Now that the Treasury’s moral hazard has instilled fear in bank depositors, it is time to reexamine the FDIC’s deposit insurance. Each individual is insured up to $100K for their total non-IRA deposits in a bank and $250K for their total IRA deposits. I am using IRAs as a general term to include all retirement accounts.
Special titling, such as trust accounts, might increase a family’s total insured deposits. But be careful, the titling must be perfectly correct to achieve this goal. Each individual’s insurance cap includes both their individual accounts and their ownership interest in joint accounts at one bank. Having multiple accounts or account types (savings, CDs, money market, and checking) does not increase an individual’s insurance within one bank.
While it is relatively easy for families to split their savings between banks, businesses have more difficulty. Business relationships often include deposits, checking, wire transfers, lock boxes, credit card processing, payroll processing and other services. Banks also might require compensating balances for the extension of credit or discounts on transaction processing. The complexity of these relationships makes it very difficult for businesses to move between banks.
The FDIC and other regulators will not inform bank customers when their bank is in trouble. They do not want to increase the problems with a run on the bank. They tell us that increasing deposit insurance would reduce the moral hazard, all the time not admitting that it is impossible for individuals and small and medium size businesses to judge the safety and soundness of their banks.
What are the benefits of limited deposit insurance? Customers will be motivated to distribute their deposits between multiple banks. A troubled bank would not be able to hoard deposits by offering higher rates. This protects the banks from destructive competition. The FDIC will suspend a troubled bank from accepting brokered CDs for this reason.
Some banks and stock brokerages have overcome insurance limits by distributing portions of customer deposits to other banks. The relationship bank sets the terms and interest rate for the customer and deposits are exchanged within a network. I have no knowledge as to whether these networks have been challenged by the FDIC or have ever been tested with a real bank failure.
What are the risks of limited deposit insurance? The biggest risk is inciting a run on the bank. The Bear Stearns and IndyMac failures have allowed rumor mongering to start to become a real problem. I think the Treasury and Fed rhetoric, as well as talk of credit default swaps and bear stock raids have incited more fear than is healthy. Regulators and market forces are not instilling the confidence that is needed now.
The last thing we need is for businesses to withdraw their uninsured deposits from the large regional banks. Remember, virtually all of a medium size business’ deposits are uninsured. And we don’t need another “Whose Next?” analyst report.
I think a reasonable compromise is to raise the insurance level to $1M for individuals, sole proprietorships and partnerships; and $5M for corporations. This would allow customers to maintain their relationships while banks take the time to repair their balance sheets.
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Special titling, such as trust accounts, might increase a family’s total insured deposits. But be careful, the titling must be perfectly correct to achieve this goal. Each individual’s insurance cap includes both their individual accounts and their ownership interest in joint accounts at one bank. Having multiple accounts or account types (savings, CDs, money market, and checking) does not increase an individual’s insurance within one bank.
While it is relatively easy for families to split their savings between banks, businesses have more difficulty. Business relationships often include deposits, checking, wire transfers, lock boxes, credit card processing, payroll processing and other services. Banks also might require compensating balances for the extension of credit or discounts on transaction processing. The complexity of these relationships makes it very difficult for businesses to move between banks.
The FDIC and other regulators will not inform bank customers when their bank is in trouble. They do not want to increase the problems with a run on the bank. They tell us that increasing deposit insurance would reduce the moral hazard, all the time not admitting that it is impossible for individuals and small and medium size businesses to judge the safety and soundness of their banks.
What are the benefits of limited deposit insurance? Customers will be motivated to distribute their deposits between multiple banks. A troubled bank would not be able to hoard deposits by offering higher rates. This protects the banks from destructive competition. The FDIC will suspend a troubled bank from accepting brokered CDs for this reason.
Some banks and stock brokerages have overcome insurance limits by distributing portions of customer deposits to other banks. The relationship bank sets the terms and interest rate for the customer and deposits are exchanged within a network. I have no knowledge as to whether these networks have been challenged by the FDIC or have ever been tested with a real bank failure.
What are the risks of limited deposit insurance? The biggest risk is inciting a run on the bank. The Bear Stearns and IndyMac failures have allowed rumor mongering to start to become a real problem. I think the Treasury and Fed rhetoric, as well as talk of credit default swaps and bear stock raids have incited more fear than is healthy. Regulators and market forces are not instilling the confidence that is needed now.
The last thing we need is for businesses to withdraw their uninsured deposits from the large regional banks. Remember, virtually all of a medium size business’ deposits are uninsured. And we don’t need another “Whose Next?” analyst report.
I think a reasonable compromise is to raise the insurance level to $1M for individuals, sole proprietorships and partnerships; and $5M for corporations. This would allow customers to maintain their relationships while banks take the time to repair their balance sheets.
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