MNI INTERVIEW2: Uninsured Bank Deposits Still Vulnerable-Bair

Smaller regional banks with large uninsured deposits are still exposed to the danger of destabilizing losses from high interest rates, despite a more proactive stance from regulators after last year's banking turmoil, former FDIC Chair Sheila Bair told MNI.

“The weaker banks are the ones with a big concentration in commercial real estate. The regulators have really been on top of this, really increasing the reserves against those potential losses,” she said in the latest episode of MNI’s FedSpeak Podcast.

But any additional round of bank failures, which might be hard to avoid in the current environment would likely lead to renewed fears of contagion, Bair said.

“I do worry that if there are more bank failures and there probably will be more bank failures, I don’t think the FDIC -- or the Fed may not either -- have a supermajority to do a systemic risk determination to protect uninsured depositors,” said Bair, who led the institution through the Global Financial Crisis of 2007-2009.

“If they do have to impose losses on uninsured [depositors], I worry about the instability that could create.”

TREASURY MARKET LIQUIDITY

Another source of concern for financial stability is the Treasury market, which has faced recurring shortages of liquidity that Bair said are related to the sheer volume of debt being issued by the U.S. government, Bair said.

“There’s a massive amount of debt out there that needs to be bought and traded and that creates problems in the system,” she said.

Another issue, which applies to financial stability writ large, is that regulators have bolstered capital rules on banks while allowing leverage to build up in non-bank financial institutions.

“There’s a problem with tightening up regulation in particular capital requirements with regulated institutions and leaving the non-bank sector out there.

“So you’ve got hedge funds now as major players in the Treasury market, and because of their leverage they go in and out very quickly, they have very low risk tolerance for losses. They don’t have any capital in the game. That’s the problem,” she said.

While banks are calling for a level playing field by removing Treasuries from their own risk-based capital calculations, Bair would rather put more controls over large players in the Treasury market, including imposing capital requirements.

BANK REFORM

Bair believes the largest financial institutions still need more capital, but she concedes that the eventual implementation of Basel III might not deliver the reforms needed.

“I’m not wildly optimistic about where this is going to end up. They’re considering significant changes,” she said.

“I think there is a very good case for needing more capital in the system. If I were a dictator I’d just slap a 10% leverage requirement on them and get rid of all this complexity but they’re not going to do that so you’ve got these hypercomplex risk-based rules.”