Mark Williams, a former Federal Reserve Bank examiner and master lecturer in finance at Boston University, recently said that the FDIC’s guarantee program, which was expanded after the financial crisis, should be cut back to pre-crisis levels.
“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,” Williams said, according to American Banker. “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.”
When the FDIC’s guarantee program first began in 1934, coverage was limited to $2,500, or less than $45,000 in today’s dollar amount. The limit was raised six months later to $5,000 or less than $85,000, which has also been adjusted to reflect inflation, and the risk-sharing agreement between the government, banks and depositors changed because depositors assumed no risk if they stayed within set limits. If the size of the bank failure exceeded the fee amount collected from banks, the government and taxpayers then became liable for the losses.
Williams said that the FDIC’s original intent with the guarantees has grown to provide “more than modest protection.”
“Few Americans have the means to keep deposits of $250,000 and benefit from this protection,” Williams said, American Banker reports. “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.”
While the FDIC’s guarantee protections expanded over the years, the sliding-scale insurance premiums paid by banks have not increased to account for the newly created risk. When the coverage limit was expanded by 150 percent, the fees paid by banks rose only 10 percent on average.
“This is a bargain for banks big and small, but potentially a significant cost to taxpayers, who are left inappropriately exposed,” Williams said, according to American Banker. “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.”
Williams said that while legislators voted not to extend the FDIC’s Transaction Account Guarantee — or TAG — program, the $250,000 coverage limit does not have an expiration date, thereby making taxpayers liable for a permanent expansion of FDIC deposit guarantees.
“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,” Williams said, American Banker reports. “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…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.”