Dedicated to Deposits: Deals, Data, and Discussion

How Much Does FDIC Insurance Cost Consumers?


How Much Does FDIC Insurance Cost Consumers?

So how much did you pay in FDIC insurance last year? If you think the answer is zero, think again. While it's true that financial institutions, not consumers, must contribute to the FDIC insurance fund, they pass those costs on to banking customers in the form of lower rates. And that raises an important question for anybody with cash in an FDIC-insured account; how much is the $250,000 in coverage costing you?

This hit home for me recently as I looked for a place to park some cash. Even a high interest savings account at online banks are only paying a little over 1% APY. But if you look for similar savings vehicles that are not FDIC insured, you begin to realize just how much peace-of-mind really costs. Here are two examples:

Non-FDIC Insured Demand Accounts

While most certificates of deposit you see advertised are FDIC-insured, there are options that are not insured. For example, charitable organizations may seek to raise funding through certificates of deposit to support the work of the organization.

AG Financial Solutions, for example, provides loans to churches looking to fund building projects. To raise money for its lending activities, it offers 30-day demand deposits and CDs ranging from 6 months to 5 years. Money invested with AG Financial Solutions is not FDIC-insured, which makes for a perfect comparison for our purposes.

As an example, the best 6-month CD rates today from an FDIC-insured institution come in at just under 1.00% APY. At AG Financial Solutions, its 6-month CD pays 2.25% APY. That spread is a significant premium to pay for insurance.

I should point out that I've never invested with AG Financial Solutions and have no affiliation with the organization. I do have friends who have invested with them for years, and they seem to prefer the higher rates over FDIC insurance.

Short-term Investment Grade Bond Funds

Another reasonable comparison to FDIC-insured deposit accounts are investment grade, short term corporate bonds or bond funds. While any bond fund presents risks not found in a savings account or CD, an investment grade rating combined with a short duration reduces both credit and interest rate risk significantly. As such, these bonds are a potential alternative to low paying deposit accounts. So how do these investments stack up to an FDIC-insured deposit?

The Vanguard Short-Term Investment-Grade Fund (VFSTX) is a good place to start. It currently sports an SEC Yield (30-day yield to maturity) of 1.78%. Of course, performance almost never tracks the SEC Yield. As interest rates rise and fall, for example, the price of the fund moves in the opposite direction. Since 1983, the fund has had a negative return in just three years. The worst year was 2008 with a return of -4.74%, followed in 2009 with the fund's best year of 14.03%. Load adjusted returns for the past 10 years settle in at 4.45%.

While the comparison of a bond fund to an FDIC-insured deposit account is not perfect, it does raise the question of just how much cash should be placed in a deposit account that is paying historically low rates.

The Takeaway

So what does all this mean? First, it doesn't mean that the spread in yields described above results entirely from the cost of FDIC insurance. The rate a bank is willing to pay on an FDIC-insured deposit depends on many factors, including the bank's capital requirements, Fed rates, and operating costs, to name a few. Second, and more importantly, whatever the cause of the spread in yields, a good argument can be made that consumers overestimate the value of FDIC insurance.

This post comes from DoughRoller.net, a popular personal finance and investing blog.



Comments
15 Comments.
Comment #1 by Anonymous posted on
Anonymous
I think the 250K limit is ridiculous.  It encourages moral hazard among banks and depositors.  I hope it returns to 100K after the higher limit expires.  People should have to take some responsibility for who they deposit there money with.  This just shows that this type of social insurance is not free.

4
Comment #2 by Anonymous posted on
Anonymous
Hate to break it to you Anonymous #1 but the $250k limit is permanent.

http://www.fdic.gov/news/news/press/2010/pr10161.html

8
Comment #3 by Anonymous posted on
Anonymous
Totally disagree with #1.  Bank and Credit Union CD's pay lower interest rates in return for safety of return of the principal.  If each person had to do a financial analysis of each bank and CU before taking out a CD, one might as well just buy the instiutuion's bonds or stocks - which is exactly what CD owners do not want to do.

Savers should not be subject to financial loss because some bank or CU mismanages a depositor's funds.

The increase to $250,000 was long overdue, and by the way is now permanet so it is not going to expire.

Also, not sure the comparisons are valid cost of FDIC insurnace. Financial institutions currently get all the funds they want for almost free from FED, so why pay much for others?  Savers are currently ****ed to bail out the debitors and the goverment's borrowing.

6
Comment #4 by Jeffry Pilcher (anonymous) posted on
Jeffry Pilcher
How do you draw a straight line between higher CD rates and no FDIC insurance? I struggle accepting that a 1.25% difference in rate can be explained by a single factor. Maybe AG pays cruddy rates on other products? And is AG completely uninsured, or are they privately insured?

2
Comment #5 by Anonymous posted on
Anonymous
Anonymos #3 your completely missing the point of #1.  Moral Hazard, banks don't have to be careful with their money when lending and depositors don't need to do research on financial strength.  Think Indy Mac, Countrywide.  Among the highest rates, but in the end it cost everyone a bunch in bailouts.

