Attacking Moral Hazard – S.2190

In June 2023, U.S. Senator Sherrod Brown (D-OH), Chairman of U.S. Senate Banking Committee introduced the RECOUP Act of 2023 (S.2190) in an effort to attack one of the rudimentary problems with deposit insurance – “Moral Hazard.”

In the insurance world, moral hazard is defined as a condition where the behavior of the insured party changes in a way that raises the costs for the insurer since the insured party no longer bears the full costs of that behavior. In the world of deposit insurance, moral hazard is inherent in federal and non-federal deposit and share insurance, since the management and board of these organizations know that whatever happens to their institution, its depositors’ savings will be protected up to no less than $250,000 by the federal government through its agencies, the FDIC or the NCUA, and to $250,000 by any approved private insurer, where they exist. 

Accordingly, an insured financial institution could make riskier loans, bad investments or poor operating decisions, knowing that the federal government will always be there to protect the depositors. In some cases, this might even include unlimited or temporarily expanded coverage during times of significant financial stress such as that of the Great Recession of 2008-2009, and more recently following the failure of Silicon Valley Bank (CA) and Signature Bank (NY) in March 2023. Unlike personal forms of insurance, this moral hazard can be, and is, assessed by the deposit insurers via onsite and remote examinations and monitored through the review of mandatory periodic financial reporting and special remote testing processes.

Senator Brown’s bill is proposing many changes to the Federal Deposit Insurance Act, one of which is to allow the FDIC to impose some of its loss in a failed institution back upon those determined to have “knowingly” or “recklessly” placed the failed institution at risk in the first place. In its current form, S.2190 would give the FDIC the power to clawback any and all compensation and benefits paid to senior executives and board members of the failed institution that are determined to have been responsible for its failure. The lookback period is 24 months. 

Watch for more on S.2190