FDIC Offers Options for Reforming the Deposit Insurance System
Commentary by Steven Lofchie
In a report titled Options for Deposit Insurance Reform, the FDIC highlighted the limitations of the current deposit insurance system finding that the current system of "Limited Coverage" may be insufficient to prevent bank runs.
The agency evaluated three deposit insurance reform options:
- Limited Coverage (Current System). Limited Coverage continues the existing deposit insurance framework of insuring all depositors up to a dollar limit. The FDIC said that Limited Coverage "does little" to address financial stability concerns of high concentrations of uninsured depositors that caused the recent bank runs. The FDIC explained that even increasing the limit by an order of magnitudes, such as "millions of dollars" would still not cover many of the largest uninsured deposit accounts in a bank system with large quantities of uninsured demand deposits.
- Unlimited Coverage. The FDIC said that Unlimited Coverage would effectively remove the risk of bank runs. However, unlimited coverage would create large inflows of funding to banks, and the FDIC queried whether Unlimited Coverage would generate "excessive risk-taking" by banks. Further, the FDIC said that Unlimited Coverage presents a (i) "significant" departure from the current banking system and (ii) risk of major disruptions to other asset markets. The FDIC added that Unlimited Coverage would substantially increase insurance assessments by 70 to 80 percent in order to support the Deposit Insurance Fund.
- Targeted Coverage. Targeted Coverage allows for different coverage based on account type with a focus on providing potentially unlimited coverage for business payment accounts. The FDIC estimated that because business accounts have the greatest chance of creating spillovers in the event of losses on uninsured deposits, coverage of these accounts would increase financial stability. The FDIC did say however, that Targeted Coverage presents the challenge of distinguishing business accounts from other accounts as well as preventing depositors and banks from circumventing those distinctions. Even still, the FDIC concluded that Targeted Coverage has the greatest potential to enhance financial stability relative to its impact on bank risk-taking, bank funding, and other markets.
In a statement, FDIC Chair Martin J. Gruenberg supported Targeted Coverage option because of the "greater financial stability concerns" posed by losses to business payment accounts and their "broader economic effects."
Commentary
It is a pretty quick transition from "everything is fine, nothing to see here" to "the bank deposit insurance system no longer works and we could have major bank runs that wreak havoc on the economy at any time, so we better revamp the whole system." The end result of this may be a fixed income market in which investors can either (i) buy the rapidly increasing supply of government debt securities or (ii) deposit their funds in a bank and obtain a government guarantee paid for by deposit insurance. In theory, that should make investors economically indifferent between bank deposits and U.S. government debt to the extent that they have the same maturity.