In this article, the author recounts the legislative history of the systemic risk exception from its creation in the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA). The author also explains how the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 amendments to the systemic risk exception shaped the recent resolutions of Silicon Valley Bank and Signature Bank. The author concludes by noting that the use of the systemic risk exception to protect the uninsured depositors of those banks was not an exceptional action, but instead was consistent with the treatment of uninsured depositors in all but a few bank resolutions since 2008.
On March 12, 2023, Treasury Secretary Janet Yellen twice invoked the systemic risk exception under Section 13 of the Federal Deposit Insurance Act (FDIA)1 to authorize the Federal Deposit Insurance Corporation (FDIC) to provide financial support to protect the uninsured depositors of Silicon Valley Bank (SVB) and Signature Bank (Signature).2 The Secretary's actions came after both institutions experienced rapid and substantial depositor withdrawals the prior week, which prompted state regulators to close SVB on March 10 and Signature on March 12.3 The FDIC had tried but was unable to promptly sell SVB. This raised the prospect that as part of each bank's resolution their uninsured depositors, who accounted for approximately 80 percent of each institution's deposits, could incur losses on the amount of their deposits that exceeded the $250,000 federal deposit insurance cap.4 Such an outcome alarmed federal financial regulators, who thought it could trigger uninsured depositor runs at other banks.5 To forestall a broader run on the banking system, the board of directors of the FDIC and the members of the Board of Governors of the Federal Reserve System (Federal Reserve Board) provided the statutorily-required recommendation to allow Secretary Yellen to invoke the systemic risk exception.
This was the first time that a Secretary of the Treasury has invoked the systemic risk exception since Congress amended its statutory language in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank). The resolutions of SVB and Signature therefore provide useful case studies on how the systemic risk exception functions following Dodd-Frank and how it could, and could not, potentially be used to respond to future bank failures or financial crises.
To explicate the legal authority conferred by the systemic risk exception, this article first recounts how Congress created the systemic risk exception in the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) in an attempt to simultaneously advance two competing public policy goals: combating too-big-to-fail and ensuring that financial regulators can respond to bank runs and financial crises. This article then discusses how Dodd-Frank's amendments to FDICIA clarified the scope of the authority granted by the systemic risk exception. It also explains why these amendments need to be viewed within the context of several other provisions of Dodd-Frank that counteract the effect of those amendments, particularly the increase in the deposit insurance cap. This article concludes with an analysis of how the use of the systemic risk exception to resolve SVB and Signature was shaped by the Dodd-Frank amendments. Ultimately, the resolutions of SVB and Signature resulted in an outcome for uninsured depositors that was anything but exceptional. Although Congress had sought in FDICIA to have uninsured depositors bear losses in bank failures, since 2008 uninsured depositors have been nearly always protected from bearing losses. Therefore, by protecting the uninsured depositors of SVB and Signature, the FDIC merely treated them in the same manner it has treated uninsured depositors in all but a small minority of bank failures.
THE ORIGINS OF THE SYSTEMIC RISK EXCEPTION
The systemic risk exception's origins lie in the aftermath of the savings and loans crisis. After the failure of more than 2,000 banks and thrifts in the 1980s, Congress passed FDICIA to reform how the FDIC resolves failed insured depository institutions.6 A primary goal of those reforms was to combat the FDIC's too-big-to-fail policy.
At the time of FDICIA's passage, Congress viewed too-big-to-fail as including two distinct policies.7 The first too-big-to-fail policy was the FDIC's determination that certain large banks should not be allowed to fail if their failure could pose systemic risks to the entire financial system. Congress cited to the FDIC's protection of all of the depositors of Continental Illinois in 1984, which cost the FDIC $1 billion, as a prime example of this policy.8 The second too-big-to-fail policy was the FDIC's customary practice of protecting uninsured depositors of even small or medium-sized banks whose failures did not present systemic risks. In Congress' view, the FDIC had too frequently protected uninsured depositors in both situations and, in doing so, had created significant moral hazard. These actions reduced incentives for uninsured depositors to monitor their depository institutions, which increased risk taking by depository institutions and created greater losses for the deposit insurance fund.9 With FDICIA, Congress sought to reform the bank resolution process to limit the ability of the FDIC to protect uninsured depositors and, thereby, enhance market discipline for insured depository institutions.
