$100,000 Is Plenty for Deposit Insurance

It looks as if Congress is about to permanently increase FDIC deposit insurance to $250,000 from $100,000 per bank account. What’s more, it plans to make this increase retroactive to Jan. 1, 2008, in order to protect certain depositors at Indy Mac and other banks that became insolvent before the financial crisis reached its height. This move will substantially raise the cost of resolving troubled banks, and isn’t necessary to protect small depositors.

The old limit of $100,000 per bank account was interpreted so flexibly by the FDIC that a family of four could easily obtain federal insurance for $600,000 by opening multiple accounts under different names. For example, a husband and wife could both deposit $100,000 in their personal accounts and their business accounts. These parents could also deposit $100,000 in savings accounts for both of their children.

Less than 2% of all bank accounts were above the old $100,000 limit. These uninsured accounts were not held by small depositors, but by high net worth individuals and local business people, many of whom could not easily create enough different accounts in one bank to cover their large deposits. Such accounts had an average balance of $432,000 as of June 2008.

By raising the maximum insurable amount to $250,000 per account, we will lose the market discipline exerted by these wealthy individuals and experienced business people. If they can split a $432,00 bank account into two accounts of $216,000, each under a different name, they would be fully protected under the new legislation. With a 100% guarantee from the federal government, why would they care whether the bank made imprudent loans or bought risky bonds?
Historically, the weakest banks have attracted a flood of deposits by advertising sky-high interest rates. These bankers typically believe that they can grow their way out of problems by investing in new loans and high-yield bonds. This practice was one of the key factors that caused the savings and loan debacle of the 1980s.

By raising the maximum insurable limit to $250,000 per account, we will enhance the ability of weak banks to expand their deposit base very quickly. The result is predictable: much higher costs for the FDIC when it takes over insolvent banks. Meanwhile, the FDIC is already struggling to handle the growing number of bank failures. It recently received a $500 billion line of credit from the U.S. Treasury.

When Congress raised the limit on insured deposits in October 2008 to $250,000 from $100,000 as a response to the financial crisis, it was supposed to expire at the end of 2009. Then, in the middle of 2009, without any hearings or much debate, Congress extended the temporary $250,000 limit until 2013. Now Congress is about to carve this limit into stone.

Congress is also giving serious consideration to making permanent an FDIC program for insuring unlimited amounts on corporate checking accounts in banks. This is another FDIC program that was supposed to be a temporary response to the financial crisis. If Congress extends unlimited insurance on corporate checking accounts, it will undermine the market discipline exerted by corporate treasurers and sharply raise the FDIC’s cost of bailing out banks.

What’s the rush? Community bankers believe they are at a competitive disadvantage to large banks that benefit from the public perception of being “too big to fail.” These bankers have been pushing for higher limits on FDIC insurance since they rely heavily on retail deposits.

Although understandable from a political perspective, these permanent extensions of temporary FDIC insurance programs are bad policy. If political pressures require a permanent expansion of FDIC insurance of bank deposits, Congress should move to a two-tiered structure. The FDIC should fully guarantee the first $100,000 in any bank account, and should guarantee a lesser percentage (e.g., 80%- 90%) of any amount in that bank account between $100,000 and $250,000. That compromise would help community banks, retain a measure of market discipline, and reduce the FDIC’s costs in resolving bank failures.