How an Equitable Financial System Could Increase Stability in Banking

In the last few weeks, we’ve seen the failure of three U.S. banks, the downward spiral of a troubled global bank, and the shares of regional, smaller, or more specialized depository institutions tumble as fears of the stability of our financial system rise. While the Federal Reserve and other major financial institutions have stepped in—to contain panic and stabilize, by lending/placing capital into financial and bridge institutions—we are left wondering what went wrong, what needs to change, and for whom? 

As Common Future seeks to reimagine an economy that works for all people—especially those who face discrimination and racism within our systems—we begin from a place of questioning: how did we get here? We know that our financial institutions are failing because they have placed more emphasis on pursuing profits through financially shaky bets than on being accountable to our communities. We also know there is a big gap between where we are as a society and our vision of an equitable economy. As we reflect on the events of the last few weeks, we notice that they speak to the changes we aim to see through our work to reimagine an equitable financial system.

Redefining Risk
In recent decades, it has become more mainstream to take risks with capital and services for the sake of technological innovation—but less so when it comes to funding and servicing solutions that are centered around building an equitable society. When we analyze the flow of capital in the U.S. financial system, it’s clear that we currently value the promise of technological innovation over the vision of equity—rather than exploring how these can be leveraged to build a more equitable society together. 

This is clear when we look at the combined assets of the three U.S. technological innovation-focused banks that failed—Silicon Valley Bank, Signature Bank, and Silvergate—at the time of their collapse: $334 billion. If we add in assets of teetering First Republic Bank—serving primarily high-net-worth clients—this brings the total to $546 billion. Comparatively, the total assets of all 1000+ Community Development Financial Institutions—including banks and credit unions with this certification, whose mission is to serve economically disadvantaged communities—was $247 billion in 2021.

Overwhelmingly, large quantities of capital are directed by funders/investors into institutions and investments that focus on scaling financial products and/or services, and centralizing decision-making to increase efficiency, reduce costs, and drive up profits. In these types of institutions, equity and inclusion are rarely or ever centered in the business model. But conversely, capital flows slowly to financial solutions that incorporate the nuance and complexity of serving and supporting a diverse set of people and contexts. These solutions may seek to look—and be—different at scale to address the root causes of inequity in our financial system. Both circumstances are innovative, but one centralizes economic benefits and the other seeks to decentralize economic benefits.

In order to build toward an equitable and inclusive society, we have to be clear about the types of innovation that create more equitable outcomes, redefine what we hold as acceptable risks to take or not take, and shift how we measure success. This begins with understanding how the risks financial institutions have taken to date disproportionately impact low-income communities and communities of color—to prioritize potential profits.

While the dominant players in the financial system orient exclusively towards shareholders and profit margins, many players—including innovative credit unions, Community Development Financial Institutions, community banks, and other community-led investment funds—seek to prioritize people alongside financial stability, and balance relationships and trust with the pursuit of innovation. These decentralized, community-based intermediaries place people—who are traditionally perceived as more risky and who have been excluded as a result of systemic racism built into our financial institutions—at the center of their work. 

As a result, we’ve seen these institutions and funds enable thriving local economies with affordable housing, access to affordable services, and a diversity of small businesses that meet the local need and reinvest in their communities. These intermediaries also integrate stability into our economy by focusing on steady opportunities rather than the pursuit of outsized risk for the sake of outsized reward. These solutions should be increasingly prioritized in moments of turmoil that expose inherent problems with financial decision-making models, given their impressive track record of stability through economic turmoil in the past. We should be looking to them to define how risks should be taken as we strive to build a more equitable society. 

Shifting Who Bears the Cost of Failure
Bank failures are costly—no matter the reason behind them. Whether failure to hedge interest rate risk or over-investment in highly speculative assets that have collapsed, poor financial risk management in the endless search for increased profitability has societal costs—and we’ve seen these failures play out throughout history. Banks are predisposed to not learn from past mistakes, and repeat risky financial practices when centering the pursuit of profits first and foremost. 

