Why banks fail: Outgoing FDIC chief Martin Gruenberg assesses banking industry risks
Russ Wiles
4 min read
The economy continues to gain ground, job openings abound, consumer and business confidence are on the upswing, while inflation and interest rates have largely stabilized.
All in all, it’s a highly favorable backdrop for banks, as witnessed by a rising balance in the FDIC insurance fund and a mere two bank failures in 2024, out of more than 4,500 institutions. The industry posted combined net income of $65.4 billion in the quarter ending Sept. 30, the most recent for which information is available, and nearly 93% of banks are profitable.
But still, there’s reason for caution, said Martin Gruenberg, who resigns as chairman of the bank-regulatory Federal Deposit Insurance Corp. at the end of President Biden's term in January, opening the transition for a new agency chief to be appointed by Donald Trump. Gruenberg has drawn criticism amid complaints the FDIC emerged as a hostile workplace marked by sexual harassment and other misconduct.
In a Jan. 14 talk at the Brookings Institution, Gruenberg reviewed the three most recent banking traumas of the last half century in arguing that many of the same factors that caused so much havoc before could recur.
Martin Gruenberg, chairman of the Federal Deposit Insurance Corporation (FDIC), speaks at a briefing about the bank and thrift industry earnings for the second quarter 2011 at FDIC headquarters in Washington, August 23, 2011.
The first crisis was marked by a slew of failures among banks and thrifts in the early 1980s. The second was the mortgage crisis that brought down more banks and plunged the economy into a deep recession around 2008-2010. Then there was the severe, if shorter-lived, failure of three large regional banks including Silicon Valley Bank, which had offices in Arizona.
"I am struck by how many common threads run through them, even as the specific context and details differ," he said.
The growing, and worrisome, role of nonbanks
The troublesome factors cited by Gruenberg included interest-rate risks for banks, liquidity risks, too much leverage, inadequate capital, too-rapid growth for some banks, a reliance on high amounts of uninsured deposits and new financial products that weren’t well understood.
Many of the same factors remain prevalent today, including financial institutions that aren’t banks and thus fall outside of their regulatory oversight, with much less transparency and supervision. In some respects, the risks are greater now, Gruenberg said, given that today’s largest banks are bigger, more complex and more deeply intertwined than ever before.
For bank customers and especially depositors, a key takeaway of his discussion reflects the growing role of nonbanks. These entities held $20.5 trillion in assets in the U.S. according to a tally by the Financial Stability Board cited by Gruenberg in a 2023 speech, compared to $23.7 trillion for U.S. banks at the time.
These nonbanks include stock and bond mutual funds, money-market mutual funds, hedge funds, insurance companies and nonbank lenders, many of which have intricate ties to traditional banks.
As for risks, few investors would assume a stock fund comes with the same protections as a bank deposit account, but the differences aren’t always so clear, such as with money-market mutual funds and money-market deposit accounts at bank. Hence the importance of understanding what you own.
The two bank failures in 2024 were at Republic First Bank in Pennsylvania and First National Bank of Lindsay, Oklahoma. One credit union, Alliance Credit Union of Florida, also failed last year.
Should deposit-insurance coverage be raised?
In his talk, Gruenberg questioned whether the FDIC's insurance protections are adequate. The fund insures bank deposits, basically to the tune of $250,000 per depositor at each institution (with a similar federal fund backing credit unions). The amount was last raised in 2008 from $100,000, and the threshold might need to be increased again, Gruenberg said.
While most consumers wouldn’t bump up against that limit, especially as they can get more coverage by spreading their deposits among multiple banks, it's a different story with business customers. For example, larger companies easily could exceed $250,000 in a deposit account dedicated to meeting payroll disbursements, Gruenberg said.
Despite that scare, uninsured deposits are on the rise again. The FDIC estimates them at more than $7 trillion, which would represent more than 40% of all banking deposits.
Gruenberg described another possibility, of providing blanket insurance coverage to all deposits, as less feasible as it would result in much higher expenses for banks, which pay premium assessments to support the FDIC’s insurance fund.
When asked by Brookings senior fellow Aaron Klein about what keeps him up at night, Gruenberg cited two key issues. One is the possibility of a shock, such as a surprise spike in interest rates, that could wreak havoc on the economy and banking sector. The second is the growth of nonbanks and the prevalence of noninsured deposits (above the $250,000 limit) at mainstream banks.
“We should not allow the relative stability (of the banking sector) to lull us into a false sense of complacency,” Gruenberg said. “I am concerned that memories are short.”
Reach the writer at russ.wiles@arizonarepublic.com.
