Does the FDIC’s Systemic Risk Exception Allow Unchecked Expansion of Regulatory Discretion?

By Cassidy Burke '27

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Overview

Within the Federal Deposit Insurance Corporation Improvement Act, there is an exception to the LCR. Under 12 U.S.C. § 1823(c)(4)(G), the LCR method can be overridden if the financial institution’s failure poses a “serious adverse effect[s] on economic conditions or financial stability.” (1) Banks are not treated as corporations or individuals in the eyes of bankruptcy law. Congress passed the Banking Act of 1933 to officially create the FDIC. (2)

Sixty years later, after numerous costly bank bailouts, Congress passed the Federal Deposit Insurance Corporation Improvement Act (FDICIA). Rather than entering ordinary bankruptcy, banks are taken under receivership of the FDIC, essentially meaning the FDIC has officially taken control of the bank’s assets, debts, and deposits. (3) The Least-Cost Resolution (LCR), the centerpiece of the FDICIA, essentially allows the FDIC to determine the least costly route to resolution to the Deposit Insurance Fund. (4)

The LCR method has the potential for the result of losses to depositors in excess of the statutory limit – $250,000 per depositor, per insured bank, for each account-ownership category. (5) Exposure to large losses from limited deposit insurance may encourage depositors to monitor bank risk and diversify their fund allocations.

The intentions behind the systemic risk exception were to prevent mass shockwaves through the economy in the aftermath of an instrumental bank’s failure. In recent times, the FDIC has interpreted this clause to be applicable to sectors alone rather than the overarching economy, opening the possibility for an open-ended statutory standard with a retrospective accountability mechanism.

The Failure of Silicon Valley Bank

Silicon Valley is known for its concentration of technology companies. Naturally, Silicon Valley Bank was a popular option that startups and individuals chose to bank with. This customer base created significant risks because of the technology sector’s cyclicality and the unpredictable nature of startup companies.

Rising interest rates both lowered the value of SVB’s securities and made funding harder for many of its customers. (6) This led to what is commonly known as a ‘bank run’; depositors were requesting withdrawals that SVB did not have sufficient cash on hand to satisfy. Silicon Valley Bank had invested deposits into long-term Treasury and agency-mortgage-backed securities whose values fell as interest rates rose. (7) For the bank, the optimal strategy would have been to hold these bonds to maturity to avoid the realized loss, but to fulfill cash withdrawal requests, SVB sold its Treasury holdings, resulting in massive losses. (8) This strategy signaled financial distress to depositors and investors, further accelerating the panic. California’s banking regulator formally cited inadequate liquidity and insolvency, took possession of SVB, and appointed the FDIC as receiver on March 10th. 

Systemic Risk Application in SVB

Silicon Valley Bank was closed by California regulators and placed under receivership of the FDIC on March 10, 2023. Prior to invoking the exception, the FDIC attempted to sell off the assets of SVB but the only viable bid did not meet the statutory LCR requirement and was rejected. (9)

The United States Department of the Treasury took a vital role in the invocation of the SRE, citing the concern that the application of the LCR would result in further bank runs at other institutions and mass financial distress nationwide. (10) While the FDIC and Federal Reserve Boards may recommend invoking the exception, the Treasury Secretary makes the final determination after consulting with the president. Additionally, multiple depositors at SVB were also large corporations. Regulators were concerned that this could potentially create the loss of access to funds to support ordinary business operations across the nation.

The FDIC cites large losses to these corporations because the SVB bank failure would further drive serious adverse effects on the economy. (11) The invocation of the SRE based on the systemic risk application determination authorized the protection of both insured and uninsured deposits.

Regulatory Discretion

Throughout the entirety of this process, Congress went unnotified; regulators are only required to give written notice in the proceeding GAO review after regulators have acted. Regulatory discretion from broad statutory language based on terms such as “financial stability” and “serious adverse effects”  plays the defining role in deciding what accounts for the potential cause of a nationwide economic crisis. (12)

Silicon Valley Bank was the sixteenth largest bank in the nation even though SVB customers were concentrated within the technology and venture-capital sector. (13) Would the failure of the technology sector from the collapse of SVB have devastating consequences? Absolutely. Does this require that all depositors should be made whole, even uninsured deposits? This is where discretion comes into play.