But who bears the cost of failure? With the recent failures, we saw companies and individuals face delays in being able to access their money, which limited their ability to operate their businesses and pay staff, partners, or vendors. For example, in addition to their tech clients, SVB worked with small businesses, grant providers, and other institutions that touched spaces outside of the tech industry. These delays have ripple effects on the stability of communities and families—especially since two out of three Americans can’t cover a $400 unexpected expense. 

What’s more, in the current bailout of banks, the Federal Reserve has agreed to use the Deposit Insurance Fund to support those who held cash in accounts above the $250,000 insurance threshold. Though this is good for depositors, this will have long-term consequences for the banking industry. The Deposit Insurance Fund is capitalized by fees that banks pay, which will likely rise in the aftermath of a significant amount of capital being depleted from the fund. History tells us that banks will likely not cover the increase in fees and the costs will be passed along to all bank customers—meaning depositors who bank even small amounts can expect to see bank fees rise. This will disproportionately impact low-income individuals, who have less financial buffer to absorb increased financial fees. 

Rectifying the mistakes and impacts of financial institution failures also involves time spent by private, nonprofit, and public sector players to identify and implement short and long-term solutions. And this time is often paid for using taxpayer resources to address and remedy these instances. Taxpayer resources are always involved, whether directly or indirectly. 

In the aftermath of bank failures, lead assets are sold to larger institutions and consolidated outside of the community where an institution is based. We see banking consolidation kick up during times of financial turmoil, and over the past decade, we’ve seen an increase in community banks closing across the nation. During the last financial crisis—that was precipitated by predatory lending practices in search of increased profits—90% of financial institutions that closed were located in low-income communities, predominantly communities of color. When banks shutter, it leaves a gap in more affordable products and services and leads to the influx of more predatory products that further extract wealth from our communities. 

Whether directly or indirectly, poor financial risk management within financial institutions disproportionately impacts low-income communities of color. We need to find ways that individuals and communities are not bearing the cost of bank failures. This could look like regulatory bodies ensuring that financial institutions are not leaving en masse out of low-income communities by providing support to stay in place, increased funding to more informal solutions that exist in a community that is providing safe and affordable credit products, or if a bank closes, making sure there is a back-up plan for affordable financial services to be provided to the community. We should look to invest in these types of solutions to ensure that we are not perpetuating inequities that exist in our society today.

Centering Trust to Build Towards Stability
Even though the Federal Reserve has stepped in to provide stability—fears of failure continue. Individuals have seen the long-term impacts of financial turmoil and are afraid of what is to come. Whether the fear is founded or unfounded, throughout the entire financial system, we see mistrust between people and institutions. 

The continued consolidation of the community banking industry post-2008 and the increasing centralization of decision-making within major banks has led to the deprioritization of relationships in financial services. It also is important to note that throughout banking history, the practices of relationship lending and banking have been used to exclude BIPOC people. When we talk about the need to bring forward relationships, this is with the goal to build relationships that trust and center BIPOC people—those most excluded from financial services. Without this solid foundation of the two-way relationship when distressing or disappointing news breaks, we lose confidence quickly and increase in distrust.

Relationships and trust should be at the crux of our financial transactions—not an afterthought. Relationships allow customers to have confidence in an institution to provide capital and return capital when needed at an equitable price. Relationships allow us to have the information we need and to trust that the person at the institution will do all that it takes to support us. In this time of banking uncertainty, we must lean into prioritizing relationships and rebuilding trust in reliable financial institutions. 

Building this takes time, is not always profitable, requires transparency, and—most of all—requires checking the bias and racism that is embedded into our financial institutions. All of which are hard to get right when we are operating in an environment that is increasingly focused on profits above all else. 

As the dust settles on the news of failures and instability in banking, we will start to see reactionary behavior to the outcomes of these events.

Looking forward, we would be wise to be cautious of three reactions that may further entrench us rather than help us reimagine a new financial system.

