What You Need to Know about Deposit Insurance in the U.S.
Exactly Who Insures What for Whom?
Types of insurance plans in use today:
1. The U.S. Government accumulates a fund by making assessments against insured banks’ annual deposits. When a bank occasionally fails, and unless a healthy bank buys the failed bank and guarantees its deposits, the insured fund is drawn upon to pay off depositors.
2. Alternatively, in some countries, the government assesses healthy banks to pay off the depositors of a failed bank only when a failure actually occurs (as in the case of Switzerland).
HOW DEPOSIT INSURANCE BEGAN IN THE UNITED STATES.
1. During the 19th and early 20th centuries many states developed insurance systems for banks headquartered within their borders, but most of these state systems eventually disappeared (usually due to mismanagement or from simply being overwhelmed with bank failures).
2. After about 9,000 banks failed in the U.S. between 1929 and 1933, the U.S. Congress responded by passing the Federal Deposit Insurance Act in the latter year and the FDIC began operations in 1934. Deposits were initially insured up to only $2,500. As the years went by, however, the insured amount was increased to deal with inflation and periods of financial crisis. Today the usual maximum coverage is $100,000 per deposit owner (an amount established by federal legislation in 1980).
3. Congress was hesitant to create the FDIC due to a problem known as moral hazard; namely bankers could benefit from having government-subsidized insurance not priced according to each bank’s degree of risk exposure. In effect, safer banks would pay to support the riskiest banks, which could gamble with the public’s funds in hopes of receiving a big reward with the government underwriting their gamble. If the bank failed, the insurance fund was left to clean up the mess. On the other hand, if the bank’s risky gamble paid off, its owners (the stockholders) walked off with handsome profits.
4. However, the U.S. Congress and President Franklin Roosevelt wanted to stop the public panic that was developing in the 1930s with “runs” occurring in which hundreds or, sometimes, thousands of depositors lining up outside their banks, demanding their money immediately. Because banks loan out most of their funds, many banks couldn’t withstand such a large “runs.” Even otherwise healthy banks found themselves under siege by angry depositors when neighboring banks failed. The public assumed that if one bank was in trouble, other banks must be as well, resulting in a 7quot;contagion effect.” At the time government protection of deposits seemed the only reasonable alternative in such a crisis.
5. In the late 1980s and early 1990s the failure of hundreds of insured banks led to passage of the FDIC Improvement Act which:
* Assessed a higher fee for banks in different risk categories, unlike the original deposit insurance system where all banks paid the same insurance fee; today the risk category of a bank and the strength of its capital (mainly the money contributed by its owners) determines the deposit insurance fee the bank will owe.
* Congress also required the FDIC’s insurance fund to be brought up at least to the level that for every $100 in deposits to be protected the reserve fund would hold at least $1.25 in insurable reserves. This figure was quickly achieved so that by the middle and late 1990s many relatively safe banks were paying no insurance fees at all.
* The FDIC was given the authority by Congress to sell assets it held and to borrow funds, if necessary, to generate enough reserves to deal with future crises.
* Finally, Congress gave the FDIC added enforcement powers to cause weak banks to strengthen their financial condition, allowing the FDIC in serious situations to remove management and even seize the bank if it was approaching failure so that the federal insurance fund could possibly sell the bank before it completely collapsed, and was of little remaining value.
BASIC DEPOSIT INSURANCE RULES.
1. Each single depositor holding one or more deposits in a single bank is protected up to a maximum of $100,000. If that depositor has more than one account in the same bank under single ownership, all the deposits are usually added together and the depositor receives a maximum of $100,000 in deposit insurance protection.
