ATR Organizes Coalition Letter in Response to FDIC’s RFI on Deposits

Today, a coalition of center-right organizations sent a letter to the Federal Deposit Insurance Corporation (FDIC) in response to a request for information (RFI) on deposits. The comment letter primarily discusses why efforts to increase the federal deposit insurance threshold are misguided.

You can read the full letter here.

The letter discusses why Congress should not raise the deposit insurance threshold for business accounts:

Increasing deposit insurance above $250,000 for business accounts is not beneficial. Most small business accounts are already covered under the current deposit insurance framework. Fewer than one percent of bank accounts have more than $250,000.  A survey of 600,000 small businesses found that their median bank balance is $12,100—far below the current $250,000 threshold.  Additionally, Americans have a median savings account balance of about $5,300 while Black and Hispanic Americans have median savings account balances of approximately $1,500 and $1,900, respectively.  Any new increase in coverage for business accounts would only benefit the wealthy.

Although the FDIC leaves its proposed coverage of business accounts open-ended, footnote 137 in its report suggests that limit could be $2.5 million. But such a limit would fail to stop runs. Footnote 129 of the FDIC report acknowledges that even if the deposit insurance limit had been $2.5 million when Silicon Valley Bank (SVB) failed, it would not have made a material difference—a run still would have occurred.  This defeats the purpose for proposing a targeted increase in the deposit insurance limit. It also proves that increases in the limit would only benefit the wealthiest Americans. 

Providing unlimited deposit insurance is also a nonstarter. The letter explains that:

Providing unlimited coverage also presents significant moral hazard concerns. According to one paper, “[u]nlimited deposit insurance increases moral hazard and represents a threat to the nation’s long-term financial stability. History has shown that unlimited deposit insurance increases the likelihood of banking crises.”  This egregious proposal would exact insurmountable assessments on banks to pay into the Deposit Insurance Fund (DIF), which will ultimately be paid by consumers in the form of more expensive checking accounts, higher credit card interest rates, and smaller unused lines of credit. Effectively, banking will become significantly more expensive for consumers and credit will be less accessible.

Increasing the deposit insurance threshold will also be accompanied with additional regulations on the banking sector:

Expanding deposit insurance will make the banking sector more reliant on the federal government. If deposits are fully guaranteed, banks will be more heavily regulated and may function more like government-sponsored enterprises, such as Fannie Mae and Freddie Mac. Fully guaranteed deposits will also give the government leverage to both determine which industries banks should favor and manipulate rates on loans. This egregious expansion of government power may lead the U.S. banking system down the road to “de facto nationalization.”

Raising the cap on deposit insurance would also make depositors more reliant on the insurance as a safety net. This is a prime example of a moral hazard:

In economics, the term moral hazard “refers to the tendency for insurance against loss to reduce incentives to prevent or minimize the cost of loss.” 

The Federal Reserve acknowledged that providing insurance for all depositors at SVB and Signature Bank worsened moral hazard. According to the Government Accountability Office’s (GAO) preliminary report on the bank failures, Fed “staff raised concerns about exacerbating moral hazard and potentially weakening the market discipline of many depository institutions.”  Additionally, GAO pointed out that its report from 2010 showed that regulators’ use of the systemic risk exception “may weaken market participants’ incentives to properly manage risk if they come to expect similar emergency actions in the future.” The 2010 report also states that expanded deposit insurance “could weaken incentives for newly protected, larger depositors to monitor their banks, and in turn banks may be more able to engage in riskier activities.”  The GAO was incredibly prescient. If depositors are aware that the government will guarantee their deposits, it may lead “them to disregard the creditworthiness of their banks,” and contribute to moral hazard.

The letter concludes by stating that:

Increasing the deposit insurance limit is unnecessary and unwise. There already exist private sector solutions that help businesses maximize coverage without increasing moral hazard or enacting new regulations on banks.  We fear the FDIC’s focus on an area that is best left to Congress is a distraction from its existing responsibilities. The banks that failed last year did so because of gross mismanagement and regulators did not act on the ample information before them. We do not need new data requirements or legislation raising the deposit insurance limit. We need regulators to focus on adequately using their existing authorities.