Two Deposit Insurance Funds Are Not Necessarily Better Than One
Thomson, James B., Economic Commentary (Cleveland)
Does the United States need to maintain two separate insurance funds for banks and thrifts? This Economic Commentary examines the arguments in support of a recent reform proposal for merging them.
The Great Depression opened an era of increased federal government intervention into private markets. It brought striking changes to the financial sector, where legislation like the Glass-Steagall Act of 1933 sought to compartmentalize financial firms and markets into distinct sets of activities (commercial banking, housing finance, investment banking, and insurance). This fragmentation was mirrored in government agencies, where a separate regulatory infrastructure was established for each segment of the financial system. The change also meant setting up two different insurance funds for depository institutions: one for those engaged primarily in housing finance (savings and loans) and another for commercial banks.1
Three eventful decades have now blurred the distinctions between financial markets and financial firms. Rising inflation in the 1970s and rapid advances in information and computing technology contributed to a rapid pace of market innovations that effectively dismantled the Glass-Steagall barriers, many of which were formally lifted by the Financial Modernization Act of 1999. For depository institutions, the 1980s thrift debacle and U.S. regional banking problems brought on the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, which reduced or eliminated differences in federal regulatory structures for commercial banks and savings associations but still retained a separate chartering agency for each.
With the passage of the Financial Modernization Act, the FDIC began reforming our system of federal deposit guarantees. Recently, the FDIC posted a "Deposit Insurance Options" paper on its Web site for public comment.2 Among the possible reforms described there is a merger of its Bank Insurance Fund and its Savings Association Insurance Fund (BIF and SAIF). This Economic Commentary explores that possibility with an examination of the primary arguments for maintaining separate bank and thrift deposit insurance funds. While each of these arguments may have seemed valid in the past, none is defensible today. Moreover, evidence that merging the two funds would reduce taxpayers' exposure to loss indicates that this deposit insurance reform is long overdue.3
Promoting Home Finance
The idea of separate deposit insurance funds for banks and savings associations took root in the regulatory and legislative environment of the 1930s. Commercial banking and home finance, traditionally viewed as distinct financial activities, were treated as such when the regulatory infrastructure for depository institutions was revamped. Commercial banks and savings banks were to be insured by the Federal Deposit Insurance Corporation, a federal government agency newly created by the Glass-Steagall Act. The FDIC would be independent from the U.S. Treasury (and its chartering agency, the Office of the Comptroller of the Currency) as well as from the Federal Reserve System, adding yet another player to the already fragmented federal regulatory system for banks. In contrast, the Federal Savings and Loan Insurance Corporation, created by the National Housing Act of 1934 to insure deposits in thrifts, would be a subsidiary of the Federal Home Loan Bank System.4 The System had been established in 1932 as a regulatory infrastructure for savings and loan associations under the Federal Home Loan Bank Board.
Congress created a parallel regulatory infrastructure for housing finance lenders to promote home building and ownership. Unlike the agencies for regulating banks, the Federal Home Loan Bank Board had a mandate to promote the industry it regulated.5 Promoting the housing finance industry, however, might conflict with the Bank Board's regulatory safety and soundness mandate and would certainly conflict with a deposit guarantor's duty to protect the depositor and the taxpayer from loss. …