(Bloomberg) -- Former Treasury Secretary Lawrence Summers urged current Secretary Janet Yellen and other top US regulators to pledge that they will back the uninsured deposits in any banks that fail in the next year — an important move that could help build confidence amid the current turmoil.
“There needs to be clarity on the situation regarding deposits,” Summers said on Bloomberg Television’s “Wall Street Week” with David Westin. While regulators don’t have legal authority to give a blanket guarantee, they do have “the essentially equivalent power to declare that, in the event of a bank’s failure, they will use the ‘systematic risk exemption’ in order to assure that depositors are paid off in full,” he said.
Summers was speaking after news that Yellen had called an unscheduled meeting of the Financial Stability Oversight Council, which includes Federal Reserve Chair Jerome Powell and other top regulators. The gathering comes against a backdrop of continued banking strains in the US and around the world — with Germany’s Deutsche Bank AG in focus Friday.
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“I suspect and hope that European authorities — with the support of the United States and Secretary Yellen and Chair Powell — will send strong signals of support over the weekend for the European banking system,” said Summers, a Harvard University professor and paid contributor to Bloomberg Television. “Given the scale of European institutions, there are potentially global consequences if problems spread from them.”
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In the US, regulators should make clear that depositors will be paid off in full, as was done with Silicon Valley Bank, and state that “it is their intention to maintain that policy for the next year,” Summers said.
“That would provide very substantial confidence to the banking system, since the only time when guarantees are relevant,” he said. “It is better to err on the side of overdoing it when you’re talking about protecting against bank runs than it is to err on the side of underdoing.”
Summers pointed to the “highly fevered environment with respect to contagion right now,” and said that with the right message of supporting depositors over an interim period, regulators “can contain a significant amount of the pressures that we’re facing.”
Officials also should “very explicitly” recognize that regulation now needs to account for the new world of “digital banking and high interest rates,” where deposits can shift much faster than in the past.
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“That’s going to put great pressure on the franchise value of many banks. It’s going to affect their solvency, ultimately, because it affects their profitability,” Summers said.
The former Treasury chief reiterated his criticism of the Fed for failing to have accounted for the risk of higher interest rates in its stress tests last year. “It is inexcusable,” he said.
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(Updates with further comments, starting in sixth paragraph.)
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