Why everybody's talking about deposit insurance
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."
- The "at least" part is taking on new meaning as a banking crisis unfurls.
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.