Can Federal Deposit Insurance Avert the Next Financial Crisis?

New York, NY — The precipitous failures of Silicon Valley Bank (SVB), Signature Bank, and First Republic Bank shook the US banking industry—as well as the millions of depositors that hold money in the wider financial sector—and raised questions about who federal deposit insurance (FDI) serves. While the Federal Deposit Insurance Corporation (FDIC) has been extraordinarily successful in preventing or containing bank panics in the past, the recent crises and the “one-off” solutions that the Federal Reserve and federal agencies have engineered in each case suggest that a larger solution may be necessary to truly stabilize the US financial system.

Taking lessons from these recent bank failures, several experts have proposed FDI reforms that range widely, but all reckon with similar themes: financial stability, depositor protection, market discipline, and moral hazard. “Options for Deposit Insurance Reform to Stabilize our Banking System and Protect Depositors,” a new Roosevelt Institute brief authored by Emily DiVito, senior program manager for the Corporate Power program at the Roosevelt Institute, synthesizes this bevy of proposals to help policymakers and advocates better understand the trade-offs that each reform carries for consumers, financial institutions, and other private firms. In doing so, the brief sheds light on what reform choices say about the larger economic purpose of the US banking system.

DiVito describes three emergent schools of thought about deposit insurance reform:

• Preserve the Current System: The current FDI is mostly functioning well and as intended, and any significant changes could invite moral hazard. This approach advocates for modest tweaks—such as linking the coverage limit to the price level or incorporating temporary emergency provisions—in order to inject more resiliency into FDI.
• Expand Insurance for Certain Accounts That Could Bring Market Discipline to Bear: This approach considers the unique position of large business accounts—which are often uninsured and able to trigger destabilizing panic, but not likely to effectively monitor bank risk-taking—and concludes that increased coverage for certain types of depositors is warranted.
• Enact Universal and Unlimited Coverage: This approach maintains that US banking will be vulnerable to acute crises as long as uninsured depositors exist. To that end, this approach supports universal and unlimited deposit insurance. More fundamentally, however, this approach seeks to reckon with questions about the relationship between private financial institutions and the US government, pointing to the need for alternative public banking infrastructure.

“Independent of achieving political passage for any of the proffered proposals, policymakers would do well to wrestle with questions about the current banking system’s purpose and efficacy—and the implications that each potential reform carries. The federal government, banking and depository institutions, and most importantly, depositors and the broader economy, will be better for it,” said DiVito.