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The core business model of a bank revolves around the balance between its funding costs and lending income. The concept is simple – borrow from customers at lower interest rates and lend at higher ones, earning a profit from the difference.
US regulators, however, have observed that bank executives often overlook the complexities involved. To address this, the Federal Deposit Insurance Corporation (FDIC) has proposed new rules for regional banks with over $100 billion in assets.
Under the proposed rules, these banks would be required to issue a certain amount of long-term debt, representing 6% of their risk-weighted assets. This adjustment aims to enhance balance sheet stability, reduce the risk of bank failures, and minimize potential costs for depositors’ bailouts.
While the proposal seems reasonable, it essentially aligns with natural market forces. Banks are already compelled to offer competitive interest rates to attract deposits, so they might as well consider the advantages of long-term bonds. These instruments provide greater stability because they cannot be redeemed by smartphone or through branch visits.
Jefferies analysts report that the 17 regional banks they cover currently have $216 billion in long-term borrowings. To comply with the new requirements, these banks would need to raise an additional $6 billion in debt (though some already meet the criteria). The impact on earnings per share would only be around 1%, considering coupon payments and reinvestment of the raised funds.
An additional layer of debt capital theoretically exposes sophisticated private sector investors to potential losses if the banks encounter difficulties. However, in a severe deposit run similar to the one experienced by Silicon Valley Bank, junior bonds would provide limited protection. During that incident, customers withdrew a staggering $42 billion in just one day.
The FDIC’s existing deposit insurance is already funded by levies on banks. The relatively high cost of deposits should make the new rules more acceptable for lenders.
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