Academic journal article Review - Federal Reserve Bank of St. Louis

What Have We Learned about Deposit Insurance from the Histor

Academic journal article Review - Federal Reserve Bank of St. Louis

What Have We Learned about Deposit Insurance from the Histor

Article excerpt

The increase in depository institution failures in the last dozen years and the resulting losses to the bank and thrift insurance funds have understandably generated interest in the costs and benefits of deposit insurance. Calomiris (1989a, p. 12) defines a successful deposit insurance system as "one that fully protects the payments system, without encouraging any excessive risk-taking," that is, risk taking beyond what would be optimal without insurance. The federal government's apparent willingness to guarantee deposit insurance fund liabilities reduces the probability of widespread banking panics that would threaten the payments system.(2) Providing fully credible insurance, however, may increase the likelihood of a significant deposit insurance bailout by giving depository institutions an incentive to take excessive risks. Until the 1980s, risk taking was discouraged by regulations that enhanced the charter values of depository institutions and limited competition for deposits.(3) Deregulation, however, has lowered the value of charters and provided the means for banks to increase risk.

Federal deposit insurance was enacted in 1933 as a response to the bank failures of the Great Depression. Deposit insurance was not, however, a new policy at that time. During the 19th and early 20th centuries, many states experimented with deposit insurance systems. The state systems were funded entirely by insured banks, and the states did not guarantee the liabilities of the insurance funds. Recently, researchers have been studying these systems to gain insights to the effects of deposit insurance in different regulatory environments. This article reviews the historical record and attempts to draw useful lessons for the current debate.


Six states operated insurance systems before the Civil War. The Vermont, Michigan and Indiana systems, and the New York system before 1842, insured both bank notes and deposits. In Ohio and Iowa, and in New York after 1842, only bank notes were insured. The performance of the different systems varied considerably. The Michigan system opened on the eve of the Panic of 1837 and subsequently closed without reimbursing any depositors or note holders of failed banks. The New York and Vermont systems were more successful because their insurance funds had time to accumulate assets before significant failures occurred. As a result, note holders and depositors of insured banks that failed in these states received at least some reimbursement for lost funds. In Indiana, Ohio and Iowa, no depositor of an insured bank lost any money. The success of deposit insurance in these states has been traced to the mutual-guarantee form of their insurance systems.

In mutual-guarantee systems, insured banks that were still solvent could be assessed any amount to cover the obligations of an insured bank that had failed.

With the exception of the Michigan system, the antebellum deposit insurance systems remained open until the Civil War, though not all of them still had active members. The tax imposed on state bank notes under the National Banking Act of 1863 caused many state banks to reincorporate as national banks. National banks were permitted to issue notes valued at up to 90 percent (later 100 percent) of the face value of the U.S. government bonds they deposited with the Comptroller of the Currency. The notes in turn were guaranteed by the federal government.(4)

During the last two decades of the 19th century, the expanded use of deposits (which were not taxed) and the liberal chartering requirements that many states adopted caused a resurgence of state-chartered banking. By the mid-1880s, Congress and several state legislatures began to consider proposals for deposit insurance. None of these was accepted until 1907, when a surge of bank failures led Oklahoma to establish a deposit insurance system for its state banks. Kansas, Nebraska, South Dakota and Texas followed within two years. …

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