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Reduce Taxpayer Risk: Roll Back FDIC Limits

As a crisis response, raising FDIC protection limits from $100,000 to $250,000 per depositor per account was very effective at alleviating customer fears, stopping vital depositor money from fleeing and keeping banks afloat. It was the right decision at the time. But now that the crisis has subsided and the U.S. banking system has come back from the brink, FDIC blanket guarantees need to be rolled back to pre-crisis levels.

FDIC insurance is more than just a sticker affixed to a bank door, it is a gold-plated guarantee that the government will step in and make depositors whole. Bank customers accept that they will earn a quarter of a percent or less on their deposits because they understand that their money is protected. And banks large and small benefit from this access to a cheap and dependable source of funding.

When it began, FDIC insurance provided depositors with only modest protection. The initial coverage limit in 1934 was $2,500, or less than $45,000 in today's dollars. Six months later, the limit was raised to $5,000 (still less than $86,000 adjusted for inflation) and the risk-sharing arrangement between banks, depositors and the government was forever changed. As long as depositors stayed within set limits, they assumed zero risk. But if the dollar size of bank failures exceeded the fees collected from the banks, then the government, and taxpayers, would become the ultimate financial backstop.

In recent years, FDIC insurance has experienced mission creep. Having grown at over twice the rate of inflation, it now provides more than modest protection.

Few Americans have the means to keep deposits of $250,000 and benefit from this protection. Instead, the larger limits have tilted the risk-sharing in favor of wealthier depositors and banks themselves.

For-profit intermediaries such as the Certificate of Deposit Account Registry Service have sprung up, helping fat-cat depositors slice deposits into smaller chunks to maximize FDIC coverage. As the limits have increased, the creativity of these firms has kept pace.

Meanwhile, the sliding-scale insurance premiums charged to banks haven't increased commensurate with the level of newly created risk in the system. After the coverage limit was expanded by 150 percent, the fees paid by banks rose, on average, only 10 percent. This is a bargain for banks big and small, but potentially a significant cost to taxpayers, who are left inappropriately exposed. The FDIC Deposit Insurance Fund, which topped $54 billion in 2008, was $20 billion in the hole by 2010 as bank failures piled up. The deficit is gone now, but the DIF remains grossly underfunded at just 0.32 percent of deposit reserves, far from the 1.35 percent reserve ratio required by 2020.

The bank bailouts of 2008 should have been a wake-up call to legislators that they are in the risk management business and need to do a better job of protecting taxpayers.

Lawmakers seemed to have heeded the call at the end of 2012, when they refused to extend the expiration date on the FDIC's Transaction Account Guarantee program, another crisis-era measure.

Unfortunately, the $250,000 coverage limit has no set expiration date. The Dodd-Frank Act recklessly put taxpayers on the hook for a permanent increase in FDIC deposit protection.

But with depositor confidence restored and banks awash in cash, it makes sense to roll back FDIC protection to $100,000 per depositor per account. At lower limits, banks would maintain sufficient deposits, but they also would have more incentive to behave prudently so as to attract and retain depositors. Alternatively, if banks want to keep limits at the current high level, they should pay the true market price for such insurance (in which case premiums at a minimum should double).

Either way, taxpayer risk certainly would be better served. And the 7,000-plus commercial banks that enjoy the many benefits of FDIC insurance would be sending a powerful message to the tax-paying public: we appreciated your support in our time of need and now it is our duty to restore the appropriate market balance between those who shoulder the risk and those who benefit from it.

Mark Williams, a former Federal Reserve Bank examiner and the author of "Uncontrolled Risk," about the collapse of Lehman Brothers, teaches finance at Boston University. This article appears in the February issue of American Banker Magazine.