2. Example: Depositor A’s coverage in “First National Bank”
* A’s checking account $30,000
* A’s savings account $50,000
* A’s business account $60,000 (a proprietorship)
* A’s deposit total $140,000
* Deposit insurance available to A is $100,000
* A’s uninsured deposits amount is $40,000
3. We notice in this example that A has no federal insurance coverage for $40,000. Does this mean if the bank fails, he or she will automatically lose the $40,000? Not necessarily. In many instances, another bank will take over the failing bank’s good assets and assume his or her bank’s deposits so in that case A is likely to be able to recover all his deposited funds. (If this occurs, A would probably want to consider moving his or her extra $40,000 to another bank where it would be fully protected since he or she would again be exposed to loss if the bank that bought his first bank’s account also eventually failed.) Still another possibility is that if no buyer for A’s failed bank is found, that bank’s assets will be sold and A will recover a pro rata share along with the bank’s other uninsured depositors of the proceeds of the asset sale. So, A may recover at least some of his or her uninsured money even if the bank in question must be liquidated.
4. Deposits in different branches of the same bank are not separately insured. They would all be added up and covered only up to the maximum allowed by law.
5. A depositor can get more protection by dividing his or her accounts across several insured banks or by, setting up different ownership categories (i.e., single depositor as in A, above), joint ownership with someone else, through a qualified retirement plan deposit, and in the form of a testamentary or payable-on-death trust account which passes to the depositor’s beneficiaries upon his or her death. To be sure you are fully covered, however, it is always best to check with the Federal Deposit Insurance Corporation, Public Information Center, 801 17th Street, NW, Room 100, Washington, DC 20434 (800-276-6003 or 800-934-3342 or www.fdic.gov). Also, for more complex insurance issues (especially where deposits are set up as part of a trust) consulting with a trust-qualified attorney is a wise and strongly recommended idea.
6. The FDIC insures checkable and savings or thrift type deposits along with certain deposit-related instruments (such as cashier’s checks). It does not insure a bank against theft, riots, or weather damage (which is a role that private insurance often plays) nor does it cover depositor investments in stocks, bonds, mutual funds, insurance plans, nor valuables left in a bank’s safety deposit box. Also, if two banks merge they are then considered one bank and insurance protection then is normally limited to the maximum coverage for a single bank (normally up to $100,000).
7. Please keep in mind that FDIC rules and regulations regarding deposit insurance coverage are always subject to change, either by the FDIC itself or through legislation enacted by the U.S. Congress. To be sure you are aware of the latest rules that apply to federal insurance coverage of your own deposits contact the FDIC’s Division of Compliance and Consumer Affairs (800-934-3342 or www.fdic.gov) if your deposit is held in an insured bank or the National Credit Union Administration, Office of Public and Congressional Affairs, 1775 Duke Street, Alexandria, VA 22314 (www.ncua.gov) if your deposit is held in a federally insured credit union.
PROBLEMS FOR CLASS DISCUSSION COVERING THE FUTURE OF DEPOSIT INSURANCE
1. FDIC insurance assessments (i.e., fees charged insured depository institutions) are still too low to really penalize poorly managed and highly risky banks compared to what private insurers would charge. How might this situation be improved? Should private insurers take over insuring deposits? Who really insures banks today in case of a national crisis? (Hint: the taxpayers).
2. As banks grow fewer in number, but much larger in size, how can the FDIC further reduce its risk exposure in case several huge banks collapse? What recommendations would you have for this problem?
3. As banks merge more and more with non-bank business firms (like insurance companies, computer companies, security brokers, etc.) how far should they be allowed to go in this activity? Doesn’t this place the FDIC at greater risk? What if a bank finds that one of its non-bank businesses is in trouble and tries to rescue it, weakening the bank? If this bank fails, should the FDIC still be responsible to its depositors? Should we insist that banks that want to venture far afield outside banking give up their deposit insurance certificates? What do you think about these issues?
4. Should deposit insurance coverage be increased to more that its present $100,000 (perhaps to $200,000)? Some experts argue that inflation has significantly reduced the real value of current insurance coverage and, therefore, more dollars of insurance coverage are needed. What do you think? Others counter that providing more coverage would encourage greater bank risk – taking and, potentially, hurt the taxpayers. Do you agree?