The Washington PostDemocracy Dies in Darkness

Opinion Scrap the bank deposit insurance limit

Customers in line outside Silicon Valley Bank headquarters in Santa Clara, Calif., on March 13. (David Paul Morris/Bloomberg)
5 min

Lev Menand is an associate professor at Columbia Law School and a fellow at the Roosevelt Institute. Morgan Ricks is the Herman O. Loewenstein chair in law at Vanderbilt Law School.

On Sunday evening, in an effort to stem a damaging financial panic, the Federal Deposit Insurance Corporation (FDIC) overrode a $250,000 cap on deposit insurance set by Congress and committed billions of dollars to rescue uninsured depositors at two failed banks, including Silicon Valley Bank. The rescue required the treasury secretary, Janet L. Yellen, to invoke the “systemic risk exception,” which allows the FDIC to bypass the ordinary rules of bank failure when following them would have “serious adverse effects on economic conditions or financial stability.”

Editorial Board: No one should be happy about these bank ‘bailouts’

While this might have averted a run on other U.S. banks, it also reveals that the deposit insurance system is broken. At this point, the $250,000 cap is illusory. Worse, it is window dressing, part of a tale bankers and others tell about their institutions — that they are more like private businesses than public utilities — which obscures the reality of what banks do and the essential role the government plays in their operation.

The time has therefore come for Congress to scrap the $250,000 cap on deposit insurance coverage, strengthen regulatory oversight accordingly and charge banks much more for operating a government-backed deposit business. Specifically, Congress should say that when the deposit insurance fund is fully funded, banks’ deposit insurance fees go to the Treasury Department as fiscal revenue — rather than being waived as they are under current law.

In 1933, Congress created the FDIC to protect bank deposits and prevent bank runs. But Congress placed a limit on this insurance, now set at $250,000. The limit is premised on the idea that deposit insurance should protect the ordinary consumer, while leaving large, sophisticated users unprotected. Such depositors can fend for themselves, the thinking goes. Moreover, with these depositors exposed, bankers will be more careful about how they operate.

Silicon Valley Bank’s rapid collapse reveals the flaw in this theory: Large depositors are both bad at monitoring banks and perfectly capable of engaging in destabilizing runs. Meanwhile, runs on banks and bank-like entities can become contagious, posing a threat to the financial system as well as ordinary households and businesses.

The “consumer protection” theory of deposit insurance, then, is incomplete. Yes, deposit insurance provides vital protection for consumers. But so long as deposit insurance is capped, much of the nation’s money is unsound and unstable — an ever-present sword of Damocles hanging over the U.S. economy. Today, 43 percent of domestic deposit balances at American banks — totaling $7.7 trillion — are uninsured: They are above the $250,000 limit.

Sunday was not the first time the FDIC rescued uninsured depositors. The government fully guaranteed all noninterest-bearing transaction accounts during the 2008 financial crisis. And famously, in 1984, the FDIC bailed out uninsured depositors of the spiraling banking giant Continental Illinois. The government is engaged in something of a dance, in which it formally caps insurance, only to waive the cap when it actually matters, making it easier for large banks to escape from paying a fair price for their public franchise.

Adam Lashinsky: Silicon Valley is again in denial about its dependency on the feds

Scrapping the cap would serve the public interest in several ways. It would reduce the likelihood that the failure of one bank would spark contagion and panics at other banks. It would eliminate the payroll disruptions and other payment challenges, as well as bankruptcy risks, that arise when businesses and other institutions suddenly lose access to their bank balances — inflicting harm on employees and suppliers.

Insuring all deposits upfront would also simplify cash management practices for countless businesses and other institutions. The limit puts the onus on every large depositor to be an expert in bank balance sheets, loan portfolios, and interest-rate and liquidity risks. Why should auto parts manufacturers and nonprofits be expected to have this expertise? They don’t, of course — and in response, many of them try to reduce risk through expensive workarounds, such as by using third-party services, to split their balances among multiple banks and other financial institutions. But this partial fix makes what should be easy — holding money — pointlessly complicated.

There are still other benefits. Removing the cap would lessen large depositors’ incentives to flock to the largest, “too big to fail” banks, where they can count on a government bailout. It would also lessen demand for non-bank “money substitutes,” such as money market mutual funds and “repo” balances with Wall Street firms, which have proved even more unstable than bank deposits.

Sebastian Mallaby: What the Silicon Valley Bank bailout teaches us

Also, while some might say that explicitly insuring all deposits would reduce market discipline on banks, there are plenty of other, less disruptive sources of market discipline on banks, including the stock, bond and derivatives markets. Besides, many depositors likely already expect the cap to be waived.

Finally, and perhaps most importantly, fully insuring all deposits would clarify banks’ place in U.S. society and their relation to the government. The best way to understand the history and structure of our banking laws is that banks exercise delegated power — a bank charter is an outsourcing arrangement, a franchise, to issue money on behalf of the government. By making all deposits a governmental product, scrapping the cap would underscore the fact that banks exist to serve the public interest, not to privatize gains and socialize losses.