US deposit insurance requires rethink, say experts 

The US deposit insurance framework may require a rethink, argue researchers with the Federal Reserve Bank of Dallas.   

Their study, published on August 5, says reciprocal deposit networks enable customers to split their deposits across multiple banks, and thereby obtain Federal Deposit Insurance Corporation (FDIC) coverage for each account.   

The authors, Christine Docherty and Alessio Saretto, say these networks raise two questions: is the current level of deposit insurance optimal, and are reciprocal networks the best way to provide depositors with additional insurance? 

On the first question, they say the deposit insurance limit could be raised and still create optimal coverage. The expected social cost of making depositors whole would be balanced by the gains that came from reducing the likelihood of bank failures. 

The Dallas Fed authors posit that the level of insurance could, under this scenario, be higher for some banks than is currently the case and lower for others.   

The authors argue that continuing with reciprocal deposit networks may be cheaper than raising deposit limits.  

“As long as reciprocal deposits continue to experience moderate growth, allowing the networks to exist while continuing with the current statutory level of FDIC deposit insurance appears to be the most economically feasible strategy,” they argue.  

All or nothing

Lawrence J White, professor of economics at New York University, argues that insurance should cover 100% of deposits.  

“The minute I say 100% deposit insurance, people’s hair starts to ignite,” he says. “They yell ‘moral hazard’, to which my response is, depositors have never been a good check on managerial actions. It is not the depositors who put a check on moral hazard. It is either institutional bondholders or holders of other debt that put a check on managerial actions, or it’s the regulators.”  

White believes 100% coverage would put an end to bank runs, which in turn would allow regulators to be more frank about specific lenders’ shortcomings. “If you’re not worried about runs, you can say a lot more in public like ‘those guys are not doing a very good job. They need to pull up their socks’,” he says.