The Transaction Account Guarantee program, which provides FDIC deposit insurance for non-interest-bearing transaction accounts in excess of $250,000, will expire on December 31. However, Congress should extend TAG for at least two years to help community banks provide much-needed loans to small businesses and, thereby, boost our economy.
Banks with assets under $10 billion presently hold almost $180 billion of TAG deposits, representing a significant portion of the $1.4 trillion currently in TAG accounts. Community banks have increased their TAG deposits by more than $30 billion during the past year.
TAG accounts provide community banks with a crucial funding source for their loans to small businesses and other customers. The FDIC collects premiums on TAG deposits to protect the deposit insurance fund against any losses.
If the TAG program ends, most TAG deposits held by community banks will quickly migrate to the biggest banks. Migration will occur because the largest banks are widely considered to be "too-big-to-fail." Investors expect the federal government will fully protect all deposits held by megabanks, including uninsured deposits that exceed the $250,000 general limit on FDIC coverage.
Investors know federal regulators followed an aggressive TBTF policy during the financial crisis. For example, regulators took extraordinary measures in late 2008 to prop up megabanks like Citigroup and Bank of America.
In early 2009, when several large banks still faced severe threats, federal regulators publicly announced they would not allow any of the 19 biggest U.S. banks (each with more than $100 billion of assets) to fail. The federal government backed up that pledge by providing more than $1 trillion of financial support to the top 19 banks through Tarp capital infusions, FDIC debt guarantees and Federal Reserve liquidity assistance.
In sharp contrast, the federal government provided relatively little help to community banks and allowed hundreds of them to fail. Is it any wonder that investors expect uninsured deposits to be fully protected at megabanks but not at smaller banks?
Extending TAG would be a simple and effective way to help community banks fulfill their traditional role as the most reliable providers of outside credit to small firms. Banks with assets under $10 billion hold 20% of domestic deposits, but make more than half of all business loans with balances under $1 million. In contrast, the four biggest banks hold 34% of domestic deposits, but make only 14% of business loans under $1 million.
Community bankers make "high touch" relationship loans to small firms because they know their local communities and personally evaluate the creditworthiness of local entrepreneurs. In contrast, the largest banks provide much of their credit to small firms through impersonal, high-cost credit card loans. Big banks can cut off credit card borrowers abruptly (as many did during the financial crisis), and credit card loans therefore do not provide a reliable basis for small firms to expand.
Thus, a temporary extension of TAG will maintain a crucial funding source for community banks and promote small business growth. It will also provide more time for regulators to demonstrate their ability to carry out Dodd-Frank's promise to end TBTF treatment for megabanks. Currently, ratings agencies and market participants believe that TBTF is alive and well, and big banks therefore benefit from a very significant cost of funding advantage over smaller banks. Investors can hardly be expected to change their views when they see that regulators have not yet adopted final rules to impose tougher safety-and-soundness standards (including significantly increased capital requirements) on the largest banks.
If Congress fails to extend TAG, community banks will be hurt, a vital source of small business credit will be lost, and there will be more pressure for further consolidation in our banking industry. Those outcomes won't be good for our banking system, our small businesses or our economy.
Arthur E. Wilmarth, Jr. is a professor of law at George Washington University Law School.