There’s a saying about banking that the key to success is to never, ever lend money to those who need it. Translated, the loans banks make must perform. That’s the business model.
Bank profits are made in the interest paid on the loans they originate. Which is why the loans must perform. One bad loan can erase the profits from 99 good ones.
All of the above is a good jumping off point on the matter of the Federal Deposit Insurance Corporation (FDIC). Some think the ceiling for FDIC-insured deposits should expand beyond $250,000 per account. That would be a mistake.
For one, it’s a solution in search of a problem. Contra the prevailing narrative in the media, banks are not prone to taking major risks. See above. They can’t. The margins in banking are so slim that there’s no incentive to take risks whether insurance on deposits is $0, or $10,000,000.
Which helps explain the second reason to avoid increasing deposit insurance: doing so would crowd out market solutions. Think about it. And in thinking about it, imagine if the FDIC were to shut its doors tomorrow. If so, it’s no reach to suggest that by the following day bank account holders would be hearing from myriad private, for-profit entities all-too-willing to insureinsure their bank deposits for a small monthly fee. If so, markets are allowed to work twice: depositors purchase the insurance they need, including cheaper insurance at the most conservative banks, and then the insurers with very real skin in the game will act as watchdogs over the banks they’re exposed to.
From there, we have to wonder whether deposit insurance warps banking and finance more broadly. Indeed, the very notion of expanding the amount that the FDIC insures per account is rooted in placating account holders who would presumably like more of their savings protected. In other words, people look out for themselves. Nothing novel there.
Still, we have to consider what might happen absent alleged policy solutions. As in what might account holders do absent any increase in FDIC insurance? For one, they might spread their wealth around a variety of different banks. Which would be fine. One could argue that it would be too precautionary in light of how conservative banks generally are, but with equity investing it’s accepted wisdom to not put all of one’s eggs in one basket. Absent federal deposit insurance, it’s not unreasonable to speculate that savers wouldn’t spread their wealth around banks and – yes – regions. Good.
After that, it’s not unreasonable to speculate that absent rising levels of deposit insurance, savers might direct more of their wealth toward money market accounts. With money as with everything else, we always must consider the unseen: what are people not doing because the FDIC insures up to $250,000 per account, and seemingly more? Government distorts, and it does here. It’s possible the banking sector is larger, and more “systemically” relevant than it otherwise might be, simply because savers know the federal government is protecting their savings.
Bill Gates once quipped, “we need banking, but we don’t need banks anymore.” Is he correct? Whether he is or not is unknowable, and one reason it’s unknowable has to do with federal deposit insurance that arguably subsidizes a bigger banking sector than might otherwise exist without it.
Which means we must not expand the subsidy through more federal deposit insurance. Not only is the latter arguably a solution in search of a problem, it creates very real problems by deforming banking and finance, all the while restraining the evolution of both.