Academic journal article Economic Commentary (Cleveland)

Raising the Deposit-Insurance Limit: A Bad Idea Whose Time Has Come?

Academic journal article Economic Commentary (Cleveland)

Raising the Deposit-Insurance Limit: A Bad Idea Whose Time Has Come?

Article excerpt

Federal deposit insurance protects the savings of small depositors, but it increases the likelihood that banks will take risks they otherwise would not have. Some bankers have suggested doubling the level of coverage, from $100,000 to $200,000. While such an increase may put smaller banks on a level playing field with larger ones, it exceeds the amount necessary to protect small savers and is unfair to taxpayers.

We at the FDIC are undertaking a comprehensive review of our deposit insurance system. I want to take a hard look at certain issues, including: (1 ) Does the deposit insurance system create the right incentives? (2) Is the system fair? (3) What is the right coverage level?

Donna Tanoue, Chairman Federal Deposit Insurance Corporation1

Is there any reason why the American people should be taxed to guarantee the debts of banks any more than they should be taxed to guarantee the debts of other institutions, including the merchants, the industries, and the mills of the country?

Senator Carter Glass Author of the Banking Act of 1933`

Less than a decade has passed since the enactment of the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA). FDICIA represented the final legislative response to the thrift debacle and regional banking problems of the 1980s. This statute enacted needed reforms to our system of bank supervision and regulation and to federal deposit insurance, including prompt corrective action, risk-adjusted deposit-insurance premiums, and discount-window-lending reforms. However, these provisions in FDICIA fall short of comprehensive reform of the intricate system of depository-institution regulations and financial-safety-net subsidies.

Since the passage of FDICIA, Congress has enacted two important pieces of financial sector legislation. In 1994 the Reigle-Neal Act removed most of the remaining restrictions to interstate consolidation of the banking system. Last year the Financial Modernization Act of 1999 (FMA) was signed into law. Also known as the Gramm-Leach-Bliley Act, this statute represents the single most important set of regulatory reforms since the Glass-Steagall Act of 1933. The FMA repeals many of the provisions of the Glass-Steagall and Bank Holding Company acts that prohibit or limit the affiliation of banks with other nondepository financial firms.3 The cumulative effect of these post-FDICIA statutes will be to accelerate the trend toward a financial system that is more integrated in terms of activities and products-a single financial firm will be able to provide commercial banking, investment banking, and insurance products. In addition, these reforms have resulted in a banking system that is more geographically integrated as the interstate consolidation of the banking system continues.

From the perspective of federal deposit insurance, the financial reforms of the 1990s were a mixed blessing. Lessons from banking history indicate that extending the geographic reach of banking organizations increases the stability of their funding and diversification of their assets, thereby reducing the need for federal deposit insurance 4 On the other hand, the resulting consolidation of the financial sector is spawning larger and more complex banking organizations-- ones that may be increasingly difficult to supervise adequately. If financial reform results in institutions too large or complex to effectively discipline, then an unintended effect of the post-FDICIA reforms will be the de facto extension of federal deposit insurance to a larger part of the financial system. As the involvement of the Federal Reserve Bank of New York in the privately funded rescue of Long Term Capital Management in 1998 illustrates, policymakers may be reluctant to allow markets to fully discipline financial firms when the impact of the failure of a firm on the short-run stability of the financial system is uncertain. There is little doubt that as regulators and policymakers work to implement the provisions of the FMA, reforms to the structure of financial regulation and to federal deposit insurance will be considered. …

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