases of SVB and Signature Bank.

On March 16, Yellen spoke in front of the Senate Finance Committee and reassured Congress, bank depositors, and investors that the American banking system remained sound and that the country should “feel confident” about the safety of their deposits.

“Let me be clear: The government’s recent actions have demonstrated our resolute commitment to take the necessary steps to ensure that depositors’ savings and the banking system remain safe,” she told the senators.

She will again appear in front of separate panels this seek, one each at the House and Senate.

Yellen is expected to face more questions about the nature of the bank failures and the government’s efforts to control the damage.

The secretary told the Senate panel that she was in close contact with the banks, state and federal regulators, market participants, and international counterparts, regarding the situation.

She called the latest crisis “very different” from the global financial crisis of 2008–09, when subprime mortgage assets put extreme stress on certain banks.

“We do not see that situation in the banking system today. Our financial system is also significantly stronger than it was 15 years ago.”

The Treasury secretary promised that regulators will examine the failures of Silicon Valley Bank and Signature Bank over the next several weeks.

She added, “We will need to reexamine our current regulatory and supervisory regimes and consider whether they are appropriate for the risks that banks face today.”

Bank Crisis May Affect Fed’s Next Move

The policy-making Federal Open Market Committee also began its two-day policy meeting to assess its current monetary policy, but this has been overshadowed by questions about the stability of the U.S. financial system since the start of this month’s bank crisis.

Expectations for interest-rate hikes are now for an increase of 25 basis points—or none at all.

The central bank will announce its decision at the end of its policy meeting on March 22.

“We have had a number of major shocks to the system. Three U.S. bank closures in a week wiping out equity and bondholders [and] the demise of Credit Suisse and the zeroing of its junior bondholders,” said hedge fund manager Bill Ackman, in a tweet, and argued for a pause on rate hikes.

Reuters and the Associated Press contributed to this report.

Bryan S. Jung is a native and resident of New York City with a background in politics and the legal industry. He graduated from Binghamton University.
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