Should FDIC Insurance Limits Be Changed?

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A banking consultant interviewed in this LA Times article makes the case that the FDIC should insure all bank deposits without limit. He contends that depositors shouldn't be expected to know if a bank is in serious trouble, and he thinks the current limits just increase the chance of bank runs that lead to bigger losses for the FDIC.

There has been times when the FDIC did cover all uninsured deposits in a bank failure. The most recent example was last month when First National Bank of Nevada and First Heritage Bank failed (see press release). Another example of this for a much larger failure was mentioned in the article. This happened in 1991 when Bank of New England with $22 billion in assets failed. For this case, it appears the FDIC chose to cover all uninsured deposits to reduce the chance of a large scale crisis. But this was costly for the FDIC, and as the article describes "Congress passed a law that decreed the FDIC had to resolve every bank failure in the least costly manner to the agency's insurance fund -- which, for the most part, meant holding to insurance limits, regardless of the broader implications for the banking system."

The article also mentioned examples from Great Britain and Japan in which the governments threw out deposit limits to reduce the impact to the financial system.

Eliminating the insurance limit or at least raising it would be nice for depositors with large savings, but there is the issue of moral hazards which can be costly for society. This post at Mish's Global Economic blog makes the case that the current FDIC limits are too generous. There's a recommendation to eliminate FDIC insurance for all but checking accounts.

Note, the $100K FDIC insurance limit may increase starting in 2011. The same law that was passed in 2006 that increased limits on IRAs to $250,000 also sets a process that would raise limits based on inflation. Here's an excerpt from the 2006 press release:
The new law also established a method by which the FDIC would consider an increase in the insurance limits on all deposit accounts (including retirement accounts) in the future, but only every five years starting in 2011. Any such increase would be based, in part, on inflation.

Note, it says the FDIC will consider an increase. Hopefully, there will be some top officials in the FDIC at that time who'll be sympathetic to savers and won't be too worried about moral hazards.

For the current rules on FDIC insurance, please refer to this post, and for ways to extend FDIC insurance above $100K, please refer to this post.

Thanks to the reader who mentioned this news story in the finding the best deals post.



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