Options for Deposit Insurance Reform

I would like to thank the FDIC’s Division of Insurance and Research for producing this comprehensive, balanced, and timely report on “Options for Deposit Insurance Reform.”

The recent failures of Silicon Valley Bank and Signature Bank, and the decision to approve Systemic Risk Exceptions to protect the uninsured depositors at those institutions, raised fundamental questions about the role of deposit insurance in the United States banking system. This report is an effort to place these recent developments in the context of the history, evolution, and purpose of deposit insurance since the FDIC was created in 1933.

The primary objectives of deposit insurance are to promote financial stability and protect depositors from loss. The business of banking, which accepts deposits that are available on demand while making long-term loans, remains susceptible to runs. Deposit insurance provides assurance to depositors that they will have access to their insured funds if a bank fails, thereby reducing the risk of bank runs. As of December 2022, more than 99 percent of deposit accounts were under the $250,000 deposit insurance limit.

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.

The report evaluates three options to reform the deposit insurance system: maintaining the current structure of Limited Coverage, including the possibility of an increased but clearly delineated deposit insurance limit; Unlimited Coverage of all deposits; and Targeted Coverage, which would allow for higher or unlimited coverage for business payment accounts.

Of these options, the report identifies Targeted Coverage as having the greatest potential for meeting the fundamental objectives of deposit insurance relative to its costs. Business payment accounts pose greater financial stability concerns than other accounts given that the inability to access these accounts can result in broader economic effects. In addition, business payment accounts may pose a lower risk of moral hazard because those account holders are less likely to view their deposits using a risk-return tradeoff than a depositor using the account for savings and investment purposes. The report points out that providing a practical definition and ensuring that banks and depositors cannot circumvent those definitions to obtain higher coverage are important to implementation of Targeted Coverage.

I believe this report will serve as a useful starting point for consideration of the issues surrounding deposit insurance and allow for an informed public discussion.