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Rising wealth inequality and booming corporate savings fuelled a ‘deposit glut’, increasing bank fragility; Silicon Valley Bank was the first victim, writes Guillaume Vuillemey.
Deposits have long been considered a stable and safe source of funds for banks. This may no longer be the case.
On March 9, Silicon Valley Bank (SVB) was the first of a series of regional banks to face large outflows of uninsured deposits – and ultimately failed.
Beyond some idiosyncrasies – risk management failures, extreme reliance on deposits from tech firms, large investments in long-term securities – what can we learn from this event?
Recent research suggests that rising banking fragility could be directly linked to the global saving glut, which itself translated into a large ‘deposit glut’ in the US.
An unprecedented deposit glut
Coined by Ben Bernanke, then chairman of the US Federal Reserve, the term ‘saving glut’ refers to the rise in global savings. Over the past two or three decades, global savings arguably increased at a faster pace than the stock of safe and liquid securities. One oft-mentioned factor behind the saving glut is the rise of emerging economies such as China.
But domestic factors within the US have also played a major role. First, the rise of wealth inequality, which implies that a small number of investors have ever-larger savings. Second, the boom of corporate savings, notably within firms relying heavily on intangible assets, such as tech firms.
global savings arguably increased at a faster pace than the stock of safe and liquid securities
As opposed to savings by investors in emerging economies, domestic savings by both wealthy individuals and corporations are likely to be channelled, in large part, through banks.
In this respect, the data shows a striking pattern.
In the US, the share of deposits relative to the aggregate economy remained fairly stable for several decades following the second world war: around 40 to 50% of gross domestic product (GDP). In the past two decades, however, they have boomed dramatically, reaching beyond 75% of US GDP.
This deposit glut is unprecedented in US history, and comes with a massive rise in uninsured deposits (that is, deposits above the Federal Deposit Insurance Corporation (FDIC) insurance limit of $250,000). Uninsured deposits now represent about 50% of the total.
Granular data confirms the fact that this deposit glut is just another facet of the saving glut: over the years, deposits grew significantly faster for banks located in US states where wealth inequality was high and booming, as well as in counties where cash-rich firms are operating to a large extent.
A new source of fragility for banks
Why might the deposit glut imply greater financial instability? First, because a larger share of deposits becomes uninsured, and thus more volatile – more at risk of bank runs. And second, because large-scale deposits are typically held by more sophisticated investors. These investors react more quickly to negative information or to small differences in yields, which are likely to arise in a context of rising rates and of increased competition between banks and money market funds.
US banks with a high exposure to local wealth inequality faced much larger drops in market valuation
The link between the root causes of the saving glut and financial fragility can be directly seen around the failure of SVB by observing the stock market returns of other US banks, excluding SVB, around March 9.
Strikingly, US banks with a high exposure to local wealth inequality – i.e., those that are more present in states where wealth inequality is higher – faced much larger drops in market valuation (by about 3 percentage points on average).
Similarly, banks present in counties where intangible-intensive firms (which are more likely to accumulate cash) are more present also faced larger stock price drops. This finding is consistent with the view that the saving glut is itself a sizeable contributor to banking instability.
The redistributive effects of deposit insurance
These findings raise questions about deposit insurance and its redistributive effects. Soon after SVB started to face deposit outflows, the response by the FDIC was to fully insure all deposits at the bank.
The first conclusion that follows from the above analysis is that this extension of deposit insurance ultimately acts as a public insurance for the ‘rich’: both wealthy individuals and cash-rich corporations. Any further extension of deposit insurance limits going forward must thus come with a proper evaluation of its redistributive effects – an issue on which there is very little evidence so far.
Another question is whether large uninsured deposits can credibly be held within banks together with insured deposits. The SVB example shows us that they may create hold-up problems ex post, which force deposit insurance authorities to intervene and provide extra safety to formally uninsured deposits.
A legitimate question is whether large deposits – of either wealthy households or cash-rich firms – would be more efficiently channelled via savings products outside banks.
As such, they would not benefit from government guarantees, which necessarily come at a cost to smaller depositors. Deposit insurance would then credibly provide safety to everyone only below a certain level of wealth.
Guillaume Vuillemey is a corporate economist and an associate professor at HEC Paris.
In collaboration with the Centre for Economic Policy Research.
