Following the chaos and mayhem in the banking system, the Federal Deposit Insurance Corporation (FDIC) has posted recommendations for deposit insurance reform. The FDIC highlights three suggestions for regulatory reform, as follows:
- Limited Coverage: Maintaining the current deposit insurance framework, which provides insurance to depositors up to a specified limit (possibly higher than the current $250,000 limit) by ownership rights and capacities.
- Unlimited Coverage: Extending unlimited deposit insurance coverage to all depositors.
- Targeted Coverage: Offering different deposit insurance limits across account types, where business payment accounts receive significantly higher coverage than other accounts.
FDIC Chairman Martin J. Gruenberg issued a statement on the recommendations explaining that the recent bank failures have raised fundamental questions on the role of deposit insurance in the US banking system. Gruenberg said:
“The report highlights that while the overwhelming majority of deposit accounts remain below the deposit insurance limit, growth in uninsured deposits has increased the exposure of the banking system to bank runs. At its peak in 2021, uninsured deposits accounted for nearly 47 percent of domestic deposits, higher than at any time since 1949. Uninsured deposits are held in a small share of accounts but can be a large proportion of banks’ funding, particularly among the largest banks by asset size. Large concentrations of uninsured deposits increase the potential for bank runs and can threaten financial stability.
The report notes that technological change may also increase the risk of bank runs. The speed with which information is disseminated and the speed with which depositors can withdraw funds in response to information may contribute to faster, and more costly, bank runs.
While acknowledging that deposit insurance can create moral hazard by providing an incentive for banks to take on greater risk, the report underscores that regulation, supervision, and deposit insurance pricing are essential for helping the deposit insurance system meet its financial stability and depositor protection objectives while constraining moral hazard.”
He added that targeted coverage has the “greatest potential for meeting the fundamental objectives of deposit insurance relative to its costs.” Clearly, the status quo will not be an option going forward.
Any changes will take an act of Congress. The recent confluence of events where the US government had to effectively backstop all deposits to calm markets, scraped off the veneer of a banking system that has been on autopilot – at least since the last crisis.
The full report is available here.