Regulatory Note — SVB I – Legal Underpinnings of Federal Intervention
On Sunday, the FDIC, the Federal Reserve, and the Treasury Department announced that all depositors in the now-closed Silicon Valley Bank (“SVB”) and Signature Bank (“Signature”) would have immediate access to all funds on deposit, even if they exceeded the $250,000 ceiling on deposit insurance. The Federal Reserve also opened a one-year liquidity facility, the Bank Term Funding Program, for any bank wishing to prepare for previously unexpected deposit outflows. Treasury will backstop the facility with up to $25 billion from the Exchange Stabilization Fund.
In taking these actions, each government entity is relying on rarely used statutes that, given the stakes of SVB and Signature interventions, deserve close attention. In a worst-case scenario, this would not be the last time the powers are invoked.
Payments to depositors. The FDIC protects all depositors through the creation of two “bridge banks,” Silicon Valley Bank, N.A., and Signature Bank, N.A. As the FDIC has explained, the bridge bank structure is designed to bridge the gap between the failure of a bank and the time when the FDIC can stabilize the institution and implement an orderly resolution. The bridge bank assumes all the deposits of a failed bank, and customers of the failed bank may withdraw funds from their deposit accounts as before. The bridge bank will not automatically close accounts and return deposits to customers. The bridge bank will draw on the Deposit Insurance Fund (“DIF”) to meet withdrawals if necessary.
The use of a bridge bank to resolve a failed bank is rare. The now-Chairman of the FDIC Chairman Martin Gruenberg provided a useful discussion in a 2019 speech. Among other things, he noted that of the 525 bank resolutions that the FDIC had conducted between 2007 and 2019, the corporation had used the bridge bank structure in only three instances. By contrast, the FDIC arranged purchase and assumption transactions for 95% of the resolutions. The legal reason for such sparing use of the bridge bank is that section 13(c)(4) of the Federal Deposit Insurance Act requires the FDIC to resolve a failed bank at the least cost possible to the DIF. This mandate means that the FDIC must compare the franchise value of a bank in a P&A transaction with the marginal cost of operating a bridge bank. The franchise value is near zero in nearly all cases and thus less than the marginal cost.
However, section 13(c)(4)(G) allows the FDIC – subject to several procedural guardrails – to forgo the least cost analysis in order to contain “serious adverse effects on economic conditions or financial stability.” (Note that the disjunctive “economic conditions or financial stability” could suggest that FDIC’s authority is not limited in systemic risk.) At least for SVB, the FDIC sought bidders for a P&A transaction but received no suitable response.
The FDIC cannot unilaterally invoke the exception. Only the Treasury Secretary may declare that the circumstances surrounding a bank failure require the exception, and she may do so only after receiving written recommendations to this effect from the boards of both the FDIC and the Federal Reserve (each acting with a vote of at least two-thirds of the members) and consulting with the President. The recommendations were made over the weekend. The General Accounting Office must review any such decision. Within three days of the decision, the Secretary must provide written notice to the Senate and House banking committees. She has done so.
In addition, any loss to the DIF as a result of the exception must be made up through special assessments on all FDIC-insured depository institutions.
Bank Term Funding Program. As described by the Fed, the BTFP will offer collateralized loans of up to one year in length to any insured depository institution that is eligible for primary credit at the discount window. Eligible collateral includes any collateral eligible for purchase by the Federal Reserve Banks in open market operations, provided that the institution owned the collateral as of March 12, 2023. Such collateral includes U.S. Treasuries, U.S. agency securities, and U.S. agency mortgage-backed securities. Critically, the collateral will be valued at par, rather than at market value. The facility will be open at least through March 11, 2024.
The legal authority for the facility is the Fed’s emergency lending authority in section 13(3) of the Federal Reserve Act. Section 13(3) authorizes the Fed “in unusual and exigent circumstances” to provide funding to any entity, provided that any funding program has “broad- based” eligibility. The Secretary of the Treasury also must give her prior approval. The Fed must provide periodic reports to the Senate and House banking committees about each program. The Fed last invoked this authority when it established several credit facilities in response to the economic effects of the COVID-19 pandemic.
The Fed will report aggregate borrowings from the BTFP on a weekly basis. It will identify borrowers one year after the BTFP ends, presumably March 11, 2025.
Treasury backstop. The Treasury will make available up to $25 billion from the Exchange Stabilization Fund (the “Fund”) to support the BTFP if needed. The Fund originated in the Gold Reserve Act of 1934 as a fund to support Treasury’s purchase and sale of foreign exchange. The functions of the Fund have broadened over the years. Treasury provided the Fund as a backstop to several of the Fed’s COVID-19-related facilities and presumably has similar authority in this case.