At the center of FDICIA's reforms is the least-cost resolution requirement. The least-cost resolution requirement prohibits the FDIC from using its authorities to provide assistance (including asset purchases, loans, and the assumption of liabilities) to an insured depository institution under 12 U.S.C. § 1823(c)(1) and (8), or to facilitate a merger of an insured depository institution under 12 U.S.C. § 1823(c)(2) and (3), (f), and (k) unless:
- such assistance is "necessary to meet the obligation of the [FDIC] to provide insurance coverage for the insured deposits in such institution;" and
- the cost of such assistance "is the least costly to the Deposit Insurance Fund of all possible methods for meeting the [FDIC's] obligations namely deposit insurance coverage]."10
Click here to continue reading . . .
Footnotes
1. 12 U.S.C. §1823(c)(4)(G)(i).
2. Joint Statement by the Department of the Treasury, Federal Reserve, and FDIC (March 12, 2023). https://www.federalreserve.gov/newsevents/pressreleases/monetary20230312b.htm.
3. See Government Accountability Office (GAO), Preliminary Review of Agency Actions Related to March 2023 Bank Failures (April 2023) (GAO Report 2023). https://www.gao.gov/assets/gao-23-106834.pdf; The Federal Deposit Insurance Corporation, The FDIC's Supervision of Signature Bank (April 28, 2023). https://www.fdic.gov/news/press-releases/2023/pr23033a.pdf.
4. GAO Report (2023) at 13.
5. See Testimony of Martin Gruenberg, Chair of the Federal Deposit Insurance Corporation, before the Senate Committee on Banking, Housing, and Urban Affairs (March 29, 2023). "Recent Bank Failures and the Federal Regulatory Response," https://www.fdic.gov/news/speeches/2023/spmar2723.pdf.
6. GAO, Federal Deposit Insurance Act: Regulators' Use of Systemic Risk Exception Raises Moral Hazard Concerns and Opportunities Exist to Clarify Provision (April 2010) (GAO Report 2010) at 10.
7. Report of the Committee on Banking, Housing, and Urban Affairs to accompany S. 543 together with Additional Views (1991) (Senate Report) at 44.
8. Id.
9. Id.
10. 12 U.S.C. § 1823(c)(4)(A)(i) & (ii). The least-cost resolution requirement also applies to the FDIC's authorities under 12 U.S.C. §1823(d) (sales of assets to the FDIC by conservators/ receivers), (h) (reopening branches of certain foreign banks), and (i) (a repealed section).
Originally published by Lexis Nexis.
Visit us at mayerbrown.com
Mayer Brown is a global services provider comprising associated legal practices that are separate entities, including Mayer Brown LLP (Illinois, USA), Mayer Brown International LLP (England & Wales), Mayer Brown (a Hong Kong partnership) and Tauil & Chequer Advogados (a Brazilian law partnership) and non-legal service providers, which provide consultancy services (collectively, the "Mayer Brown Practices"). The Mayer Brown Practices are established in various jurisdictions and may be a legal person or a partnership. PK Wong & Nair LLC ("PKWN") is the constituent Singapore law practice of our licensed joint law venture in Singapore, Mayer Brown PK Wong & Nair Pte. Ltd. Details of the individual Mayer Brown Practices and PKWN can be found in the Legal Notices section of our website. "Mayer Brown" and the Mayer Brown logo are the trademarks of Mayer Brown.
© Copyright 2023. The Mayer Brown Practices. All rights reserved.
This Mayer Brown article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.
SIGNATURE BANK 