(14) Comments



Comments (14)
I'm with terryj. The primary risk to US taxpayers and the US economy resides with less than a dozen institutions out of some 6,000 in the country. Federal regulators want to pretend this is a monumental task, when it is not. Give the banks 6 months to separate their government-insured bank from the casino-gambling operations. If they haven't accomplished the task after 6 months, they lose both their FDIC insurance and their licenses as primary dealers in US government securities. Keep stripping away government business until they "see the light." Without forceful action, TBTF will never get sorted out.
Posted by jim_wells | Wednesday, February 13 2013 at 5:20PM ET
With all due respect! How do we unwind or confront massive leveraged amounts of Derivative product under FDIC???
Posted by hedger | Wednesday, February 13 2013 at 5:10PM ET
Mark, with all due respect, How do you roll back Derivative Positions that reside under FDIC in volume if we count the leverage???
Posted by hedger | Wednesday, February 13 2013 at 5:07PM ET
spoken like a professor with only regulatory experience....arguments are weak if not non existent...another step to try and kill the community banks...keep it up and we will only have the big five to serve all the local needs
Posted by Rhsmith999 | Friday, February 08 2013 at 8:39PM ET
Smalltownbanker, are you saying that would be a bad thing? We already have laws and regulations mandating accuracy and transparency of financial statements. If banks had to demonstrate their soundness to attract deposits, why would not market discipline and competition be sufficient (or even better than bureaucratic regulations)? Do we really need all those FDIC - or OCC or Federal Reserve - regulations?
Posted by Bob Newton | Friday, February 08 2013 at 4:38PM ET
You got it all wrong. "Reduce Taxpayer Risk: End Too Big To Fail"
Posted by tjorde | Friday, February 08 2013 at 3:14PM ET
Don't forget that when you remove the Bank funded Insurance coverage, you also remove all of the FDIC rules and Regulations that will no longer be required to oversee the risk to the fund.
Posted by mainstreetbanker | Friday, February 08 2013 at 12:15PM ET
Yes, roll it back, right to zero. Politically and economically, deposit insurance by the government, like any other scheme of crony socialism, was a terrible mistake. The best way to restore sanity and probity to our capital markets is to get rid of it.
Posted by Bob Newton | Friday, February 08 2013 at 11:12AM ET
IMHO, there's also a fairness issue here. Banks are not giving depositors a fair return on their deposits, nor are they using increases in deposits to make more loans. Why should the FDIC encourage consumers to put more money into banks under these conditions?
Posted by jim_wells | Friday, February 08 2013 at 10:49AM ET
We agree with Prof. Williams. We would also point out that any level of guarantee by the FDIC adds a moral hazard (risk) that taxpayers have had to shoulder twice in the last 30 years. OMG's estimate of $180 Billion for the S&L crisis and the recent $700 Billion bank bailout. The so- called FDIC self-funding mechanism is a flawed model from two perspectives. First, when the FDIC needs funds the most are in times of crisis. This is the worst time to increase rates on the pool of banks they are funded by. Second - an inherent moral hazard - as its always easier to play with other peoples money. The banks' boards, executives, depositors, and bank investors need to have more skin in the game not less.

VERIBANC, Inc. Michael M. Heller, President
Posted by veribanc | Friday, February 08 2013 at 10:41AM ET
Totally disagree. There are many local depositors now at smaller local banks that would simply have to break down their deposits and spread them out elsewhere. Same FDIC coverage, more inconvenience for the consumer. The $100k limit was unfairly stuck at that level for way too long. Leave it alone
Posted by scdrb | Friday, February 08 2013 at 10:32AM ET
It should be noted that the FDIC is self funded by the organizations it insures. In other words as banks were failing in recent years, healthy banks, not taxpayers, absorbed the costs as they saw fdic insurance premiums rise
Posted by dyatesgp | Friday, February 08 2013 at 9:00AM ET
You have to remember that FDIC insurance is really just a general ledger entry to the US Treasury, meaning the premiums are revenue to the government. If coverage is reduuced premiums drop and total revenue to the Treasury is reduced. I don't see Congress doing that.
Posted by dahlers | Friday, February 08 2013 at 8:49AM ET
Amen. It's way past time that the FDIC stopped acting like a marketing and public relations organization for banks.
Posted by jim_wells | Thursday, February 07 2013 at 10:44PM ET
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