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At the heart of Silicon Valley Bank’s bankruptcy are uninsured savers — particularly start-up companies that had far more than the $250,000 insured limit and couldn’t make payroll without access to their accounts. It is tempting given the fact that the SVB does not assume that the insured deposit limit should be increased, but that solution creates new problems. A better approach would be for the US to follow other countries’ example and create “payment banks” that take on little to no risk, are highly regulated and have access to the payment network. They would be a place where companies could park money — such as venture capital investments destined for payroll — without exposing themselves to the risks normal banks create.
The bankruptcy of Silicon Valley Bank has exposed the underappreciated vulnerabilities of the US banking system. While banking crises have traditionally focused on credit risk, this recent crisis of confidence stemmed from unrealized losses on safe securities that left depositors anxious for liquidity. The liquidation of those securities crystallized market value losses and amplified the fears of these depositors, and a bank run ensued.
While insured depositors have no cause for alarm, the recent crisis has highlighted the critical role of large uninsured depositors, who are understandably prone to fear. They form more than $8 trillion – or about 40% of all US deposits.
And one particular fear stands out: the prospect of many companies not being able to do payroll was a critical aspect of this crisis, when it became clear that some uninsured savers were corporate customers who could not pay their employees without access to their accounts.
The problem of uninsured deposits
As a stopgap measure, it became necessary for the FDIC to effectively lift the limit on the deposit guarantee and declare troubled banks as systemically important to restore calm. That solution is problematic for many reasons. In the absence of much new regulation, unlimited deposit insurance gives banks terrible incentives. And the regulations needed to mitigate those terrible incentives could stifle risk-taking in the wider economy.
The deeper solution to this problem lies in understanding the dilemma of the uninsured depositor and addressing their needs in a more direct way. It is easy to caricature the uninsured depositor as a reckless risk-seeker that flashes between banks looking for yield. That caricature is not worth a bailout or much sympathy. But the reality is that many uninsured savers face a huge dilemma.
Take the problem of private sector payrolls, which are more than $9 trillion in the annual cash flows in the US alone. Large sums of money must be facilitated on a regular basis and that money must be placed with a bank in order to gain access to the payment system. These deposits simply have no alternative to banks and are therefore exposed to the actions of banks who can use those large deposits to lend or buy assets. In that process, all of our salaries are exposed to the decisions of bankers who can accept these large, volatile deposits, take risks with them, and then socialize the losses when we are forced to hedge deposit insurance.
The Case for “Payment Banks”
The problem of uninsured savers is really the problem of access to the payment system – a system monopolized by central banks and then delegated to banks. The payroll problem is a notable example of this problem, as payroll funds must necessarily be parked at banks, where they are exposed to the aforementioned risks.
Happy, other countries have started to come up with solutions to this problem. The United Kingdom, AustraliaAnd Singapore have all been innovating and we can usefully learn from their efforts. There are basically two possible solutions: giving non-banks access to the payment system, as the UK and others have allowed, or creating banks that do nothing but solve this ‘payroll problem’. We prefer the latter.
To solve the problem of uninsured creditors without disrupting risk-taking incentives, the US should create a special class of bank called a “payment bank” that does nothing but process payments. Their deposit base would be large and potentially volatile, they would be very tightly regulated (even more so than money market funds), and they would not be able to take any credit or maturity risk. Basically, they would take payroll and other similar large B2B transactions and facilitate access to the payment system.
What would be the business model for these payment banks? There are two options: they can earn a safe return by investing these deposits with the Federal Reserve at the federal funds rate, or they can charge their clients a very small fee for facilitating these large payments. Investing large amounts of these deposits in a risk-free manner for very short periods of time can generate significant income, especially in the current environment, and some of this income may even be returned to depositors.
While we’ve characterized this as a salary problem, there are plenty of other economic actors that have large, volatile deposits that are just trying to access the payment system. Consider a $100 million business that has $70 million in annual expenses and prudently holds cash equivalent to a month’s expenses in a bank to cover payments. You may also consider a venture capital or private equity fund that seeks to raise capital or deploy capital to acquire companies.
Currently, these funds must access traditional banks to access payment functionality. That is indeed exactly the business model for both Silicon Valley Bank and First Republic Bank. But every bank has that these kinds of customers. Indeed, the broader field of card-based merchant payments – Where $9 trillion in card payments find their way to merchant bank accounts through the merchant acquirers – has similar characteristics.
By establishing payment banks, the large, volatile deposits that far exceed any reasonable deposit insurance limit will find a suitable home with a tightly regulated bank that effectively takes no credit or maturity risk and can facilitate their transactions. More importantly, the entire banking system will no longer bear the burden of these uninsured deposits and can return to their core business of retail deposits and making prudent lending and asset-liability decisions. And we can prevent the deposit insurance limit from being lifted and all banks from becoming systemically important. In a way, this solution is a less ambitious and much more realistic attempt than using stablecoins or a central bank digital currency to enable B2B payments on alternate payment rails. In many ways, this idea reflects the industrial power principles of clearing and settlement applied to the financial markets to a wider range of payments.
The reality is that the US banking system has become much less dynamic since the global financial crisis. There is almost no entrance. While the number of US banks may be high compared to many other countries, the truth is we don’t need more traditional banks — we need different kinds of banks. Crises are terrible things to wasteand this could lead us to a much more secure banking system by recognizing the problem of the uninsured depositor and creating a home for them.
