“On Deposit Stability in Failing Banks” Christopher Martin, Manju Puri and Alexander Ufier

1. “On Deposit Stability in Failing Banks” Christopher Martin, ManjuPuri and Alexander Ufier Comments by Larry D. Wall Federal Reserve Bank of Atlanta

2. Disclaimer The views expressed here is the discussant’s and not necessarily those of the Federal Reserve Bank of Atlanta, or the Federal Reserve System.

3. Overview of the paper • Looks at the failure of a $2 billion bank • Failure primarily due to credit losses on exotic residential mortgage products (including adjustable rate mortgages?) • Data available on • End-of-day, deposit account level balances • Age of deposit • Whether deposit was held by an institution • Proportion of days where account had deposit or withdrawal • Time line of events including supervisory intervention

4. Overview of the paper • Empirical results • Deposit insurance proved credible • Uninsured transactions accounts were more stable • Uninsured term deposits more likely to run • Older accounts less likely to run • Deposit runoff by account type did not exceed LCR assumptions but did sometimes exceed NSFR assumptions • Bank could replace runoff with new institutional term deposits that paid a 65 basis point premium

5. Comment: Paper is overly focused on deposits • Paper does not discuss why depositors run • Depositors care about PD and LGD of their bank • PD depends upon the regulators • Solvency and liquidity of the bank • Other factors, including available resources • LGD depends on • Value of bank’s capital and assets • Whether the claim is insured • Other relationships with the bank

6. Comment: Paper should discuss non-deposit factors • The value of the bank’s assets and capital • Public information • Private information maybe available to some depositors • Nondeposit sources of funds • FHLB funding both as substitute deposits and increasing deposit LGD by taking collateral • Capital Purchase Program (TARP)

7. Comment: Term versus transaction deposit run-off • Standard view is that uninsured transaction deposit are more subject to deposit run-off. • My understanding of the reasoning behind this view • One day a previously healthy bank is hit with adverse shock and becomes insolvent • Transactions deposits run immediately because they can • Term deposits run as they mature because they must wait • However, the paper finds term deposits are more likely to run

8. Comment: Term versus transaction deposit run-off • What happened in this case (and most U.S. failures) • Solvent bank is hit with a series of shocks that ultimately cause it to become insolvent • Forbearance given so reported losses < economic losses • Transactions depositors can run any time and have larger switching costs so they can afford to wait • Term deposits can only run at maturity and have low switching costs so are more likely to run • Implications • LCR and NSFR based on particular scenarios • But which deposits will run depends upon the scenario.

9. Comment: Market discipline versus “Improving funding stability” • Paper concludes that banks can undo disciplining effect of market by raising new insured deposits • But also says “we find that deposit insurance is effective in improving banks’ funding stability.” • These are two ways of describing the same phenomenon • Deposit insurance helps banks retain and attract funding

10. Comment: Market discipline versus “Improving funding stability” • Market did provide some discipline • Bank paid 2.8 percentage point premium before the crisis • Premiums (and deposit competition) reduced through time Likely average maturity of new/roll-over term deposits also decreased • But authorities acted to mute that discipline • Congress increased DI from $100,000 to $250,000 • FDIC provided optional coverage for transactions accounts • If authorities are going to suppress market discipline then disciplining banks is up to supervisors

11. Comment: Implications for the future This is not a “TBTF” bank. Depositor behavior may well be different at systemically important banks The implementation of current expected credit loss (CECL) for recognition of losses (IFRS 9 and changes to US GAAP) will likely reduce banks’ ability to understate credit losses

12. Comment: Speculation about the future • The timing of depositor withdrawals will depend in part on the costs of switching to another bank • Development of FinTech may change switching costs for transactions accounts • Some changes may lower the cost of moving accounts • EU PSD2 mandates information sharing • Some changes may raise cost of moving accounts • Some US banks reaching separate agreement with individual FinTech firms

13. Further discussion On Deposit Stability in Failing Banks By Christopher Martin, Manju Puri and Alexander Ufier