The FDIC suggests changes to deposit insurance, including increased coverage for some business accounts

Article by Jenna McNamee | May 3, 2023

The news: The Federal Deposit Insurance Corporation (FDIC) released a report covering the deposit insurance system and recommended options for potential deposit insurance reform, per a press release.

Three options, one favorite: The FDIC’s report outlines the history of deposit insurance and explains that its main roles are to promote financial stability and prevent bank runs. But the recent collapse of four US banks has put its current format under pressure. The FDIC offered three options for improving the system.

Limited coverage: Keep the status quo of the current FDIC insurance structure—the current limit of $250,000, or potentially a higher, static limit.
Unlimited coverage: Extend deposit insurance to all depositors.
Targeted coverage: Allow for various insurance limits across different account types, with higher coverage for business payment accounts, like payroll accounts.

The FDIC said targeted coverage would best support financial stability and mitigate many undesirable consequences related to the cost of the coverage. The agency made it clear that any changes to the deposit insurance system would require congressional approval.

Pros and cons for all: The FDIC outlined the strengths and weaknesses of all three options.

Limited coverage is the most tested model for deposit insurance. It also has the least impact on the Deposit Insurance Fund (DIF) and causes little disruption to other markets. But its use can cause financial instability related to uninsured deposits, which can sometimes be a large part of a bank’s funding.
Unlimited coverage would nearly eliminate the risk of bank runs and provide a clear, undisputed method for resolution. But unlimited coverage could cause banks to take outsized risks, which would fall on debtholders and shareholders to resolve. It would also have major impacts on the DIF and the assessments banks must pay into it.
Targeted coverage will prevent the disruption of businesses’ payments processes, promote financial stability in uncertain times, and have a limited impact on risk-taking and depositor behavior. However, the option lacks transparency, would cause increased funding to the DIF, and would require the purpose of accounts to be clearly specified.

All options would require some form of complementary policy tools. Some examples the FDIC suggested are increased liquidity and capital requirements, interest rate management, limits on convertibility for large deposits, and simplified account ownership categories.

The big takeaway: The FDIC’s options and preferred recommendation will cause a stir in the banking industry.

As the FDIC noted, any changes to the deposit insurance system will require approval from Congress. But a divided Congress will likely prove to be a bottleneck as the deposit insurance debate heats up again.
Regional banks will most likely continue lobbying for unlimited coverage, especially after the recent collapse of First Republic Bank. Smaller banks will argue that financial regulators played favorites by covering uninsured deposits at Silicon Valley Bank and Signature Bank. Smaller banks fear that even fully FDIC-insured customers will pull their funds if they sense any danger
Reforms to deposit insurance don’t fully address the financial instability that’s been rippling through the industry. The FDIC’s argument for additional policy tools is valid—deposit insurance alone can’t tackle interest rate risk, nor can it prevent poor management at banks or mitigate the effects of rapid communication. All financial regulators must play a part in calming the US financial system.