While what you say is true, maybe we shouldn't allow mergers and other avenues to allow these banks (and other verticals) to be too big to fail. We've made that a target for all companies. Just get too big to fail and you get all the upside and none of the downside for free. That is my main complaint. By allowing deposits to be invested without risk, these too big to fail banks are encouraged to chase the highest yield, highest risk re-investments possible. If it works, another yacht for everyone! If it fails, we must be made whole!
I think at least a part of the solution is to increase regulation as banks get larger. Since it is clear that the fate of very large banks is tied in to the the fate of the economy itself, they should be appropriately regulated. In particular, short term asset/deposit ratio requirements should be modified as a bank gets larger. That could reduce the need for the FDIC to step in when depositors get nervous and provide disincentives to getting too large.
I think something like this could make large banks more of an asset for the economy rather than a liability. I wouldn't want to just set a maximum size. If a bank wants to get huge and maintain conservative and safe asset/deposit ratios, good for them.
The problem is that guaranteeing a bank and regulating it's investments still changes the incentives for the bankers. The banker has an incentive make an investment that can presented as "prudent" but which actually has a large up and down side. The banker keeps the upside, the bank's depositors are protected from the downside and the worst the investors face is losing their existing capital.
I would argue no. The issue is that the FDIC has deposit insurance limits already. The depositors are free-rolling on the amount they are getting made whole on above the limit. Then you are just encouraging some new kind of "bank" with limited access to become a customer (e.g. > $50M deposit) and then you can just put all "shareholders" in the role as customers. You are still giving free upside outside the rules that all other depositors are stuck with. Every investment comes with the statement: "Investment contains risk". If the bank wasn't leveraging these deposit as investment cash, there would have been no collapse.
You're right this produces risk but you're wrong about exactly how.
Any bank call pull in deposit and use them as capital. But being a customer also doesn't give one any particular upside - you just get interest on the money you deposit. And if you have a special bank with only large deposits and paying extra high interest, then regulators look at you and quite likely see something not to be protected in the same way.
The way you get risk is basically the way SVB did it. Share holders can lose at most their entire capital but they can get to play with all the money the depositors give them. If they bet on something that pays off big, they get that payoff minus the modest interest they pay depositors and if they lose, they lose at most their capital.
If you can use just a bit of capital to borrow a whole lot of capital, with the only risk to you being your original capital, then you can engage in very risky ventures, getting a huge payoff if you succeed and at worst losing your original capital if you lose.
Come to think of it, that seems a bit like what SVB did. Buying long term bonds when interest rates were likely rise seems like a recipe for disaster - and in fact the logical outcome was this bankruptcy. But there was a chance that interest rates wouldn't have risen, at which point the shareholder get a big payoff, pocket it and go on to the next risky maneuver.