3
Comment #6 by Bancxman (anonymous) posted on
Bancxman
AG Financial Solutions cannot in any respect be compared to a bank.  It's an investment company whose activities are limited to church lending.  The CDs they offer are, in fact, similar to the uninsured investment instruments offered by GE Capital and GMAC.  They have no branch network which keeps their overhead down relative to many other banks.  They also do do not offer traditional bank services such as ATMs, credit cards, checking or consumer loans.  In short, they're playing in an entirely different league.  Moreover, #4 has the better analysis.  A lot of decisions go into pricing deposits and the interest rates banks want to pay to hold  them.  This is particularly true in the case of large banks like Citibank that are not "deposit aggregators" and tend to obtain a lot of their funds from other sources.  Furthermore, while deposit insurance is certainly a business expense, it also represents a lure to persons who want absolute safety for their money and who are willing to give up some interest to get it.

5
Comment #7 by eric2 posted on
eric2
Even in looking at purchasing individual bonds (investment grade) you can see a substantial premium vs. FDIC insured instruments.

I could buy bonds that mature in 2-3 years from a major bank, rated BBB , yielding 2.75%. The CDs from that same bank yield 1%.

I'd rather have the BBB rated bonds from a bank than commercial paper from some firm that lends to churches. Plus, the yield is higher.

Those of you in high tax states can probably find muni bonds with an even higher tax equivalent yield. I don't see why anyone is putting money in CDs today instead of bonds. If you look at the historical default risks of bonds (esp. investment grade munis), they are quite low. Not zero, but low enough that you'd do way better over time in the munis rather than CDs.

Plus, as was pointed out above, FDIC really isn't "risk free" in that it costs everyone money to operate FDIC. Now that we have bailouts it isn't even limited to bank depositors, it affects everyone. Whereas if you buy munis and the municipality has financial problems and has to raise taxes to pay back the bonds, it doesn't affect you...unless you bought bonds from your own city or county.

6
Comment #8 by cactus posted on
cactus
The article is fallacious. You can't assume that all of the difference between uninsured rates and insured rates is due to FDIC/NCUA insurance. For example, the outfits pushing those flaky deals in daily newspaper ads have very high marketing costs.

1
Comment #9 by Anonymous posted on
Anonymous
Given that the US of A is beyond bankrupt today, one has to question the value of FDIC and NCUA insurance big time.  Face it, folks, absent massive inflation this country is finished.  Most people, and this includes the sophisticates here, cannot possibly grasp being over $14 trillion in debt.  That debt is NEVER going to be paid off, and only stubborn fools believe it might be.  This country is today little more than a house of cards . . . and that includes our "insured" savings.  We are circling the drain ever more rapidly, and quickly approaching the point of no return.  You want safety?  Go into Australian dollars or even into loonies.  Shun and avoid the sick US$.   

2
Comment #10 by Anonymous posted on
Anonymous
Anonymous #3, gives an example of people not wanting to take the responsibility (a few minutes when opening an account) to look at safe & sound rates.  That's why some want increases in social insurance programs like the FDIC & NCUA.

1
Comment #11 by Anonymous posted on
Anonymous
Anonymous #3 is ABSOLUTELY CORRECT!

I believe the FDIC insurance limit should even be higher than the $250,000 limit and would be more than willing to give up a little interest to pay for the cost. 

Asking for higher insurance limits has nothing to due with not taking on personal responsibility to make certain the bank is strong.  Circumstances and varying conditions over time could cause even strong banks to fail.  Long terms CDs need to be covered by FDIC insurance period.  Some people's life savings are at stake. 

2
Comment #12 by Bancxman (anonymous) posted on
Bancxman
I would be extremely wary of suggesting that depositors bear any sort of responsibility for ascertaining the financial stability of an FDIC-insured bank or thrift.  Unless someone has an up-to-date examination report, it is almost impossible to critically evaluate the stability of a bank or thrift's loan portfolio. For example, in the 1980's a lot of thrifts looked great on paper because they over-valued their real estate portfolios. However, once examiners marked their loan portfolios to market, these lenders were found to be insolvent and then closed.  In addition, depositors are entirely without the means to detect a fraud scheme such as a check kite that might ultimately render a bank insolvent. In short, financial statements and the safety and soundness rates that are predicated on them aren't a substitute for the security offered by deposit insurance.

4
Comment #13 by Anonymous posted on
Anonymous
The cost of deposit insurance is ultimately thrust on tax payers when losses rise to high/during a crisis.  The 100K limit was enough.  If your fortunate to have that kind of money you should put it with different banks.  I guess everyone just wants a goverment handout. 

1
Comment #14 by Anonymous posted on
Anonymous
how many people in the whole United states have 250,000 to put into a bank account?
Most bank accounts pay less than the 1 year tbill. a one year cd gets about 1.05%.
what happens to the millions of accounts that are close to the minimum balance requirements of the banks? the banks are paying fdic insurance for 250k for accounts that are less than 1000$ and the costs of the insurance is passed on by the banks in the form of fees and lower interest rates.

1
Comment #15 by Anonymous posted on
Anonymous
Trust is the fundamental basis of any modern economy and FDIC insurance is solely designed to encourage consumer TRUST in the banking system. It does not protect bank assets. Remember, deposits do not cause a bank to fail; bad assets and/or management do.

Investors never hear brokerages or advisers say, "Don't worry, your losses are covered." FDIC, however, says, "if your bank's assets fail we'll cover your deposits up to this limit." It's insurance, plain and simple. The false comparison to AG is misleading at best.


 

1