By invoking the SRE to exceed statutory limits, regulators essentially weakened the ordinary limit’s purpose. At the time of its collapse, SVB was the sixteenth largest bank by assets. (14) The majority of its depositors were venture-backed startups, making it an extremely specialized institution. (15)

Ultimately, the idea behind the SRE points to the prevention of “serious adverse effects on economic conditions or financial stability,” not a sector or specialized industry. (16) Silicon Valley Bank’s collapse could have potentially spread to other financial institutions, but may not have established a threat serious enough to justify the protection of every uninsured deposit. 

Final Thoughts

The key issue with the SRE legislative framework is its ambiguity. Within the statute, the phrases of “serious adverse effects” and “financial stability” do not provide regulators with clear, quantitative thresholds. (17) Systemic risk is too broad a term to provide explicit guidelines when deciding regulatory next steps—especially when billions of dollars are on the line with largely retrospective checks of power.

Discretion is vital to a functioning government; however, there exists an excess of discretion in the presence of existing procedural checks when the substantive standard remains too broad. Defining systemic risk with greater statutory precision by considering liquidity conditions and interconnectedness of depositors could lead to the reduction of an overexpansion of regulatory discretion. It is imperative that this discretion is preserved while maintaining a clear guideline to prevent substantial discretion with retrospective oversight. It also must be acknowledged that an overly rigid definition of systemic risk could make the application in a time of unforeseen financial crisis more difficult.

Additionally, implementing immediate congressional notification and an expedited independent review of the FDIC’s decision could also be considered a way to reduce this. In the case of SVB, the bank bailout was not illegal. Rather, the FDIC’s exercise of lawful authority objectively weakened the ordinary insurance limit and shed light on the substantial discretion with retrospective oversight the exception allows. 

Endnotes

1. Federal Deposit Insurance Act, 12 U.S.C. § 1823(c)(4)(G).

2. Ellen Terrell, “Research Guides: This Month in Business History: Federal Deposit Insurance Corporation (FDIC) Established,” Library of Congress, 2023, https://guides.loc.gov/this-month-in-business-history/june/fdic-established.

3. Donald W. Jr., “S. 543—102nd Congress (1991–1992): Federal Deposit Insurance Corporation Improvement Act of 1991,” Congress.gov, 2025, https://www.congress.gov/bill/102nd-congress/senate-bill/543.

4. Ibid.

5. “Bank Failures: The FDIC’s Systemic Risk Exception,” Congressional Research Service, 2025, https://www.congress.gov/crs-product/IF12378.

6. Anita Ramasastry, “The Silicon Valley Bank Collapse Explained,” University of Washington School of Law, 2023, https://www.law.uw.edu/news-events/news/2023/svb-collapse.

7. Ibid.

8. Ibid.

9. “Special Assessment Pursuant to Systemic Risk Determination,” Federal Register, November 29, 2023, https://www.federalregister.gov/documents/2023/11/29/2023-25813/special-assessment-pursuant-to-systemic-risk-determination#page-83331.

10. U.S. Government Accountability Office, “Bank Regulation: Preliminary Review of Agency Actions,” 2023, https://www.gao.gov/assets/gao-23-106736.pdf.

11. Ibid.

12. “Bank Failures: The FDIC’s Systemic Risk Exception,” Congressional Research Service, 2025, https://www.congress.gov/crs-product/IF12378.

13. David Y. Aharon and Shoaib Ali, “A High-Frequency Data Dive into SVB Collapse,” Finance Research Letters 59 (January 2024): 104823, https://doi.org/10.1016/j.frl.2023.104823.

14. Ibid.

15. Ibid.

16. “Bank Failures: The FDIC’s Systemic Risk Exception,” Congressional Research Service, 2025, https://www.congress.gov/crs-product/IF12378.

17. Ibid.