Consolidation of Assets with Larger Wall Street Banks
Though governing bodies of financial institutions—Institutional Investment Committees—may consider consolidation with larger banks for all of the factors named above, these bodies should remember that our major banks are not, by definition, less risky. Big banks received preferred stock investments in 2009, which means that they purchased troubled assets from their balance sheet using taxpayer money—with Citigroup and Bank of America receiving the most taxpayer resources at $45 billion each. Increased centralization leads to the centralization of systemic risk as well. 

Instead of centralizing assets further, banking regulators should explore decentralizing the financial system by investing more in community banks using products that ensure the safety of other financial institutions, such as FDIC insurance or NCUA insurance in the case of credit unions. It’s worth noting that many products exist now to support this decentralization, including the Certificate of Deposit Account Registry Service that breaks up deposits across thousands of banks to maintain full FDIC insurance for accounts that hold amounts above the normal limit of $250,000. These products can be accessed via many banks that are mission and community-focused. If investors and depositors were aware of such insurance products, perhaps there would be less fear around banking in such institutions. 

Increased Regulatory Oversight
A natural reaction to bank failures is to examine how regulation could prevent this from happening in the future. In the last financial crisis, Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act to help increase regulatory supervision of how well-capitalized banks were to weather shocks. In the wake of the most recent bank failures, critics are wondering whether the recent exemption passed by Congress—eliminating the need for banks under $250 billion in assets to comply with Dodd-Frank regulations—may have a hand in more lax risk management. 

We all want our financial institutions to be able to weather economic shocks. However, the concern with enacting certain requirements across all banking institutions, no matter the size, is that the cost to implement and maintain may limit the ability of an institution to adequately serve its community. From our vantage point, Community Development Financial Institutions that are regulated may face higher financial and operational hurdles to be in compliance if they are being held to the regulatory standards of large international financial institutions. 

Rather than just applying regulations, our governing bodies should consider providing additional financial backstops and support to help smaller financial institutions build stronger and more stable capital bases. Possible strategies could be to fully guarantee accounts at smaller institutions to encourage people to deposit capital, or to provide technical support and capital to banks to help them build the infrastructure needed for stronger risk management. Our regulatory agencies have many tools in their toolkit to bolster institutions outside of punitive actions.

Growing Mistrust
Many communities, especially BIPOC communities, already have a lack of trust in banks—given systemically embedded and proven racist practices of extraction and exclusion. This distrust grows in communities in moments like this when, yet again, we see our institutions failing. Growing mistrust means growing inequality for our BIPOC communities that have already been disproportionately disconnected from financial services and products and are less able to acquire assets and build wealth. The cycle will continue if we cannot center on building trust and designing financial services and products equitably. 

Building trust with our BIPOC communities necessitates being in a relationship and understanding what they need. It takes practice, listening, and patience from financial institutions who are willing to take the time—innovative credit unions, Community Development Financial Institutions, community banks, and other community-led investment funds are some examples of institutions we need to protect. At this moment, we have to show up, not hide behind facts, figures, and overly complex analyses. Again, these are institutions that are redefining how capital flows equitably, for the benefit of communities, not shareholders. If we continue to operate as we have before, we will further distance ourselves from actualizing an equitable financial system.

Moments like this demand that our institutions take stock of how they have operated in the past. Are we taking risks in the name of potential profit for shareholders, on the backs of taxpayers and depositors? Or, are we investing in ways to more equitably and affordably provide capital to communities that have been long ignored? If we don’t use these moments to pause, reflect, and orient ourselves to people, especially Black and Indigenous people and people of color, not just in rhetoric, but in practice then we will have failed to pick up on the most important lessons. We want to build an economy where all people can thrive—that starts with addressing the harms of past practices to build trust, rectifying inequities by shifting our perspective on what we perceive as risky, and designing how we move forward together.

At Common Future, we seek to bring forward examples of the innovation needed in our systems that are moving capital. We iterate on solutions that are led by and center BIPOC communities that have been most alienated by our financial institutions. These concepts that we explore are not new and are rooted in cultural histories that desire to see the long-term prosperity of all people and our planet. Something has to shift—and it begins with who we place at the center of decisions in order to innovate toward equity.