Bank watchdogs are mulling changes to deposit insurance schemes after a string of lenders failed. Yet one of the most promising fixes has little to do with insurance, or even deposits. Forcing more U.S. banks to fund more of their loans and investments by issuing long-term debt, and relatively less with deposits, could offer an extra layer of protection for customers. The only question is who shoulders the cost of the extra safety.
, already issue oodles of loss-absorbing bonds – a product of post-2008 regulations designed to end government bailouts. Yet unlike in Europe, where even small lenders fund themselves with this class of debt, the vast majority of U.S. players don’t have to. That’s a problem for depositors, since long-term debt acts as a buffer for customers too.
It works thus: if the asset side of a bank’s balance sheet shrinks – say because loans or securities it holds fall in value – the liability side of the balance sheet must get crunched too by the same amount. First to take the hit is equity. Once that has been vaporized, any unsecured debt the bank has issued will be next.
, whose customers are shielded by a giant slab of long-term borrowings, which would get wiped out before deposits in a crisis. The difference helps to explain why it was so expensive for the Federal Deposit Insurance Corporation, which backstops U.S. bank accounts, to wind the three lenders down. The agency chaired by Martin Gruenberg has
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