Janet Yellen says the U.S. is ready to protect depositors at small banks if required

Treasury Secretary Janet Yellen suggested depositors at small banks might be eligible for the same kind of emergency government aid extended to customers at two regional banks that failed this month, while emphasizing that lenders of all sizes are critical to the U.S. economy.

The comments, made at a banking conference Tuesday, were intended to stress the U.S. commitment to protect the U.S. banking system – and the customers who trust their money in it.

They come nine days after the government announced extraordinary measures to guarantee all deposits at Silicon Valley Bank and Signature Bank, which collapsed when panicked depositors moved to withdraw their money.

"Similar actions could be warranted if smaller institutions suffer deposit runs that pose the risk of contagion," Yellen said in a speech to the American Bankers Association.

"The steps we took were not focused on aiding specific banks or classes of banks," she added. "Our intervention was necessary to protect the broader U.S. banking system."

Yellen defends U.S. actions

The Treasury secretary defended a decision by the Federal Deposit Insurance Corporation to cover all deposits at the two failed banks, even though deposit insurance is usually capped at $250,000 per account.

The government worried that not backstopping larger deposits would encourage big depositors to pull their money out out of other banks, triggering a more widespread bank run.

The Federal Reserve also set up a new lending program to help banks cover withdrawals, so they don't have to sell assets at fire-sale prices.

The actions have raised concern that a government "bailout" of big depositors could encourage risk taking by customers at other banks.

"Every step we have taken has been intended to reassure the public that our banking system is resilient," Yellen said, adding that the government's emergency measures are working.

"We see the situation as having improved," she said. "Deposit outflows have stabilized."

Smaller banks had been in focus

Smaller banks have been concerned about whether their customers would get the same relief — over and above the usual insurance limits — offered to depositors at Silicon Valley Bank and Signature Bank.

If not, they worried, big customers would have an incentive to move money to larger banks, believing these larger institutions would be more likely to draw government backing.

Yellen fed that concern last week when she told a Senate committee that deposits over $250,000 at a small bank would not be guaranteed unless the bank's failure seemed likely to cause more widespread problems.

Bank runs may be more contagious, though, than the government had expected.

Yellen said while big banks play an important role in the economy, small banks do, too.

"They can provide services that larger banks can't replicate," Yellen said. "They know the special features of their markets and the people who are active in those communities."

Some lawmakers have called for raising the $250,000 limit on deposit insurance. That would require an act of Congress and prospects for legislation are uncertain.