Mar 22, 2023 - Economy

Why everybody's talking about deposit insurance

Illustration of a hundred dollar bill with Benjamin Franklin holding an umbrella.

Illustration: Aïda Amer/Axios

Walk into any bank branch in America, and you will likely see a sign that says, in big letters, "FDIC" — that would be the Federal Deposit Insurance Corporation — and "each depositor insured to at least $250,000."

Why it matters: The Biden administration and financial regulators are sending every signal they can that no U.S. bank depositors — even those with more than the $250,000 federal insurance cap specified in federal law — will lose money in a bank failure.

  • They are trying to avert a cascading series of bank runs if people withdraw their money from smaller banks en masse.
  • But in the process, they are setting a precedent with potentially long-lasting consequences and thin legal authority.

Reality check: Technically speaking, there is no formal FDIC insurance for any deposits over $250,000 right now.

State of play: Ten days ago, the government invoked a "systemic risk exception" to guarantee all depositors in Silicon Valley Bank and Signature Bank. Officials have been not-so-subtly suggesting they won't allow large depositors in any banks to lose cash.

  • In a speech on Tuesday, Treasury Secretary Janet Yellen emphasized that "similar actions" could be warranted if smaller banks face runs — opening the possibility of even community banks receiving implicit backing.
  • The goal of Yellen and other officials is to prevent financial contagion, where depositors withdraw cash from small and mid-sized banks and spark a freeze-up of credit across the economy.

The big picture: The cap on deposit insurance is a long-standing feature of U.S. banking regulation. To abandon it, especially without explicit Congressional authorization, opens up a world of issues.

  • It could create a "moral hazard" issue in which banks can take extreme risks without the discipline created by large depositors being wary of loss.
  • It raises questions about how the fees banks pay for FDIC insurance ought to evolve given that they have been set historically assuming larger deposits are not covered.

The bottom line: If you have large deposits at a U.S. bank, you are probably safe, and that in turn lowers the risk of a major crisis.

  • But the actions have opened a can of worms involving how the nation's banking system will work in the future.
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