What is “moral hazard” and why is it used to question bank bailouts like Silicon Valley Bank’s?

The extraordinary measures taken by the Federal Reserve of USA With the support of the Joe Biden government to rescue depositors from Silicon Valley Bank (SVB) and Signature Bank, they open a new chapter in the country’s banking history.

The unprecedented step that the US authorities took last week was to rescue all the clients of these banks regardless of the amount of their deposits, something that was not contemplated in the current regulation, which insures deposits up to US$250,000.

Look: A Florida bill aims to ban menstruation classes for girls

In the case of the SVB, which represented the biggest drop for a bank since the Great Recession of 2008, almost 90% of its clients were technology companies with deposits of more than US$250,000.

But faced with the possibility of a bank run that had the potential to infect the rest of the systemthe authorities decided to extend the protection to all depositors, whether they had a single dollar or a million dollars in their account.

In addition, US regulators created a new lending program so that troubled banks can use some of their financial assets as a means of obtaining a loan from the Federal Reserve.

It essentially works as a backup to ensure that banks can meet the needs of their depositors.

“A turning point”

“For now you need the fire brigade”tells BBC Mundo Javier Díaz-Giménez, professor of Economics at the IESE Business School, in Spain.

What is not very clear, he adds, is what will happen tomorrow when another bank has the same problem.

SVB customers stood in long lines to get their deposits. (GETTY IMAGES)

“This episode is going to change everything. This is a turning pointa crucial time for banking regulations and supervision of small and medium-sized banks.”

“Here there has been a supervision failure that seems serious to me,” says Díaz-Giménez.

Those doubts about what will happen are shared by many economists. Among them Nicolas Véron, Senior Research Fellow at the Peterson Institute for International Economics and the Bruegel Think Tank.

“(With these interventions) we are facing a new system and, for now, it is very difficult to know what consequences it will have.”

moral hazard

After the rescue of all the clients of the two banks, the debate on the “moral hazard” that this measure supposes has arisen.

In economics, moral hazard occurs when people dare to make bolder decisions because they know someone will protect them.

(GETTY IMAGES)

And in this case, moral hazard enters the picture when the authorities decide to bail out all the depositors of the two troubled banks.

The signal that the market receives is that it is not so serious that they are walking a tightrope.

A bit like the doctor telling you not to worry because he will always be there to heal you and that gives you more confidence to expose yourself to danger.

the discussion is to what extent that moral hazard is really important given the current circumstances.

Because seen from another perspective, there was also the alternative that regulators let banks fall without guaranteeing deposits to their customers.

But that could have come at a gigantic cost if the panic had spread.

“The new system could generate a bit of moral hazard, but we don’t really know, because it will depend a lot on the supervision of the banks in the future,” says Véron in dialogue with BBC Mundo.

Still, he adds, “The fact that there is some moral hazard does not mean that the world is going to end tomorrow.. We have to see what happens.”

For some, maintaining the stability of the banking system, whatever it may be, is essential in an emergency situation like the one experienced by the United States in recent days.

Even more so when the SVB and the Signature bank received a third bailout, although this time the mechanism was different.

The big US banks on Thursday bailed out another entity that was in danger of bankruptcy, the First Republic Bankinjecting US$30,000 million into it.

This comes as concern about the financial sector has spread globally, raising fears about a possible global banking crisis, especially when this weekend the bank Credit Suisse it had to be acquired after intense negotiations by another Swiss bank, UBS, for US$3.240 million.

“A cost for all citizens”

Hung Tran, a senior fellow at the Atlantic Council’s Center for Geoeconomics in the United States, argues that in the short term, protecting large SVB depositors “was a necessary and justified rescue to avoid a possible banking crisis, imposing enormous costs on the whole of society”.

However, in the long run, “the bailout reinforces the problem of moral hazard, weakening market discipline and setting the stage for future crises,” the specialist in money and capital markets told BBC Mundo.

GETTY IMAGES

“This represents a cost for all citizens,” he adds, although the bailout was not financed with taxpayer money.

The point is that by insuring all deposits to make the system more stable, Tran explains, “all banks and their customers will have to pay higher deposit insurance premiums.”

On this point, Díaz-Giménez says in dialogue with BBC Mundo, “the stability of the banking system is not free”.

In the end, he maintains, if banks are better regulated and supervised, and are required to have more demanding capital buffers to face crises, that comes at a price.

Source: Elcomercio