There is something seriously wrong with FDIC’s insurance strategy

Let’s cut straight to the chase—there’s a big, messy problem with how the Federal Deposit Insurance Corporation (FDIC) insures banks, and it’s time to talk about it. No beating around the bush, no sugarcoating. Just the hard, cold facts laid bare.

We all love snagging a deal, right? Whether it’s choosing the local mom-and-pop shop over the giant supermarket chain to save a few bucks or snagging that sweet deal online. But when it comes to the big players in banking, the FDIC’s current approach to insuring failed banks is causing more harm than good. By law, they’ve got this “least cost test” thing going since 1991, making them sell off the failed banks to whoever flashes the most cash, which usually means the already-too-big-for-their-britches mega banks. These behemoths get even bigger, stomping over the little guys and leaving our banking system looking more like a monopoly game gone wrong.

A Closer Look at the “Least Cost Test”

This “least cost test” may sound sensible at first—after all, protecting the Deposit Insurance Fund (DIF) sounds like a noble cause. Keep those depositor’s confidence high and the risk low, right? But here’s the kicker: this test has a dark side. It blindly pushes the FDIC to hand over failed banks to the highest bidder, no matter if it turns our banking system into a playground for the Goliaths, leaving the Davids in the dust.

Last year, when First Republic hit the skids right after Silicon Valley Bank’s fall, it was JPMorgan Chase, the Hulk of U.S. banks, that swept in with the winning bid. Sure, they’ve got the muscle and the money, but what does this mean for competition and choice? Down the drain, that’s what.

Now, don’t get me wrong. There were times when selling to a mega bank made sense. Take the financial crisis whirlwind, for example. The FDIC had to make some quick moves, like offloading Washington Mutual to JPMorgan. It was a different game back then—stabilizing the system was the goal, and JPMorgan was the only player ready to jump in. But let’s not make emergency measures the norm.

The Big Picture: Competition and Concentration

So, what’s the big deal with all this, you ask? Here’s the rub: our banking system is tilting dangerously towards becoming a “barbell” dystopia, with the heavyweights on one end and the scrappy community banks on the other. Middleweight champions, the regional banks, are getting squeezed out, and their vital role in serving mid-sized businesses is under threat.

And here’s a fun fact: with over 4,500 banks in the mix, the top ten big shots already hog 60% of the industry’s total assets. Let that sink in. If we keep letting these giants gobble up failed banks, we’re heading straight for a future where a handful of mega banks call all the shots. Imagine the thrill of banking diversity turning into a bland, one-flavor ice cream. Not so thrilling.

But wait, there’s a glimmer of hope. Before a bank can strut its stuff in the bidding arena, it needs a thumbs-up from its federal regulator. For the heavyweight champs, that’s the Office of the Comptroller of the Currency (OCC). This gatekeeper has the power to think beyond the wallet size and consider what these acquisitions do to the competition. It’s high time the OCC flexes its regulatory muscles to ensure smaller, but equally stable, players get a fair shot at expanding their turf.

In the shadow of these banking behemoths, let’s not forget the backbone of our communities—the local banks. These institutions are vital, yet they’re caught in the crossfire of this banking battlefield. Their survival and ability to serve their communities are at stake if we don’t act to preserve a diversified banking landscape.

Reports from the FDIC themselves show a mixed bag of financial fortunes. While the banking industry’s net income in 2023 took a slight dip, the truth is, it’s still cruising above pre-pandemic levels. But don’t be fooled by the glittering generalities. Community banks, the unsung heroes of the American economy, faced a tougher climb, with their net income taking a hit. And as loan balances swell and deposit dynamics shift, the pressure on these smaller institutions mounts.