The Federal Deposit Insurance Corporation (“FDIC”) guarantees bank deposits of up to $250,000. Following the failure of two banks in recent weeks, regulators created some confusion among the industry and the public when they guaranteed customer deposits above this limit claiming that doing so was necessary to stem serious systemic risk to the financial system. Subsequently, lawmakers, financial industry professionals and other commentators are examining whether the FDIC limit, which has not been raised since 2008, needs to be increased or abolished altogether.
The confused puzzle works like this: On one hand, regulators’ actions send the message that deposits of more than $250,000 at an important-enough bank are safe. However, most depositors (and many lenders) believe the limit still exists and uninsured deposits remain uninsured. Finally, the third piece of the confusion puzzle is that it is unclear what makes a bank important-enough: First Republic Bank, Silicon Valley Bank's (“SVB”) similarly sized peer, continues to experience withdrawals of uninsured deposits after SVB's rescue by the FDIC and subsequent sale to First Citizens Bank.
The deposit limit was created on the theory that everyday Americans are low-information lenders. We deposit our money into a bank, unsecured, without performing due diligence on the bank's finances to make sure it is safe and sound. Knowing that deposits are backed by the FDIC’s deposit limit obviates the need for every person to become a bank analyst. One would think that larger and wealthier depositors would be more sophisticated to take the risks of losing deposits. Why should average depositors under the deposit limit care? Because bank runs by these larger and wealthier depositors impacts the small depositor. As we have seen this month, payrolls become imperiled and other banks start to falter. Opponents of raising the deposit limit or eliminating it have long argued that insuring all deposits would give banks too much license to take risky bets with depositor money, but the bottom line is that when trouble begins as it has in recent weeks, everyone starts paying more attention to the mundane subject of FDIC insurance.
