What Banking Turmoil Could Mean for Regulation and the Debt Ceiling

Apr 12, 2023

Banks may face higher expenses from policy responses to recent disruption, but the government’s efforts to fortify the banking system will likely have a limited impact on the ongoing debate addressing the federal debt ceiling.

Lawmakers in the U.S. are facing down a two-part problem. On one side, they are considering whether and how to craft a policy response to recent banking turmoil. On the other side, a looming debt ceiling limit could see the country defaulting on its obligations and delaying key benefit payments such as military salaries, tax refunds, food stamps and unemployment insurance. For investors, questions have emerged as to the effects of these two major sets of circumstances. 


Morgan Stanley Research outlines what could be ahead for banking regulation, including: how changes in regulation could affect the financial services sector and whether regulation might introduce costs that would have an impact on the timeline for the country’s ability to borrow and pay bills. 


How Regulators Responded to Turmoil

Federal regulators sprang into quick action to contain spillover risks from recent disruptions in the banking system brought on by the failure of a few mid-size U.S. banks. This included the Federal Reserve establishing a $25 billion backstop from the Treasury to provide extra access to liquidity for banks, giving investors confidence that regulators stand at the ready in case of future failures.

Although the Treasury Secretary has some leeway to make unilateral changes to the FDIC insurance cap to abate systemic risk, permanent changes require congressional approval, and policy action seems unlikely—at least in the short term. “While there is bipartisan agreement on taking action, there’s no consensus even within the parties on the possible scope of new rules or changes to existing regulations governing banks,” says Morgan Stanley policy strategist Ariana Salvatore. “And with markets calm, lawmakers aren’t necessarily feeling as pressured to make moves.”

Broader regulations—such as reinstating Dodd-Frank rules or imposing stricter capital requirements—are unlikely for the same reasons, Salvatore says. It’s important to note that the FDIC’s current insurance cap of $250,000 per account resulted from a change the agency made during the global financial crisis in response to concerns about deposit safety. Investors may expect the FDIC and the Fed to exercise the full extent of their powers to potentially enhance stress tests and impose fresh liquidity standards, and implement more targeted responses if markets again become disorderly. 

According to a 2020 FDIC report, 85% of assets are held in banks that aren’t classified community banks—meaning a vast majority of deposit-holding financial institutions could be subject to the special assessment, and see costs increase as a result.

Banking Sector Implications

For banks, a higher deposit insurance cap would mean higher premiums, and in turn, higher expenses. The FDIC assesses deposit insurance rates based on a variety of factors, such as risk and complexity, and expenses for banks are generally proportional to asset size.


When the FDIC last raised the cap in 2008, it increased the insurance assessment rate. The agency is expected to propose further changes to the rate, as well as the types and sizes of deposits to insure, in its report to Congress on the recent banking failures, due May 1. The FDIC report is also expected to include guidance on a special assessment on the banking industry, likely excluding community banks. This would help to shore up a $128 billion deposit insurance fund, as the cost of guarantees on deposits at recently failed U.S. banks are estimated to total $22.5 billion. According to a 2020 FDIC report, 85% of assets are held in banks that aren’t classified community banks—meaning a vast majority of deposit-holding financial institutions could be subject to the special assessment, and see costs increase as a result.


Whatever happens with the FDIC insurance rate and special assessment, banks with at least $100 billion in assets are likely to face liquidity requirements equal to banks with $250 billion to $700 billion in assets, if not stricter thresholds, according to Morgan Stanley banking analysts. 


Debt-Ceiling Impact

In addition to impacts on the banking sector, investors are concerned about how any policy response to the turmoil—including government guarantees and the expectation of further support should volatility return—will affect the debt ceiling: Will this additional spending pull forward the so-called X date (the projected point when the U.S. will exhaust its ability to borrow and the potential for adverse market and economic impacts spike sharply)?  


Even with the government interventions, Morgan Stanley Research still estimates that the X-date will be early August, though the end of tax season should bring more clarity on the timing for when the Treasury will run out of cash. “The main factors affecting the debt ceiling limit continue to be the timing and magnitude of outlays and tax receipts,” says Salvatore.


In fact, the $27 billion that the FDIC pulled from the Treasury could have helped to create some space under the current limit. “This would allow the Treasury to issue more debt, likely via T-bills, to cover the FDIC outflows,” says Salvatore. “Looking ahead, we continue to expect the debt limit to keep the Treasury General Account trending lower over the coming months as we approach the X date.” 

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